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Palomar Medical Technologies, (NASDAQ:PMTI)

Q2 2010 Earnings Call

July 29, 2010 11:30 am

Executives

Kerry McAnistan - Investor Relations Assistant

Dan Valente - Chairman

Joe Caruso - President and Chief Executive Officer

Paul Weiner - Chief Financial Officer

Analysts

Dalton Chandler - Needham & Co

Anthony Vendetti – Maxim Group

Bill Plovanic - Canaccord

Excuse me everyone, welcome to Palomar Medical Technologies Second Quarter 2010 Financial Results Conference Call. Please be aware that each of your line is in a listen-only mode. At the conclusion of Palomar’s presentation, we will open the floor for questions. At that time, instructions will be given as of the procedure to follow if you would like to ask a question.

I would now like to turn the conference over to Kerry McAnistan, Investor Relations Assistant of Palomar. Miss McAniston, you may begin.

Kerry McAnistan

Good morning and welcome to the Palomar Medical Technologies second quarter 2010 conference call. Before we start this morning's call, there are a couple of items we would like to cover. This conference call is on a recorded line and you may access the webcast replay at Palomar’s website, www.palomarmedical.com, through Thursday, August 5.

Various remarks that we make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from 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, 2009, and the company's quarterly reports on Form 10-Q, which are on file with the SEC and available through Palomar's website.

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

Joining us this morning are Dan Valente, Chairman; Joe 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

Thanks, Kelly. Thank you all for tuning into this conference call. We have made up initial -- in operating goals again for the second quarter. As you know, Palomar will be entering a new and exciting phase in achieving the company’s direct-to-consumer commercialization goal. The [indiscernible] our plans to introduce our first home product by the end of 2010. Now let’s hear from Joe Caruso, President and our CEO

Joe Caruso

Thank you Dan. As the economy remains weak, it continues to affect the aesthetic device business in the short term. However, we have seen signs of stabilization with an increase in position confidence and an increase in lead generation and demos. We have yet to see any material change in the availability of credit for our customers. Fortunately, Palomar’s products are very well positioned for these challenging times. Even in this environment, our products make economic sense to our customers due to their high reach on an investment profile and the flexibility of our platform.

We also continue to add technology in product configurations that fit into today’s economy. Our sales force has the ability to march our technology to fit not only the clinical needs of our customers but their financial constraints as well. We also benefit from a diversified business model that includes a significant portion of our revenues being derived from multiple sources. 41% of our revenues during the second quarter were generated from sources other than one time capital equipment sales.

During the second quarter, we opened an office in Tokyo, Japan. We have hired direct sales and marketing staff as well as set up people or peer capability with service technicians. This office will not only service the Japanese market but helps support our office in other Asian countries.

We continue to focus on executing our diversified strategy by addressing the professional light-based aesthetic market today, working -- driving our technology directly to the consumer market and capitalizing on the value of our extensive client portfolio. This business model has enabled us to invest more in research and development than our competitors and we will continue to do so. We experienced an increase in revenue as compared to the same period last year.

Quarterly revenue over the past four quarters has remained relatively constant indicating that we may have reached the stability point in this difficult economy. Even with this lower level of revenue, we were able to achieve good gross margins during the quarter. Average selling prices also remained stable for our products. Paul will give us more detail during his comments in just a few minutes on the financial results for the quarter.

This year at the American Academy of Dermatology meeting in Miami, we launched a new platform system called Addison. It is positioned to penetrate the ever growing skin rejuvenation market. It combines the best of our non-ablative and ablative fractional laser technologies with total facial IPL technology; this combination of technologies can be used to provide my other treatments, plutonium texture up to the more aggressive fractional ablated laser treatments for wrinkles. Physicians are able to have the multiple tools they need for an overall best in class treatment protocol depending on individual age, skin condition, potential down time, and financial constraints at even more attractive price point.

We started shipping Addison during the second quarter domestically and we will start shipping internationally in the third quarter. During the second quarter, we achieved the financial and operational goal set forth in our planning process for the year. Receivable and inventory turnover was better than our targets and product pricing was what we expected.

Operationally, we continue to execute both our short term and long term product development strategies. We will continue to monitor the economic environment and adjust as necessary; our intent is to balance our short term operating goals with our long term opportunities as we invest in research.

