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Theragenics Corporation (NYSE:TGX)

Q1 2011 Earnings Call

May 5, 2011 11:00 AM ET

Executives

Christine Jacobs – President and CEO

Frank Tarallo – CFO

Analysts

Jonathan Lewis – Ardent Research

Operator

Greetings, and welcome to the Theragenics first quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce Christine Jacobs, Chairman and Chief Executive Officer for Theragenics. Thank you, you may begin.

Christine Jacobs

Thank you, Manny, and good morning. Welcome to Theragenics first quarter 2011 conference call. Thank you for joining us this morning. In just a few minutes, I'll provide some comments on the quarter and our outlook for the year ahead. But first, our Chief Financial Officer, Frank Tarallo, is going to provide comments on the financial result. Frank?

Frank Tarallo

Thank you, Chris, and good morning to everybody. This morning we released our consolidated financial results for first quarter of 2011. If you did not receive this new release or if you like to be added to either our fax or e-mail distribution list, please contact Investor Relations at 800-998-8479 or 770-831-5137.

Before I begin my review, please be aware that some comments made during this conference call may contain forward-looking statements involving risks and uncertainties regarding our operations and future results.

Please see our press release issued today and our filings with the Securities and Exchange Commission, including, without limitation, our Form 10-K and Forms 10-Q, which identifies specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Now, onto our results. Consolidated revenue in the first quarter was $20.3 million, which is flat compared to 2010. Earnings per share in the first quarter was $0.01 per share, compared to $0.00 per share last year.

We had special items in the first quarter of each year that affected our EPS. In 2011, we incurred expenses related to an unsolicited offer to acquire the company and charges for amounts due from Core Oncology, for which we believe collection is doubtful. Our 2011 EPS, excluding the special items, was $0.02 per share.

Last year, in 2010, we incurred expenses related to the lawsuit we initiated against the former owner of CP Medical. Our 2010 EPS, excluding the special, item was $0.01 per share. A reconciliation of our GAAP-based EPS and the non-GAAP measure of EPS excluding special items is included in our press release.

Let’s turn to our segments now. Revenue in our surgical products segment was $14.4 million in the first quarter, which is a decline of 1% from last year. We’ve talked in the past about the volatility in the ordering patterns of our larger customers in this business, and we saw this in the first quarter.

Looking at operating results; our surgical segment incurred an operating loss of $191,000 in the first quarter. This includes $220,000 of the special charges I mentioned. In 2010, we incurred an operating loss of $390,000, which included $351,000 of the special charges.

Our gross profit margins on sales increased slightly from 33% last year to 34% this year. We saw improvements in process efficiencies, especially in our new needle facility. However, customer behavior continues to affect our margins. In addition, our gross margins were negatively impacted by winter storms, especially in our Texas facility. Our plant in the Dallas area was closed for four days in the first quarter due to weather.

Returning to our brachytherapy business; revenue was $6 million in the first quarter, an increase of 1% over the last year. This was our third consecutive quarter of year-over-year revenue growth in this business. Given the state of this industry, we believe this is an impressive accomplishment.

Operating income in our brachy business was $1.1 million in the first quarter of this year, this includes $291,000 of the special charges I referred to earlier. Operating income in the first quarter of last year was also $1.1 million, but we incurred no such special charges last year.

Let me now update you on the circumstances with Core Oncology. Recalled at last year, in 2010, sales to Core represented 14% of our brachytherapy segment revenue. Also recall then on February 1, 2011, this year, we provided notice of termination of our supply contract to Core. Let me say upfront that our relationship with Core continues to be very positive. Our objectives at the time of termination were to retain as much TheraSeed unit volume as possible and to obtain repayment of amounts due to us.

Subsequent to termination of the contract, we have continued to sell to Core on a prepaid basis. Sales to Core represented 11% of brachytherapy segment revenue in the first quarter, including sales under our prepayment arrangements. So I am pleased to report that we’ve not seen any material erosion of TheraSeed unit sales during the first quarter as a result of our actions with Core.

Now, there is a nuance I’d like to explain related to the accounting for our circumstances with Core Oncology. At that time, we provided notice of termination to Core – we agreed to honor all orders that were already placed at that time and to honor any orders that were placed within seven days of our termination notice. We did this to ensure that no cancer patients and no doctors were caught in the middle of this issue. These shipments, the ones to honor orders on the books through the seven days subsequent to notice of termination, do not qualify for revenue recognition under U.S. accounting rules. The total value of those shipments, which did not qualify for revenue recognition in our brachy business, was $248,000. If Core is successful in obtaining refinancing and repays these amount due to us, then this revenue will be recognized at that time. Chris is going to talk more about Core Oncology and his remarks in just a couple of minutes.

