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Obagi Medical Products, Inc. (NASDAQ:OMPI)

Q1 2010 Earnings Call

May 06, 2010 09:00 am ET

Executives

Ina McGuinness - IR

Steve Carlson - CEO and President

Preston Romm - CFO

Analysts

Anup Mehta - Canaccord

Larry Neibor - Robert W. Baird

Aaron Mishel - Thomas Weisel Partners

Scott Henry - Roth Capital

Jose Haresco - Brean Murray

Operator

Greetings and welcome to the Obagi Medical Products first quarter 2010 earnings conference call. (Operator Instructions). It is now my pleasure to introduce your host Ina McGuinness. Thank you Ms. McGuinesss you may begin.

Ina McGuinness

Thank you, operator. This is Ina McGuiness of ICR. Earlier this morning Obagi Medical Products released financial results for the first quarter ended March 2010. If you have not received press release it is available on the investor relation section of the Obagi Medical Products website at www.obagi.com.

This call is being webcast and a replay will be available on the company’s website for 30 days. Before we begin we would 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 the information provided in today’s call is as of the date of the live broadcast, Thursday, May 6, 2010, 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. Steve.

Steve Carlson

Good morning everyone and welcome to our conference call. We are very pleased with our first quarter results which demonstrates continued solid sales trend with revenue growth nearly 14% to $25.7 million and net income nearly tripling to $1.9 million or $0.09 per share year-over-year.

Our strong performance during the first quarter validates initial signs of a slight economic recovery and a promising potential future of the broader esthetic market. As a result of improving consumer confidence and new marketing initiatives almost all of our product lines achieved high double digit sales increases.

We are encouraged by the progress we made on both international and domestic fronts and believe our investments in high quality products with proven subsidiary efficacy will continue to cause patients at the Obagi systems and products is better and much more affordable option for their skincare and more highly price procedures.

With that as background let me review our first quarter performance by geographies and product lines. Our international revenues for the first quarter increased approximately 17% year-over-year to $4 million fuelled by robust growth in the far eastern Europe. Our new distribution partner in Japan Cutera commenced shipments to Japan in February and we are pleased with the initial results.

Licensing fees for the quarter were up 30.3% to $989,000 due to timing of new product releases through our Japanese consumer partner Rohto Pharmaceuticals. Sales from our US business increased 13.1% to $21.0 million year-over-year. During the quarter we also added 387 new domestic accounts, an increase of over 11% compared to 350 million accounts in the previous quarter and yet an 18% increase from 329 accounts a year ago.

As of March 31 we had 6367 active accounts at 10% increase from a year ago. Our performance price specific product lines were as follows. Nu-Derm, Condition & Enhance had an increase of 8% versus a year ago with sales of $12.9 million for the first quarter. Reorder rates for Condition & Enhance were high at 81%. Sales of our vitamin fee based systems and products which included Obagi-C Rx and Professional-C increased nearly 52% to $4 million year-over-year. This strong growth was attributed to the introduction of two new skews in the CRX line which helped increased both the efficacy and the overall awareness in growth vitamin C based products.

ELASTIderm which includes Eye cream, Eye Gel and Decolletage grew 32% to $2.8 million for the first quarter. Reorder rates for both Eye cream and eye gel were high at 89% and 79% respectively. Sales from our therapeutic products which includes CLENZIderm and Rosaclear decreased 40%, $1.6 million compared to the same quarter a year ago. This decrease was primarily attributed to large stocking orders of Rosaclear a year ago due to the products lines in the first quarter of 2009.

Much of this we have seen with other therapeutic products, the acceptance of these products and the build of repeat sales are slower than with the launch of our esthetic products. Reorder rates for CLENZIderm however were strong at 89% and the initial reorder rates for Rosaclear were pretty good at 70%.

Other product categories were up 37.8% year-over-year primarily due the addition of Refissa, our new Tretinoin in the third quarter of last year. Reorder rates for Refissa were 65% for the first quarter. Regarding our sales organization we now have about 117 sales people in United States. This is down 1 from the last quarter and up 3 from a year ago excluding the [Nesari] contract sales force.

Looking for the remainder of 2010, we are conservatively optimistic about opportunities ahead of us and we will manage our business forecasting expenses accordingly. We are on the right track with our marketing initiatives to expand our account base, improve patient retention and increase our international presence while leveraging our strong Obagi brand equity.