We have built a core competency in life based cosmetic devices and we intend on maintaining it as we navigate through this tough economic period. We also plan on investing in new markets prior to the economic turnaround to be best positioned for the next growth period. Although these challenging times could be with us for a while, we firmly believe that the long term outlet for our life based cosmetic devices remains a great opportunity.

We have made significant progress over the past few years with our plans to take our technology directly to the consumer markets. We have FDA over the counter clearances for the first at home laser for periorbital wrinkle treatment in and at home consumer hair removal product. At the beginning of the year, we announced that we will take the first steps towards commercialization of our consumer products on our own, so this is a big challenge, we are excited about the initial launch, with our in house manufacturing expertise, additional manufacturing space in our new facility and FDA clearance, we are on track to launch our consumer products on a limited basis to specific channels by the end of this year.

Manufacturing scale-up is in process, our first target is into the specialty retail market. The specialty retail markets includes potentially selling through televised shopping programs, specialty retail outlets, the internet and (inaudible) positions. We will first build a basis business in those channels before expanding into the boarder markets.

We have completed our launch strategy for our consumer products and now we are in the process of fine tuning our message and branding strategy. Having full control over the initial introduction of our consumer products will enable us to build a core expertise in a market that we do not address today; this is a great opportunity for us as we build the business and fill these new channels, once we establish the presence in these channels we will be able to develop and launch a number of new products.

Our entry into the consumer markets is one of our core strategic initiatives. We understand that entering into the consumer market is not going to be easy in the short term, however, we believe that our efforts will be worthwhile in the long run and the consumer markets can substantially increase our business and increase the value of our technology and brand. This is a new business for us, and as such we expect many challenges along the road in the consumer market, but we are well positioned to deal with those challenges and my management team is enthusiastic and prepared to do whatever it takes to make this a success.

We firmly believe that one day in the not so future distant future light based aesthetic treatments at home will be the standard. Palomar will be well positioned to exploit this new opportunity because of the investments we are making today; we continue to execute our intellectual property enforcement strategy. To date, we have received over $85 million in growth repayments from this portfolio.

Last year the US Patent Office issued a reexamination certificate and certificates for our hair removal patents confirming the validity of the claims in those patents. All in these successful reexaminations, the court restarted our lawsuits against TN dollar and separately against [Ceneron]. We believe we are in a stronger position now than prior to the reexaminations, we expected to go to trial against TN dollar by the end of 2011.

In the short term, our business, like many others is being affected by the down turn in the overall economy. Over the years, we have successfully built our business and accumulated the assets needed for a continued growth. We are expanding our product portfolio in a professional business, we remain focused on investing in the long term through research and development, and we’ll continue to strengthen our intellectual property position.

We are working on penetrating the very large consumer products markets with our first products in the near term. When economic prosperity returns, we believe we will be one of the best positioned companies on our space. Now Paul will brief us on the financial performance for the quarter.

Paul Weiner

Thank you Joe. Revenues for the quarter were 16.6 million as compared to 15 million for the same quarter last year, a 4% increase. Product and service revenues for the quarter were 13 million as compared to 12.1 million for the same quarter last year, an 8% increase and product revenues excluding service was 9.2 million as compared to 8.3 million, an 11% increase.

66% of product and service revenues were in North America and 34% were outside North America, this compared to the year ago quarter of 60% product and service revenues in North America, and 40% outside North America. Comparing second quarter 2010 to second quarter 2009, North American product and service revenues increased 1.3 million or 19%, and international product and service revenues decreased 400,000 or 9%.

Royalty revenues remained consistent at 1.3 million as compared to the year ago quarter. Other revenues include 1.25 million quarterly payment from TNG related to the non-exclusive license to televised technology and patent portfolio in female consumer life based hair removal.

Products in service gross margin was 63% this quarter as compared to 57% for the same quarter last year. As a percentage low life product and service revenues, product and service gross margin was positively affected by higher product revenues which resulted in higher overhead absorption, our cost containment initiative in product mix. Gross margin was also positively affected by an increase in North America, product and service revenue as a percentage of total product and service revenues. That’s North America’s sales [inaudible] and customer as compared to international field as lowest distributor [indiscernible].

Average selling prices continue to remain stable, research and development expense for the quarter was 3.6 million as compared to 3.1 million for the same quarter last year. Research and development as a percentage of total revenue was 23% this quarter as compared to 21% for the same quarter last year.