Let me return to our consolidated results now. Adjusted EBITDA was $2.8 million for the first quarter, compared to $2.6 million in 2010. Our capital expenditures were approximately $700,000 in the first quarter. A significant portion of this amount related to our new ERP systems. We continue to expect to our CapEx spend to be in the range of $2.5 million to $3.5 million for the full year this year.

Speaking of ERP, we went live and implemented the new system at another location during this first quarter. We experienced no significant disruptions in our operations from the implementation. We have one location remaining to install, which we expect to be completed over the next 12 months.

We ended the quarter with $39.3 million in cash, cash equivalents and marketable securities. We had $26.2 million outstanding under our credit facility. This results in a net positive position of $13.2 million.

That wraps up my comments and I’d now like to turn the call back over to Chris.

Christine Jacobs

Thank you, Frank, and good morning again. As we’re reporting, we’ve had a world-wind (ph) first quarter, executing on our strategy, managing through the circumstances with Core Oncology and a brand new distribution agreement with Oncura, a division of GE, was completed in April, and it all made for a very busy quarter.

Let me start by commenting on results. We saw 1% decline in year-over-year revenue in the surgical business. Now we talked many times about the lumpiness of the ordering patterns, especially with larger customers. This affected us in the first quarter, as we had a couple of large customers who didn’t order at the same pace as they did last year, especially in the wound closure platform. We don’t believe that this reflect any changes in fundamental demand. We also believe this is simply reflective of the variability of the ordering patters of large customer. Indeed, our open orders, which represents firm order on the book scheduled for future delivery, totaled $15 million at the end of the first quarter. This is a 16% increase over year end.

While we expect to continue to seek quarter-to-quarter revenue fluctuations in the business, we also continue to expect double-digit organic revenue growth over time just as we’ve deliver the last calendar years, which saw 10% growth each year.

Last quarter, I mentioned that we were focusing on improving profitability in the surgical segment. In his remarks, Frank mentioned that our gross margins on sales were up slightly in the first quarter compared with last year. We did see some improvements in operating efficiencies during the quarter, especially at the new needle facility. As stated, customer behavior continues to be unpredictable, which of course affects the margins.

We also saw price increases for some raw materials. In one instance, a vendor was unable to supply and we had to turn to an alternative, more expensive supplier on a temporary basis. Plus, it’s difficult to raise prices to customers in this environment. However, we believe that we’re going to be able to make some pricing adjustments as a result of increased material cost.

Finally, we also lost several production days to winter storms, especially in Texas. We added temporary labor and we incurred more overtime than usual to make up for the last weather days. This of course had an unexpected negative impact on margins.

On a macro level, much uncertainty remains. The impact of healthcare reform is no clear now than it was several months ago, and customer behavior will continue to be difficult to predict. We have seen some customers announced continued layoffs.

On the flip side, customers have also announced a return to R&D expenditures. While this behavior continues to unfold, we’re going to take steps to improve our efficiencies and incorporate cost control. Going forward, focusing on improved profitability in this segment remains a higher priority.

Let me move now to brachytherapy. We saw our third consecutive quarter of year-over-year revenue growth in the business and profitability continues to be strong. As noted previously, we’ve been focused on increasing our market share in this segment.

Now I’d like to comment on two such circumstances in the business. First, our relationship with Core Oncology continues to be viable. We are in constant communication with Core’s management, as they continue to attempt to obtain refinancing. Recall that we had primary objectives at the time that we terminated the supply agreement with them. We wanted to retain as much of that TheraSeed volume as possible and we wanted to collect the amounts due us.

Even with the uncertainties created in the marketplace with our termination of the contract, Core continues to be a significant customer. Sales to Core represented 11% of our brachy revenue in the first quarter, and that’s fairly close to the 14% that they represented for all of 2010. And as Frank’s comments reflected, we had shipments totaling 248,000 to Core that are not included in the 2011 revenue numbers.

So, I think it demonstrates a couple of things. First, Core’s continuing commitment to the brachy space; and second, physicians’ and patients’ loyalty not only to Core and Theragenics, but for our TheraSeed brand. We intend to continue to work with Core under our prepayment arrangement and support their efforts where we can. At the current time, we believe this remains the best course of action to enable us to achieve our objectives, which again are to retain the volume and collect the amounts due.

The second item that I want to talk about is new distribution agreement with Oncura. We announced that a couple of weeks ago. Under this agreement, we have the opportunity to sell all of Oncura’s brachytherapy products in North America. Oncura’s brand OncoSeed, also known as the 6711 seed, is the oldest and most recognized iodine brand in the world. While we currently have our own iodine seed, we believe that having access to the 6711 seed will allow us to more effectively compete in the iodine segment of the market. With TheraSeed and OncoSeed, we now have the two most recognized and leading brands in the brachytherapy markets.