We have a strong pipeline and planning to introduce two new products again this year. As our business and market continues to improve, we believe that Obagi medical products is well positioned to capitalize on the global opportunities for our products and expand our customer base and market leadership.

And with that I’d like to turn the call over to Preston.

Preston Romm

Thanks Steve and welcome everybody to the call. As Steve said we are very proud of our financial milestones achieved during the first quarter. Our sales are $25.7 million marked the highest revenue quarter for the first quarter in our history. The increase was primarily attributable to improvements in the economy and willingness of consumer suspenditiy esthetic space along with the success of our promotional activities.

This quarter is particularly pleasing as it comes on the heels of an extremely strong fourth quarter. Also as a reminder, on January 1 we implemented a price increase approximately 4% on those products. This is our first price increase in two years. In spite of legal expenses we incurred during the quarter our net income almost increased 200% year-over-year to $1.9 million or $0.09 a share compared to $645,000 or $0.03 a share a year ago.

Our operating metrics for the fourth quarter were as follows: Gross margin improved to 79.2% from 77.6% a year ago due primarily to writing off $400,000 of (inaudible) related inventory in the first quarter of 2009. Total operating expenses for the first quarter 2010 were $17.2 million compared to $16.6 million a year ago. This increase was primarily attributable to higher variable sales expense and legal fees. During the first quarter we incurred approximately $700,000 in legal fees associated with our current litigation, we anticipate spending slightly more in the second quarter. We are going to vigorously defend ourselves against these claims and actions and although the timing cannot be predicted we will incur legal fees until this is resolved.

Our operating income for the first quarter 2010 more than tripled to $3.2 million or $1 million a year ago. Operating margin increased to 12.4% from 4.4% a year ago validating the success of our continuous focus on achieving operating efficiencies. We ended the quarter with the strongest balance sheet in our history, cash, cash equivalents the short term investments totaled $39.8 million compared to $36 million as of December 31, 2009.

Working capital increased to $59.6 million compared to $57.1 million as of December 31, 2009. Additionally we generated free cash flow from operations of $4.1 million for the first quarter. Now let me provide you with our guidance for the second quarter and total year. Based on current trends and anticipated legal fees, we expect the second quarter 2010 net revenue to be in the range of $26.5 million to $27.5 million and fully diluted earnings per share to be in the range of $0.15 to $0.17.

For the total year we are reiterating our previous guidance and revenue between $108 to $112 million and earnings per share between $0.67 and $0.71.

Now, I’d like to open the call to questions operator.

Question-and-Answer session

Operator

Thank you. (Operator Instructions). Our first question is from David Amsellem with Piper Jaffray. Please proceed with your question.

Unidentified Analyst

Hi this is actually (inaudible) for David. Just seeing pretty good account growth and wondering what you consider to be a sustainable level going forward and what percentage of the potential customer base, do you think has been penetrated at this point? Thank you.

Steve Carlson

I think there is two parts to that and I appreciate your question. And I think if you go back and look at, as we indicated on the call, we've been running in the mid 300s to the low 400s for the last three to four quarters and we certainly believe that is sustainable. One of the initiatives is that we've also indicated is to really look at the new account growth going forward and if we break up kind of the percentage of the physicians by segment you know we've indicated previously that we do business with 50% some of the plastic surgery base of the total dermatology community or a little more than 10 or 11% and as we look at the opportunities and internal medicine, gynecology and other family practitioners that are turning to esthetic health care for the patients we are just scratch so we think there is a lot of opportunity and potential going forward with our marketing initiatives. Preston do you want to add anything to that?

Preston Romm

One other thing I would add to that is we also measured churn rate and although you can back into the number we don't publicly say what it is but it has been relatively high as we went through 2009 and exiting 2009. What we call churn is someone who has not (inaudible) in a year. So you go back a year ago from Q4 of '09 and little bit of Q1 of 2010 and you saw a number of doctors either joining other practices or medi-spas going out of business. So we expect that number to improve as we go through the second half of 2010. So the accounts we are adding will be probably getting a larger increase year-over-year of active accounts.

Operator

Thank you. Our next question is from Anup Mehta with Canaccord. Please proceed with your question.

Anup Mehta - Canaccord

Could you comment at all about your initiatives that you have mentioned in the past. Can you talk about the PDS system as well as any programs that your end development on in terms of patient retention.