Selling and marketing expense for the quarter was 4.9 million as compared to 4.7 million for the same quarter last year, selling and marketing as a percentage of total revenue was 31% this quarter as compared to 32% for the same quarter last year. General and administrative expense for the quarter was 3.4 million as compared to 2.2 million for the same quarter last year. General and administrative expense as a percentage of total revenue was 22% this quarter as compared 15% for the same quarter last year.

G&A expense this quarter concluded $704,000 in part litigation costs. That’s compared to only 179,000 for the same quarter last year, we estimate part litigation cost of between 1 million and 1.5 million per quarter throughout the rest of 2010. We estimate additional cost over last year related to commercialization of consumer products expense, of between 1 million and 1.5 million per quarter throughout the rest of 2010. Loss before taxes this quarter was 1.7 million, that’s compared to a loss before taxes of 266,000 for the same quarter last year.

We incurred additional cost over last year of $500,000 in part litigation expense, and 1.5 million in consumer commercialization spending.

Net loss this quarter was 1.7 million or $0.9% per share as compared to a net loss of 244,000 or $0.1% per share for the same quarter last year. The balance sheet is solid with cash, cash equivalent and short term investments of 102 million and no borrowings. We have been successful in maintaining lower accounts receivable days outstanding of 27.

We are now ready to take your questions; operator.

Question-and-Answer session

Operator

Thank you Sir. Ladies and gentlemen, at this time we’ll open the floor for questions. (Operator instructions). Our next question comes from the line of Dalton Chandler; please proceed.

Dalton Chandler - Needham & Co

Good morning, I was wondering if you could comment on the launch of the Addison product maybe in the level of interest you saw in that product compared to Silver Starlux.

Paul Weiner

It’s really two different segments of the markets Dalton. We’ve got a lot of interest in the Addison because it really gets right on point on the particular segments of the overall aesthetic light-based device markets, it’s really geared towards all the tools that one needs in order to do a great job on skin rejuvenation, whether it be a patient that is interested in very mild treatment or one that is interested in a very aggressive treatment, and the reason that we developed that system was because in this economy we found that a lot of physicians were making choices in technology picking one particular technology where they really needed two or three different technologies to treat their patient base.

So it’s a great product for those physicians that want to really focus on skin rejuvenation and extend their business in skin rejuvenation areas. Compared to Starlux, Starlux is in all inclusive platform that can grow with the physician’s business; it includes many more things other than skin rejuvenation, so someone that might be interested in a full platform is more interested in the Starlux versus someone that may have a different hair removal system, or they may have something for acne or they may have something for skin tightening and really want to round out their skin rejuvenation process that’s an Addison sale; so it really works well depending on which segment sales people focus on.

Dalton Chandler - Needham & Co

I guess am not clear on why a physician would want to focus specifically on skin rejuvenation to the exclusion of all the other aesthetic procedures they could be doing.

Paul Weiner

It’s not that they want to only do that but they might have already purchased the skin tightening system for instance, or they might have a different hair removal system, or they might have a platform for instance they might have a Starlux platform in part of their practice and they want to extend their skin rejuvenation part of their business but not necessarily some of the things that Starlux does and the rest of it does not. So it really is a good sub-platform for that particular group of treatment, and that particular group of treatments is one of the fastest growing in all of the segments.

Dalton Chandler - Needham & Co

Okay, turning to the consumer product, you’ve mentioned many times you expect to have it from the market by the end of the year, but would you expect to have it on early enough to capture some of the holiday selling season?

Paul Weiner

Our goal is to have to have it on the market to capture that how much of that will influence the purchase, we are not sure yet. Is it driven by a particular time of year or is it driven by a broader need. And we think that it will be a system that is just not sold during the holiday season even though we will be on the market for that time period. We don’t think it will be able -- sales will be able to influence because it will be a gift item for instance.

Dalton Chandler - Needham & Co

Okay, and just a final question I noticed that your service margins are actually better than your product margins in the quarter; that’s pretty unusual. Can you comment on how that happened?

Paul Weiner

Yeah we are just -- it depends on the quarter. We just happened to do well as far as contracts coming in and available service in that particular quarter and it depends on timing as far as when the hand pieces are replaced as far as the IPL hand pieces. Also obviously we have had the fire out there for a while now and it is possible; one time it is possible to this fire -- really starting to kick in and should continue to kick in as quarters progress so over time, we’ve been having more and more of our revenues come from the reoccurring revenue side of our business as Joe had mentioned now 41% of our revenue will be coming from that side as opposed to just the one time product sales of the capital equipment.