So, why have we taken these steps? For this 24-year-old industry, the real issue of brachytherapy is no longer isotope selection, it’s about the future. Let me explain. To be sure, we have always been about palladium-103 and TheraSeed, and we continue to believe in palladium-103. But we have always first and foremost the brachytherapy company created to cure cancer, specifically prostate cancer. With the challenges presented by reimbursement and competing technologies, success in this business will be defined by serving all brachy users, regardless of the isotope that they use. We think this is the future of brachytherapy and we think this is what it’s going to look like; and we intent to remain the leader in this industry. While I don’t have mediate forecasts or specific near term, we’re excited about the opportunity that this disagreement affords.

Now, I’d like to change subject. I’m going to turn now to the unsolicited takeover offer we received during the first quarter.

I don’t have much to add to the public disclosures that have already been made. But, as you can imagine, the exercise was a source to distraction for us during the first quarter. And although the offer has since then withdrawn, it involved a lot of management’s time

But, I do note two things. First, your Board of Directors and management team is committed to ensuring that all shareholders recognize the appropriate value over time for our company. We’re simply not interested in an opportunistic offer it does not reflect our true intrinsic value, especially when we’re poised for growth.

Second, we’re committed and focused to redoubling our efforts to drive organic growth and improved profitability in the surgical business, while increasing market share and sustaining cash flows in the brachy business.

In sum, it’s been an eventful and a fast-pace quarter to start the year, as we celebrate our 30th year in business and we look back. Our path is one of rich accomplishments, most notable. Our reputation is a reliable medical device manufacturer who cures cancer.

And our future; we see our future as full of potential as ever, and we have a balance sheet to support any number of choices or challenges represent themselves.

So, to reiterate the statements I made from last quarter, our intent is to be U.S.-based manufacturer of medical devices known for quality reputation, accountability, and devices that medical providers can depend on. It’s our intent to improve the delivery of healthcare in the United States and we do that with every order that we ship. And lastly, our intent is to deliver appropriate shareholder value over time.

That concludes my remarks. And with that, Manny, Frank and I will open up for questions.

Thank you.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator instructions) Our first question is from the line of Jonathan Lewis with Ardent Research. Please go ahead.

Jonathan Lewis – Ardent Research

Thank you. First, Frank, very nice. I love that you guys are doing well in the brachytherapy again.

Frank Tarallo

Thank you.

Jonathan Lewis – Ardent Research

It looks like the net interest expense is a solid 15% or so of operating income. Can you comment on the capital requirements and why you’re running significant debt and cash at the same time?

Frank Tarallo

First, the interest expense; you see that the interest expense has fluctuated pretty significantly from last year to this year. The one thing to know is we do have interest rate swap contracts in place to hedge our interest rate risk, so changes in the value of those swap tends to distort our interest expense somewhat from time to time. So, you should know that. Last year, we had about $100,000 of additional expense that was simply an unrealized loss in the change of the fair value of those swaps; and this year we had a small gain, it was about $30,000.

In terms of how we use our cash and our debt; over time, we have developed an approach in terms of having cash available to allow us to take advantage of opportunities as they present themselves. You see in the past several years we’ve done three acquisitions. So, we like the idea of having cash available to take advantage of those opportunities. So in connection with a couple of those acquisitions, we’ve drawn down on our credit facility, and of course, we’re paying down a portion of that, $10 million over three years.

In terms of the capital structure, the other thing you should understand is that the nature of our assets back here, we have radioactive assets and banks don’t tend to like radioactive assets as collateral. So some of the things for example that we said in the past are; in order for us to obtain $30 million of financing, we have to have $30 million of liquidity in the bank. So, that has to do with the nature of the assets that we have that the banks look to us for collateral. I hope that gives you a little of bit of insight into why we have the structure that we do.

Jonathan Lewis – Ardent Research

You’re saying that you like to keep a lot of cash on hand in case of on opportunistic acquisition, and at the same I’m hearing a lot of – I like the sounds about organic growth a lot better than asset acquisition. Usually asset acquisition doesn’t work out as well for the shareholders. So, can you comment on what you see as the future use of your cash flow?

Frank Tarallo

Well, first maybe let’s comment on – we don’t disagree that organic growth is probably the best driver of value. But, if you look at our acquisitions that we’ve made over the past few years, we feel like we’ve been fairly successful. Our idea has always been to drive organic growth through those acquisitions of those small businesses, and then I think two those cases, the top line, the revenue of each of those businesses has more than doubled since we have acquired them. So, it is helping us to build scale and we feel like we’ve been fairly successful at that.

Jonathan Lewis – Ardent Research

I’m sorry. Frank, I couldn’t…

Frank Tarallo

It is. Yes, it is. Thanks.