Steve Carlson

I think we can comment on some of them. As you know and we've discussed this in previous calls we added sometime ago an internal sales organization which we call practice development specialists and that organization is of eight - nine people to date and they assist with our lower level accounts and our (inaudible) end our outside field sales. We are early days of new marketing initiatives to look at. How do we most cost effectively and productively expand our account base and as Preston touched on that account retention and that patient retention are also important variables as we look to future growth but its really early days as we are evaluating and testing various programs at this time.

Anup Mehta - Canaccord

Okay and have you had any redevelopments in terms of the partners internationally.

Steve Carlson

Nope again. International distribution is one of those learning curves you go through and each country has a different set of both opportunities and challenges to those. We are very pleased with the success we are making on the international fronts. We are very pleased with the amount of information and the landscape that we are able to have going forward. Its premature to speculate when we will announce new geographies and new distribution agreements.

Anup Mehta - Canaccord

And then could you just go over some of the reorder rates for me again. I think I've got to rethink your last term and then you mentioned CLENZIderm, Rosaclear and Refissa. Could you just give us the numbers one more time.

Steve Carlson

Yeah CLENZIderm was at 89%, Rosaclear was at 70% and Refissa was at 65% for its initial first quarter.

Anup Mehta - Canaccord

The guidance for the full year, so that’s $0.67 or $0.71, I just want to may be clear that does not exclude your expectations for legal expenses going forward and we should consider it as a $700,000 expense quarterly going forward.

Steve Carlson

Well certainly for Q2 that's what we are saying. Anything beyond Q2 we are not going to comment on because as you know these things are pretty fluid. The total year guidance and again we are reiterating what we said before but it would include legal fees for Q1 and Q2 in that number.

Operator

Thank you. Our next question is from Larry Neibor with Robert W. Baird. Please proceed with your question.

Larry Neibor - Robert W. Baird

Can you give us some idea of what part of your growth came from physicians who have been with you for more than a year versus the new account pickups you had in the past year.

Preston Romm

At this point in time we that's more detailed from a competitor standpoint, then we are prepared to shared. I think we have a good balance between new accounts and actually existing accounts that are more than a year with us that have shown growth and I think as we've discussed before we are seeing that improvement in the economy. We are hearing and seeing much as other set of companies, for traffic has come up certainly from a year ago. There is a greater consumer confidence to go back and take care of your skin care.

Larry Neibor - Robert W. Baird

And can you give us some idea of how much [wells] were pulled into the December quarter due to the planned January price increase?

Steve Carlson

We saw what we've historically seen with price increases as it relates to pull in or pull through and pulling forward and I guess Preston indicated on the call having the level of first quarter that we did was really a strong performance given historical pull forwards of price increases.

Larry Neibor - Robert W. Baird

Right. Finally the 17% increase in sales outside of the US would you expect that to be consistent pattern through 2010 or were there unusual shipments that helped in the first quarter?

Steve Carlson

I think international has a dynamic and we've indicated before we don't guide on breaking out domestic firm international growth for future quarters.

Operator

Thank you. Our next question is from Aaron Mishel with Thomas Weisel Partners. Please proceed with your question.

Aaron Mishel - Thomas Weisel Partners

Hi a few on therapeutic if you strip out the Rosaclear stocking from the year ago quarter what was the year-over-year growth rate in therapeutic?

Preston Romm

Yeah I don't have it Aaron at the tip of my fingers, I would say its relatively flattish to up a little bit may be single digits, but I am kind of making an educated guess on that I have to get back to you.

Aaron Mishel - Thomas Weisel Partners

And then what was the Nu-Derm reorder rate in the quarter.

Steve Carlson

We didn't break out Nu-Derm but the condition in (inaudible) which is an important part of combination and some procedures was that I believe 89% Nu-Derm was at 81% (inaudible).

Aaron Mishel - Thomas Weisel Partners

And then on the Vitamin C what were the new skews and is the Q1 number a good kind of run rate going forward or was there some stocking revenue there?

Steve Carlson

We introduced skews as a replacement from the C Rx System the most prominent one was a new counter that actually enhanced outcomes as we saw from sort of evidence from a clinical study and so we certainly as we have in the past got excellent distribution of those new skews and greater awareness of the overall Vitamin C line which helped us pull that up. Again we don't guide and break out going forward segments for future quarters.

Operator

Our next question is a follow up question from Anup Mehta with Canaccord. Please proceed with your question.