Joe Caruso

Yeah we have always had a pretty good margins because our products are very reliable but the business over the past couple of years has transitioned from a traditional service contract business to one where some of the reoccurring revenue and disposable revenue are really starting to kick in now and that’s obviously at higher margins; margins close to if not exceeding the margins that we have in the regular capital equipment business. So we have done in groups especially research development and manufacturing groups have done great jobs in looking at that part of the business as a little bit differently than a tradition capital equipment manufacturer.

Dalton Chandler - Needham & Co

Okay, thanks a lot.

Operator

Our next question comes from Anthony Vendetti of Maxim Group. Please proceed.

Anthony Vendetti – Maxim Group

Sure thanks, good morning.

Joe Caruso

Good morning

Anthony Vendetti – Maxim Group

I just wanted to clarify; did you say that the trial with Candela should be by the end of 2011? Has a date been set or is that just right now your best estimate?

Paul Weiner

We don’t have a date -- yet final date so that is an estimate that we have out there. I think the next stage of this enforcement action is some revetments which will happen soon and hopefully we will have a date very soon.

Anthony Vendetti – Maxim Group

Okay, and just a follow up on the disposables. Is that about 5% of your revenues now or still less than 5% but growing?

Paul Weiner

We don’t break that out. But it is slow overall but relatively small percentage but growing at a higher margin. So it does affect positively our margins, but we don’t break that out publicly.

Anthony Vendetti – Maxim Group

Okay, and how about the core and noncore breakout this quarter?

Paul Weiner

46% core 54% noncore

Anthony Vendetti – Maxim Group

And I just want to go over these numbers. So the second quarter did you say the investment in the home based product was 1.5 million this quarter and you expect it to be 1 to one and a half million every quarter for the rest of the year?

Paul Weiner

Yeah, the 1.5 million more in our spending in the second quarter of 2010 over what we spent in the second quarter of 2009.

Anthony Vendetti – Maxim Group

Okay.

Paul Weiner

So when you do and compare it as far as year-over-year comparatives, we have an additional $1.2 million that affect our bottom-line as compared to what we had in the same quarter a year ago, and we will anticipate that that 1 to 1.5million in additional spending as we continue each quarter through out the rest of this year over above what we spent in the prior year.

Anthony Vendetti – Maxim Group

Okay, and you mentioned Paul that North America was up 19% year-over-year is that correct?

Paul Weiner

Yeah I think it is 18% 19% year-over-year, I guess.

Anthony Vendetti – Maxim Group

Okay, and what about -- do you have that number sequentially what it was up?

Paul Weiner

Sequentially, I don’t have. They were some 7.3 million to 8.6 million.

Anthony Vendetti – Maxim Group

Okay, and in terms of the credit markets is it tight loosening up a little bit, are some of the leasing companies are you seeing trying to dip their toes back in? Are you working with any large banks? How is that evolving this quarter versus first quarter?

Paul Weiner

You know we’ve been stating since the middle of last year and we saw that the financing was certainly was tough and it was getting tougher all along around the middle of last year it pretty much stabilized. As far as financing was regeneration and revenue was certainly a comeback from the close. But the financing as of now is still tough. We haven’t seen any indications that it’s getting looser. We haven’t seen it getting any tougher either which is good.

But we haven’t seen a clear indication that it is getting easier to get credit. But certainly the doctors are out there, it’s been the longest period of time and they are looking for different ways in order to get financing because this equipment really helps them with their return on their business. So they are trying to find different ways to get these products financed but the leasing companies themselves aren’t loosening too much on credit.

It’s more that the doctors are adjusting and adapting to the environment and they are figuring out ways to get it done because they know that they can make money with this type of equipment. But it’s not so much that we see a change in the supply but we do see a change in how the doctors are approaching the problem.

Anthony Vendetti – Maxim Group

Okay, and Joe maybe you can just give a little more color on how you expect to roll out this home based product since it sounds like here like you just need to fine tune the product launch and so forth. Is it specialty retail stores first? Will it be the internet first then QBC home shopping type network QBC or something like that?

Joe Caruso

We have our strategy; we haven’t announced it publicly. The strategy is done. The branding and the marketing approach is basically done as well. So we are in the stage where we are ramping up our manufacturing as you might expect you have to build a number of these units to be able to fill the channels that you go into. One thing I can tell you is that we will do it somewhat sequentially; we won’t be in all channels at once on day one but we will have a rollout strategy that will move them up with the channels.

