Derma Sciences' (DSCI) CEO Steve Wills on Q2 2016 Results - Earnings Call Transcript

| About: Derma Sciences (DSCI)

Derma Sciences Inc. (NASDAQ:DSCI)

Q2 2016 Earnings Conference Call

August 09, 2016 11:00 AM ET

Executives

Kim Golodetz - IR, LHA

Steve Wills - Chairman and Interim Principal Executive Officer

John Yetter - EVP, Finance and CFO

Russell Olsen - CEO, BioD

Maurice Donnelly - SVP, Global Advanced Wound Care Sales

Analysts

Scott Henry - ROTH Capital

Operator

Welcome to the Derma Sciences’ Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks we will hold a Q&A session. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, August 9, 2016.

I would now like to turn the conference over to Kim Golodetz. Please go ahead ma'am.

Kim Golodetz

Thank you, operator. This is Kim Golodetz with LHA. Thank you all for participating in today’s call. Joining me from Derma Sciences are Steve Wills, Executive Chairman and Interim Principal Executive Officer; John Yetter, Executive Vice President of Finance and Chief Financial Officer; and Russell Olsen, Chief Executive Officer of BioD.

Earlier this morning, Derma Sciences announced financial results for the 2016 second quarter. If you have not received this news release or if you would like to be added to the company’s distribution list, please call LHA in New York at 212-838-3777 and speak with Carolyn Curran.

Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements regarding the operations and future results of Derma Sciences. I encourage you to review the company’s filings with the Securities and Exchange Commission, including without limitation the company’s Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Factors that may affect the company’s results include, but are not limited to, product demand, market acceptance, impact of competitive products and prices, decisions by third-party payers, product development, commercialization or technological difficulties, the success or failure of negotiations and trade, legal, social and economic risks.

All forward-looking statements speak only as of today’s date, August 9, 2016 and except as required by law, the company assumes no obligation to update these forward-looking statements whether as a result of any new information, future events, changed circumstances or otherwise.

With that said, I would like to turn the call over to Stephen Wills, Steve?

Steve Wills

Thank you, Kim, and many thanks to each of you for joining us this morning. As you know we've been very busy this past few months at Derma Sciences. Today I'm especially pleased to report that while management was focused on two very important transactions; the acquisition of BioD and the sales of our first aid business what we call FAD, the staff of Derma Sciences was able to grow revenues largely to plan and cut our cash and operating expenses even more than we anticipated.

Our most important financial metric, operating profit loss, improved significantly for the second quarter to $2 million compared with a $5.6 million loss for the second quarter of 2015. We budgeted for cash burn from operations for the first half of 2016 to be $7.5 million. But we burned only $4.4 million from operations. The primary drivers here were lower operating expenses and improved inventory management.

In addition we realized a gain from the sale of our Comvita Limited common stock of $4.7 million which resulted in net cash proceeds of $7.6 million. All told we are extremely pleased with the direction of our company and with our recent progress. We had a strong second quarter. While our traditional wound care or TWC business continued to operate profitably, we recorded a significant improvement in our advanced wound care or AWC segment contribution.

For Q2 the negative contribution from AWC narrowed to just $0.4 million. This compares with a negative $3.8 million for the second quarter of 2015, an improvement of $3.4 million comparing the quarters. AWC net sales increased 6.6% year-over-year with continued growth from MEDIHONEY, TCCEZ and AMNIOEXCEL. In particular MEDIHONEY resumed double-digit growth with strong sales across all regions.

AMNIOEXCEL also posted rapid growth during the quarter, with sales rising 22.5% to $681,000. We began the period April 1 to be precise, with the CGS Administrators issuing a local coverage determination. So we now have six of the eight medicare administrative contractors permitting coverage for AMNIOEXCEL and 86% of medicare beneficiaries are now covered. We are working to obtain positive coverage determinations from the remaining two MACs and have submitted level one evidence from our randomized controlled trial, augmented by published peer-reviewed clinical data and in vitro characterization studies.

Given our positive experience with AMNIOEXCEL and the growth outlook for the entire regenerative wound care sector, on July 28 we announced a definitive agreement to acquire BioD. We licensed AMNIOEXCEL and AMNIOMATRIX from BioD about 2.5 years ago. I'm extremely pleased to report that we close on the transaction last week.

We held a conference call the day we announced the acquisition. But to reiterate what we said two weeks ago BioD is a Para IV [ph] strategic business fit with Derma Sciences and the purchase is immediately accretive on any number of metrics. We gained four proprietary high margin, 90% range product families with trailing 12 months revenues of approximately $22 million. Our scale is now considerably enhanced. We have new cross selling opportunities and the addition of BioD products will boost our gross margin.

Russ Olsen, the CEO of BioD will tell you a little more about development milestones and targets in a few minutes. In addition to this acquisition as part of our initiative to enhance shareholder value and expand gross margins, we signed a definitive agreement to sell our FAD last month for approximately $12.2 million, which includes inventory.

The sale removes a lower-margin product line, while providing additional capital to invest in higher margin AWC opportunities. I anticipate that closing of this transaction taking place later this month.

The plan we initiated late last year to match expenses to achievable sales targets, to create sustainable, profitable growth to reach positive EBITDA and operating cash flow, and to advance our growth strategy to increase our AWC segment revenues, margins and cash flows, is working, we are executing.

