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SonoSite, Inc. (NASDAQ:SONO)

Q3 2010 Earnings Call Transcript

October 21, 2010 4:30 pm ET

Executives

Kevin Goodwin – President and CEO

Marcus Smith – SVP and CFO

Analysts

Alan Robinson – Royal Bank of Canada

Evan [ph] – JP Morgan

Operator

Good day, everyone, and welcome to the SonoSite third quarter results conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I’d like to turn the call over to Mr. Kevin Goodwin. Please go ahead, sir.

Kevin Goodwin

Thank you, operator. And good afternoon to everyone on the call. This is Kevin Goodwin, President and CEO of SonoSite. And along with me today is Marcus Smith, our CFO.

This conference call contains certain projections and/or forward-looking statements regarding future events or the future financial performance of the company. And except for historical information discussed during the conference call, the statements made today contain forward-looking statements that involve substantial risks and uncertainties.

Actual results could differ materially because of the risk factors listed in the Management Discussion and Analysis section of the company’s 2010 Form 10-K and in other filings and reports with the SEC. We do not undertake any duty to publicly update any forward-looking statements.

All right. On the call today, I will cover our financial performance for Q3 2010 and the first nine months of 2010. I will then move on to discuss some forward-looking initiatives, opportunities, and wrap up with our outlook for the remainder of 2010.

I’ll start off with revenue for the quarter. Revenue came in at $68.5 million, up a solid 28% versus 2009 Q3. VisualSonics, which we acquired in Q2, recorded $8.7 million of this revenue. Excluding VisualSonics, revenue was up 12%, representing yet another quarter of double-digit growth. Our US revenue was up 17%, our international revenue was up 7%, and the newly acquired VisualSonics revenue was up 30% organically year-over-year in the quarter.

Looking a little deeper into the revenue compared to last year’s Q3, US hospital revenue was up 13%, enterprise revenue was up 32%, and that includes the non-recurring charge to revenue of $813,000. Stabilization in Europe and a 15% increase in Asia-Pacific resulted in strengthening overall international sales. And changes in currency had a minimal impact on Q3.

Now moving over to the first nine months of 2010. Revenue was $186.1 million, up 18% from the prior year’s nine months. Revenue from VSI was $8.7 million. Revenue excluding VSI was up 12% for the nine months. Overall US revenue was up 19%. US hospital revenue was up 16%. Enterprise was down 22% year-to-date, as expected. International was up 7%. And currency changes had a positive 1% impact on total revenue for nine months.

I’m going to shift over now to gross margin. Gross margin came in at 71.3%, up 120 basis points for the quarter and 190 basis points for the first nine months. Stable pricing and geographic mix helped gross margins.

Operating expenses now. For the quarter, including $1.4 million of one-time acquisition-related and restructuring charges, OpEx came in at $43.8 million. Excluding one-time charges, OpEx was $42.4 million, up 28%, including the acquisition of VSI. SonoSite’s core OpEx without VSI or without one-time charges was $37.1 million, up 12%.

For the first nine months, including $3.9 nine months of one-time acquisition-related and restructuring charges, OpEx was $119 million. Excluding one-time charges, OpEx was $115.1 million or up 16%, again including the acquisition of VSI. SonoSite’s core OpEx without VSI or without one-time charges was $109.8 million, up 10%.

The impact of having our cardiovascular disease management division on the P&L for nine months of 2010 account for 8 percentage points of the increase in OpEx, currently cited at 10% for the core business. Changes in currency had a minimal impact for both the quarter and nine months on OpEx.

I’m going to shift over now to EBIT and EBITDAS. First, for the quarter, excluding one-time charges, EBIT was $7.3 million or 11% of revenue, representing a 50% increase over the prior year. Again, excluding one-time charges, EBITDAS was $11.9 million, an increase of 55%. For the first nine months, excluding one-time charges, EBIT increased 86% to $18.6 million. And again excluding one-time charges, EBITDAS increased 54% to $28.7 million.

I’m moving down now to net income and EPS. For the quarter, excluding one-time charges, net income was $2.6 million or $0.18 a share versus $0.6 million or $0.04 a share last year. With the one-time charges included, net income was $942,000 or $0.07 a share compared to a $0.01 loss last year.

For the first nine months, excluding one-time charges, net income was $7.9 million or $0.51 a share versus $3.5 million or $0.20 a share last year, a 224% increase. With the one-time charges included, net income was $4.2 million or $0.27 per share versus $1 million or $0.06 a share in the prior year.

I’m moving over to cash flow. For the first nine months, cash flow from operations was $17.5 million compared to $8.9 million last year, an increase of $8.6 million or 96%. Over the same period, the company used $126.1 million of cash to repurchase 4.2 million shares of stock under our previously announced share repurchase program.

That moves us down to the balance sheet. Cash and investments totaled $71.7 million as of September 30. Convertible debt totaled $114.7 million as of September 30. Accounts receivable, DSOs decreased one day from 91 to 90 days versus the prior year. Inventory increased 20% over the first nine months, inclusive of $5.1 million from VSI. Excluding VSI, inventory increased 4%.