Anup Mehta - Canaccord

Just two more questions could you give me that ELASTIderm revenue number one more time.

Steve Carlson

$2.8 million.

Anup Mehta - Canaccord

2.8, and then the second question I am going to push a little bit on this one. You maintained your full year guidance of $108 million to $112 million. And despite the fact that you put up an excellent quarter and the seasonally softest quarter of the year what is it that you think you are cautious about the full year, why don't you lease bring up numbers a little bit based on the performance in the first quarter?

Preston Romm

We want to see how Q2 goes. There is still some uncertainty out there although we are feeling more bullish now than we did in the beginning of the year and certainly our sister companies in the esthetics space are saying the same thing but this last couple of days things happening in the Gulf and things happening at Times Square kind of make you pause to see if there's going to be another shoot dropping or not. So we just want to see another couple more months go through.

Operator

(Operator Instructions). Our next question is from Scott Henry with Roth Capital. Please proceed with your question.

Scott Henry - Roth Capital

I apologize I got on the call late as I've couple of calls this morning so I hope I am not repeating any questions. But the first question I guess for Preston is that cash and cash equivalents starting to reach a pretty good number closing in on $40 million still strong off a lot of cash, any thoughts what you want to do with all that money certainly not a bad problem to have.

Preston Romm

Well we do have thoughts and we discussed it fairly often and as both management team and with the board we don't view that as our money. We view it as shareholder money. So we want to put to work for the shareholders in some accretive manner. Other than that I won't tell you what the specifics are that we are debating about, but we want to put that money to work some time this year.

Scott Henry - Roth Capital

Would you consider a dividend or just largely just waiting for the right opportunity and I like the fact that you used the work accretive.

Preston Romm

We would consider all the above.

Scott Henry - Roth Capital

And then I don't know, I think you touched on a little bit but any color, are we still looking for two new product launches this year any color on the timing or what they may be?

Steve Carlson

(inaudible) is indicated did probably nurse it in opening remarks we still believe we have a very strong pipeline and intend to launch two new products this year.

Scott Henry - Roth Capital

Okay and final question I know you touched on the legal side of SG&A which sounds like that impacted Q1, you give a specific number on how much it impacted Q1 anything else in the SG&A line moving that number?

Preston Romm

Well couple of answers, we said it was around $700,000 of legal fees in Q1. We also said that we would expect the same or slightly higher number in Q2, nothing beyond Q2 was stated and also we had some variable selling expenses in the quarter.

Operator

Our next question is from Jose Haresco with Brean Murray. Please proceed with your question.

Jose Haresco - Brean Murray

I am sorry if I missed this what was the amount that could have been attributed to the litigation in the first quarter again?

Preston Romm

Around $700,000.

Jose Haresco - Brean Murray

And we should just assume that for the second quarter as well. One thing that I noticed that Vitamin C and elasticity grew at kind of astonishing rates in the quarter. Just off hand it seems to tell me that people are willing to spend a little bit more on what you call the non core perhaps non maintenance products. Is that a fair conclusion to make.

Steve Carlson

Jose I would characterize in couple of different ways. One, as we have new account growth, we are getting great breadth to end depth with those new accounts and so we are seeing some benefits in Vitamin C in ELASTOderm. I think secondarily Vitamin C and ELASTOderm are frequently added to Nu-Derm as part of more of an ongoing maintenance for prevention system. So I think you need to think of them as I know these are the add on products after Nu-Derm condition and people look to, to get that incremental benefit and or to maintain the outcomes they've got.

Jose Haresco - Brean Murray

Are we seeing any regional differences and you said things are getting incrementally better are you guys seeing anything in terms of the geography both domestically and internationally where you are seeing particular strengths or weaknesses as we kind of go through this slow recovery in the aesthetic markets?

Steve Carlson

I don't think there's a specific geographical location dramatically better or stronger growth what we are seeing is a pretty good balance and we are seeing pretty good balance as we look at the international markets and as we indicated previously we saw strong growth in Australia, Far East. Canada. That's a pretty good price factor I have various geographies to see nice growth in.

Jose Haresco - Brean Murray

And just lastly on the gross margins they've been still tracking at the 79% level is that a fair number for us to think about as we go through the year or should we think about it as up or down just because of the seasonality.

Preston Romm

I think that's probably a fair number as we go through the year, something from the 79.0, 78.8 up to an 80.1 but I think that's probably a fair number to the whole study for good.

Operator

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

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