Jonathan Lewis – Ardent Research

Let me apologize. You are absolutely right. I just recall that I have built a model on your acquisitions and actually you guys have been very successful. I’ve got to note here that says you’re proper predators.

Frank Tarallo

What, proper predators?

Jonathan Lewis – Ardent Research

Yes.

Christine Jacobs

This is Chris. I have to write that down. I really like that phrase. But, I can add a little color here as well. We do like and keep – there is a cash cushion that we’ve never made public but we have identified. If you have a stumbling block, when you have radioactive assets, your stumbling block is not going to be 30 days off-line. It will be longer than that. So, we have a history of wanting to make sure that we were covered. And the last thing you need is to spend as much money as we do on employees to get them certified to manufacture our radioactive equipment than have to lay them off and think that you can go find them in 30 or 60 days after your issues are over.

Now, we’ve never had that circumstance and so I’m very excited and I’m knocking on wood right now that I have never had it. But it exists and has existed in our competitors’ hands. So, I like the cash question, number one. Number two, Frank is correct. Anytime we have had a great idea of being able to come in with a tuck-in or to diversify our revenue stream, we don’t like having our strategic plan sensitive to the credit market, because we just have never been able to count on them. So we like to bring up (inaudible) cash, make a move, be thoughtful, and hopefully prove to the shareholders when we buy something, given time, we roll it in, and in this case we have produced 10% organic growth over two consecutive years. So, the use of cash is something that we study often, and I agree with you, 80% of acquisitions fail. If you’ve follow this for a long time, you heard us discuss it often, because I think the graveyard tell us a lot, and I am hoping that Theragenics has learned from others’ mistakes.

So that’s my comment on cash.

Frank Tarallo

And just to finish that thought, you also asked about some thoughts on how we might deploy our cash going forward.

Jonathan Lewis – Ardent Research

Yeah.

Frank Tarallo

I think Chris would probably agree that just because we have not the deployed our cash as certain was in the past does not mean we will not do that going forward. And so all options are on the table, and as Chris said a few minutes ago, we look at those options on a very frequent basis.

Jonathan Lewis – Ardent Research

Thank you, Frank. I’m glad to hear that. I must have been holding on for a long time. And we love you and then we love your growth, at the same time we’re – it’s always good to show things going back to the shareholders, get the market to recognize your value.

To Chris there, I do understand what you’re talking about. In fact I had (inaudible) worker too for years and I’ve seen that type things that you’re talking about.

One final question here; can you guys talk about how your accelerators appeal on the balance sheets in terms of depreciated value?

Frank Tarallo

Yeah, the Cyclotron?

Jonathan Lewis – Ardent Research

Yeah.

Frank Tarallo

I don’t know what their book value is off-hand. It’s relatively low, because they’ve been around a long time. We’re depreciating them over a period of 15 years and I think we’ve got a couple that are already fully depreciated.

Jonathan Lewis – Ardent Research

Kind of from the ‘80s I believe so.

Frank Tarallo

Yeah, actually early ‘90s is when the first – ‘93 is when the first one…

Christine Jacobs

‘93 was the first one that came on line.

Frank Tarallo

I don’t if you know, but a couple of years ago, we actually changed the life. We went from 10 years to 15 years because they were still sort of chugging along. And so I’m happy to report that they continue to chug along, and chug is actually is not being fair to how well this equipment actually runs. But the majority of what you see in terms of property and equipment on the balance sheet is our two factories that we own – the specialty needle plant up in the Boston or in the Massachusetts area, and then our factory here in Buford. The accelerators are being depreciated all pretty quickly and they probably will be gone over the next five years or so.

Christine Jacobs

They came in groups. They started with one at a time, one at a time then we ordered four, then we ordered six or something.

Frank Tarallo

Right.

Jonathan Lewis – Ardent Research

How many do you have in total?

Frank Tarallo

We have eight that are in operation today.

Jonathan Lewis – Ardent Research

Okay. I wouldn’t mind saying a section that some in one of your quarterlies or annuals just running that down.

Frank Tarallo

Okay.

Jonathan Lewis – Ardent Research

I hadn’t come across that and I think it might be an unrealized value there on your book that people aren’t appreciating. The cyclotrons the people are building now I think are probably more expensive than what you’ve got there and my experience is that accelerators last an also long time, if they’re maintained.

Frank Tarallo

I think you’re right, and appreciate that comment and we will take a look at that. Thank you.

Jonathan Lewis – Ardent Research

Okay. That’s the end of my questions. Thank you.

Frank Tarallo

Good. Thank you.

Christine Jacobs

All right. Thank you. Manny, are there any other questions queued?

Operator

(Operator instructions). Ms. Jacobs, we have no further questions at this time.

Christine Jacobs

All right. Thank you all for listening and participating today, until next time. Thank you.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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