Moving over now to new products. During the quarter, we introduced Advanced Needle Visualization, a new proprietary algorithm that enables anesthesiologists to see the needle during steep – deep and steep angle nerve block applications, conditions under which previously the needle has been very difficult to, impossible to image. This is a very important advancement in needle visibility. It has potential to improve patient safety and reduce cost and time and increase physician confidence. Advanced Needle Visualization has quickly become a key differentiator across our marketplace and is gaining strong acceptance.

I’m going to talk now about some opportunities. If you may have seen today, we formed two strategic partnerships in the quarter, one of which was announced today. That was the National Basketball Association. We are doing this to drive awareness amongst sports medicine providers on the benefits of ultrasound visualization. We see this initiative as a great opportunity to increase visibility in musculoskeletal medicine.

Secondly, during the quarter, we announced a partnership with the University of California, Irvine, Medical School to actually integrate SonoSite hand-carried ultrasound into their four-year medical school curriculum. This is a very progressive education program that will prepare students to use ultrasound effectively and ultimately increase the utilization of ultrasound visualization in point-of-care medicine. This program kicked off in September, and we are very excited to be participating in this innovative program to prepare students for the 21st century medicine.

I’m going to move over now to outlook and make a commentary on our outlook. We had a good quarter. We made substantial overall progress toward improving our business model as well as strengthening SonoSite strategically. We sustained double-digit revenue growth in the US hospital channel. We are on track to meet our revenue expectations for the newly acquired VisualSonics.

We also saw some visibility on improving international sales, which came in faster than expected for the quarter. We also implemented actions to reduce structural operating expenses to enable expansion of our forward operating margins. Overall, we are encouraged with the performance of the company in the quarter, especially in what continues to be an evolving healthcare marketplace.

I’m now pleased to introduce Marcus Smith. As you know, Marcus was recently appointed as our CFO. He offers unique perspective with his experience in business development and investment banking, and he is off to a very strong start. And again, I want to say thank you to Mike Schuh for his ten years of service for the company. We wish him the best of luck and (inaudible) in his retirement.

Marcus, would you take the financial outlook, please?

Marcus Smith

Sure. Looking at the 2010 financial outlook, the company is maintaining its outlook and providing the following guidance for the full year 2010, which includes the impact of the VSI acquisition. Core business revenue growth of 10% to 12% is what we are expecting, including $17 million of estimated revenue from VSI. That will help us to take overall growth to a projected 18% to 19%.

We are reaffirming gross margins in a range of 70% to 71% for the year. We are also reaffirming core business EBIT margins of 11% to 13%. Including approximately $7 million in transaction costs, amortization and stock compensation expenses from the VSI acquisition, we project EBIT margins of 8% to 9% based on higher overall revenue.

We are also reaffirming a core business EBITDAS margin of 16% to 18%. We are projecting a positive contribution from VSI and overall EBITDAS margins of 15% to 17%. And finally, we are revising full year guidance on the effective tax rate to 36% compared to prior guidance of 40%.

Kevin Goodwin

Okay. With that in mind, we are going to open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll take our first question from Alan Robinson with Royal Bank of Canada.

Alan Robinson – Royal Bank of Canada

Good afternoon, gents. Congratulations on a very solid quarter there.

Kevin Goodwin

Thank you.

Alan Robinson – Royal Bank of Canada

Could you provide some more commentary regarding VSI’s growth during the quarter? You mentioned 30% organic growth here. What were the drivers and how much of that 30% was due to cross-selling?

Kevin Goodwin

Well, none was due to cross-selling. It’s all organic growth in their preclinical market, which, as we told you when we acquired them, we thought it had a very long runway for growth, and it does. And so they nailed their quarter nicely. Our continued evaluation of their business opportunities in the preclinical world, for example, cardiovascular research, cancer research, stem cell and biomarker research, just to name three areas, looks very promising. But otherwise, no cross-selling at all.

Alan Robinson – Royal Bank of Canada

Okay. I noticed you still expect $17 million in the year from VSI. Was there a pull of orders to the third quarter from the fourth quarter? Was there anything back-end loaded there at all?

Kevin Goodwin

No, but they carry backlog, Alan. So they came into the quarter with some backlog. They exited the quarter with some backlog, a level backlog, I should say. And so now they are in a pretty good position to hit the number this quarter. As always, I’ve got to bring in some orders this quarter in time to ship, but they are off to a nice start.

Alan Robinson – Royal Bank of Canada

And then just in terms of your guidance, you mentioned gross margin is expected between 70% and 71% for the full year. Nine-month to date, we are running at 71.4%. Is there anything specific that is likely to pull down gross margins in the fourth quarter, which has informed your new range there?

Kevin Goodwin

Nothing specific, but historically, there tends to be a little bit of dampening in pricing and margins at the back end of the fourth quarter. We’ve got years of looking at that pattern. Now we’re doing, I think, a pretty credible job of managing price, but buyers certain learn how to buy. And so there is some of that estimated in there and just in general, kind of steady as we go approaching.