Anthony Vendetti – Maxim Group

Okay, and our physician offices still part of that potential channel?

Joe Caruso

Yes that is correct.

Anthony Vendetti – Maxim Group

Okay. Did you have any negative impact this quarter from FX?

Paul Weiner

Yes. There is a $100,000 from Australia subsidiary [indiscernible] company, non cash

Anthony Vendetti – Maxim Group

Correct, you don’t do any hedging. So it was just $100,000 negative this quarter?

Paul Weiner

That is correct.

Anthony Vendetti – Maxim Group

And internationally where are you seeing the most strength and where are you still seeing the greatest weakness or the best opportunity to see an improvement by the second half of the year?

Paul Weiner

It really varies by quarter -- just standing -- falling historically. In this particular quarter Europe was actually flat to up a little bit and the rest of the world outside of North America was actually down. Last quarter it was the opposite so the quarter is really big depending on when to passed deals come in. Just as Joe had mentioned, we just opened up recently an office in Tokyo so we would expect Japan to get a lot stronger in the second quarter half of this year and going to next year and we’ve implemented some strategies to within the rest of Asia to second those countries as well going into next year.

Anthony Vendetti – Maxim Group

Okay. And just to verify lastly Addison was launched and started shipping in the second quarter and you expect to start shipping internationally here in the third quarter is that correct?

Paul Weiner

Yeah, depending on regulatory clearances in different countries internationally that’s going to start shipping whether that is going to start in some countries in the third and then the rest in the fourth and we started shipping that product at the very end of this second quarter in North America.

Anthony Vendetti – Maxim Group

Perfect. Thanks very much.

Paul Weiner

Thank you.

Operator

Our next question comes from the line of Bill Plovanic of Canaccord. Please Proceed.

Bill Plovanic - Canaccord

Good morning sirs. Just a couple of follow up questions. So the disposable as a percentage revenue is it over 10% that you have to start disclosing the amount?

Paul Weiner

I don’t think so. It is separated from the products within the service. Once -- it is included in the service line and it hasn’t reached that level yet.

Bill Plovanic - Canaccord

Okay. And then once it is over 10% of total revenues, you would probably have to disclose that. Is that correct?

Paul Weiner

Yes, and we would look at possibly disclosing it.

Bill Plovanic - Canaccord

Okay, and then you mentioned that the home based investment was up a million though year-over-year. How much did you spend in Q2 09 on that product?

Paul Weiner

It’s up a million five year-over-year and we don’t disclose the exact spending [indiscernible] professional.

Bill Plovanic - Canaccord

Okay

Paul Weiner

That 1.5 includes the revenue that we might have received last year in expenses. I did not receive a reinvestment for [indiscernible] and research funding and obviously our commercialization expenditure and manufacturing expenditures. So last year we were getting funding which was positive for our revenue line and we were obviously spending money on research and development side. This year we have spending in the ramping up in the manufacturing and the commercialization.

Bill Plovanic - Canaccord

Okay. And then if any color on your direct OPS OUS, the Japanese subsidiary. How many people do you have out there, how many reps? When were they trained? So that we can get a feel for the type of contribution they’ll start making through the back after the year?

Paul Weiner

It totals about eight people out there including administration and sales marketing and service. So there are about eight people out there and there is not a lot of operating expenses that is going to negatively affect our operating line. But it should surely over the coming quarters positively affect our top line.

Bill Plovanic - Canaccord

Got you. And then again -- I think actually that was all I had. Thank you very much.

Paul Weiner

Thanks

Operator

(Operator instructions) A follow up question from the line of Anthony Vendetti from Maxim Group; please proceed.

Anthony Vendetti - Maxim Group.

Sure, I think I didn’t ask enough questions so I had one more. Do stock base -- broken out from cost of goods sold down to R&D and sales marketing G&A.

Paul Weiner

I don’t have a break up by line. It totaled about 957,000. In the total[indiscernible]. If you want the detail by line, I can get you that out.

Anthony Vendetti - Maxim Group

Sure, no problem. Thanks Paul.

Operator

With no more questions at this time, I would now like to turn over the call to DanValente for closing comments.

Dan Valente

Thank you operator. I hope we answered your questions as directly and clearly as possible. Thanks for tuning in and we look forward to seeing you at our next call. Thank you

Operator

This concludes Palomar second quarter 2010 financial results conference call. Thank you for attending. You may now disconnect at this time.

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