Alan Robinson – Royal Bank of Canada

Okay. And then obviously the US market is doing very well. But in terms of Europe, in particular, I know that the UK is having some tighter budget issues going on there. What are your UK salespeople telling you to expect for the UK hospital channel?

Kevin Goodwin

Well, the UK had a tough second quarter. It had a pretty good third quarter compared to what we thought it might be. We feel things have stabilized, which is that we are getting some flow-through. But our growth expectations for the UK are different than they were. And right now, I’d say we have a kind of a flattish to slightly up disposition about the UK as we head out the next several quarters as they work their way through healthcare reform. Fortunately, we have a number of other countries around them and around the world that are growing at faster rates. So, probably consistent. I imagine that’s what you heard.

Alan Robinson – Royal Bank of Canada

Okay. Thank you.

Operator

(Operator instructions) We’ll go next to Tycho Peterson with JP Morgan.

Evan – JP Morgan

Hi, it’s Evan [ph] in for Tycho. First question would be on – I know it’s a little early to start talking about 2011, but could you talk about some of the cost savings initiatives possible with VisualSonics and how you see that working into margin improvements going forward? Thank you.

Kevin Goodwin

I’m going to have our CFO handle that. Marcus?

Marcus Smith

Okay, great. We announced a while back that we are implementing a series of options to reduce cost in the business and drive operating leverage. As part of our progress in Q3, we’ve achieved a run rate of $1.6 million on an annualized basis. We’re still targeting by the end of Q1 a $5 million to $6 million range. So any additional savings or expense reductions is part of VSI. We’ll be part of (inaudible) to that additional number that gets to $5 million to $6 million.

Evan – JP Morgan

Okay, great. Could you talk some about LumenVu, now that it’s approved, how we should think about the go to market strategy and how that ramp might look?

Kevin Goodwin

Yes. Right now, LumenVu is a technology we are still working on. We had it through a couple rounds of clinical. We’re not really pleased with where it is just year. So we’ve – it's still back on the shelf working – not on the shelf, but on the bench – work bench, so to speak, working on it. Right now, if you look at our outlook, we don’t have any revenue plans in there for LumenVu just yet, which hasn’t affected our outlook based on our organic trend line. But at this stage, I would just hold on it.

Evan – JP Morgan

Okay. Great. And then, could you talk about your plans for the remainder of the share repurchase and/or other capital deployment? Thanks.

Kevin Goodwin

Okay. I think as far as repurchase is concerned, Marcus, do you want to handle that?

Marcus Smith

Sure. So we’ve already repurchased $36 million worth of $50 million that was authorized in the program. And we’ve got that program that remains open. And I think the amount of shares that we repurchase between now and the near future will be dependent thus certainly to a large extent on how the share price moves.

Kevin Goodwin

And then capital deployment, steady-state capital deployment, Evan, relative to SonoSite and I think regarding VisualSonics, I think regarding a capital deployment there, there will be some capital deployment into that business for scaling their transducer line. I don’t think it will be material enough to get your attention, but beyond that, I’m not aware of any major capital move between now and year-end.

Marcus Smith

I think we’ve spent a lot of the money on the share buyback and on the acquisition of VisualSonics.

Evan – JP Morgan

Okay. Thanks. And then my last one will be on the musculoskeletal market. Could you talk about the rate at which that is growing? I saw the – we all saw the partnership announcement this morning and other initiatives like that that you’ve planned. Thank you.

Kevin Goodwin

Yes. Well, the musculoskeletal market, which is what we referred to as the orthopedic MSK market, consists of a stack of physicians that includes orthopedic surgeons, non-operative sports medicine physicians, rheumatologists, physiatrist, and even eventually athletic trainers. And we have seen very, very healthy growth, both in the quarter and year-to-date, approaching a doubling of the overall revenues in that space. And we anticipate going forward that we can double again. So we’re pretty excited about what’s happening there. Ultrasound is emerging in the musculoskeletal space for the first time in American medical history as a new high-value tool that can help reduce cost, shrink patient cycle time to healing, and to back to work, and also offer alternative ways of getting therapy accomplished such as platelet-rich plasma and other things like that. So it’s really happening in a nice way, and it looks like a nice vertical ramp in front of it.

Evan – JP Morgan

All right. And maybe I’ll log one last one in. Could you talk some about the NanoMaxx and how that product is doing?

Kevin Goodwin

Achieving expectations. So that’s about all I can really say. We continue to be dominated by the M-Turbo and the S system, as our flagship revenue drivers. Turbo, or rather the Nano is tracking. And just to remind everybody, we’ve got a very healthy dose of new products expected as we go out 12 months that we are extremely excited about that will really, we think, accelerate our move ahead. So just remember that too.

Evan – JP Morgan

Okay. Great. Thanks.

Operator

There are no further questions at this time.

Kevin Goodwin

Okay. Well, very good. Thank you for your time today on the call. And we, of course, will keep everyone up to date as things develop. We look forward to a very strong finish to 2010.

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