For many years, our balance sheet has been a source of strength for Derma Sciences, and it continues to be so. We had cash, cash equivalents and short-term investments as of June 30, 2016 of $44 million, which includes the proceeds from the sale of 925,000 shares of Comvita stock for $7.6 million. In addition, we have $15.8 million in marketable securities, representing the remaining Comvita position.

Following the sale of FAD and the purchase of BioD, and a $2.3 million equity investment from BioD stockholders, our current cash, cash equivalents, short-term investments and marketable securities are expected to be approximately $52 million. These funds coupled with the fact that we have no long-term debt provides us with the resources and the flexibility to be thoughtful as we pursue our goals.

Our strategy is to grow our current business and brands organically, and also to be opportunistic, but disciplined with acquisition and licensing opportunity, in particular for our AWC business. While we will work now to integrate the acquisition, I want to point out that the BioD is an excellent standalone business, and beyond generating additional opportunities for some collaborative selling initiatives, the integration will be minimum.

As a final topic, I want to update you on our search for a permanent Chief Executive Officer. We continue to work with a leading nationwide executive search firm and are actively advancing the process. I want to point out that Derma Sciences continues to operate productively with the support of an excellent Board and talented senior management and employees. I think that's abundantly clear from our recent transactions and our Q1 and Q2 financial results.

I'd now like to turn the call over to John Yetter to review our financial results. After John's remarks, Russ Olsen will provide some commentary on BioD, and then we will open up the call for questions. John?

John Yetter

Thank you, Steve, and good morning, everyone. I'd like to point out that we filed our 10-Q last evening, which contains more detail on the financial results that I will be reviewing with you this morning. Here are the highlights.

Net sales for the second quarter of 2016 were $22.2 million, down $348,000 or 1.5% from the prior year quarter and down 0.6% on a constant-currency basis. This includes Advanced Wound Care sales of $11 million, up $682,000 or 6.6% from the prior year quarter, and TWC sales of $11.2 million, down $1.03 million or 8.4% from the prior year quarter.

The Advanced Wound Care sales increase was led by MEDIHONEY, TCC and AMNIO products in the U.S. and MEDIHONEY in Europe, Middle East and Africa. The decrease in TWC sales was driven by lower FAD sales in the U.S., due to the non-recurrence of a large new retail product stocking order in 2015 and lower sales in Canada, due principally to inventory rebalancing on the part of our exclusive distributor there.

Gross profit for the second quarter of 2016 was $8.3 million, down $111,000 or 1.3% from the second quarter of 2015. Gross profit for the AWC segment was up $990,000 or 20.4% to $5.9 million compared to $4.9 million last year. The increase was driven by higher sales and a higher gross margin percentage, due to product - favorable product mix and lower product costs.

Gross profit for the TWC segment was down $1.1 million or 31.4% to $2.4 million compared to $3.5 million last year. The decrease was driven obviously by the lower sales and a lower gross margin percentage, due principally to product mix and higher product and manufacturing costs.

Operating expenses for the second quarter of 2016, which is now comprised solely of selling, general and administrative expense was $10.3 million, down $3.6 million or 26.2% for the second quarter versus the second quarter of 2015. The decrease was principally due to lower compensation and benefits, professional services, IT and travel expenses reflecting the company's cost reduction and restructuring initiatives implemented in the fourth quarter of 2015. The $3.6 million decrease contributed to a reduction in our operating loss as Steve mentioned earlier from $5.6 million in 2015 to $2 million in 2016.

Other income improved $3.6 million to $4.5 million in the second quarter of 2016 versus the second quarter of 2015. The drivers behind the increase were the aforementioned $4.7 million gain on the sale of Comvita stock plus an absolute change in foreign exchange from income in 2015 to expense in 2016. The main contributor to the 2016 foreign exchange loss was the Brexit decision in late June.

Net income from continuing operations for the second quarter of 2016 was $2 million or $0.08 per share basic and diluted compared with a net loss from continuing operations for the second quarter of 2015 of $5 million or $0.19 per basic and diluted share. The increase includes the sale of Comvita stock with the realized gain of $4.7 million before taxes.

For the first half of 2016, net sales were $42.5 million, up $396,000 or 0.9% from the first half of 2015 and 2.3% on a constant currency basis. Advanced wound care net sales were $21.6 million, up 7.5% from the prior year period and traditional would care net sales were $20.9 million, down 5.1% from the prior year period. Gross profit at $15.9 million was flat period to period as was our gross profit percentage of approximately 37.8%.

Operating expenses decreased 7.3% or 26.5% to $20.2 million in line with our restructuring initiatives. This contributed to the improvement in operating loss of $4.3 million in the first half of 2016 versus an operating loss of $11.6 million in the first half of 2015.

The company reported net income from continuing operations for the first six months of 2016 of a profit of $200,000 or $0.01 per basic and diluted share compared with a net loss from continuing operations for the same period in 2015 of $11.5 million or $0.45 per share basic and diluted. Net income for the 2016 period again includes the sale of Comvita stock for a realized gain of $4.7 million.

As if June 30 Derma Sciences' had cash, cash equivalents and short term investments of $44 million compared with $40.8 million as of December 31, 2015. In addition the company had $15.8 million investment in equity securities as of June 30, compared with $16.1 million as of December 31, 2015. As Steve mentioned, our liquidity is in excellent condition and pending the closing of the FAD sale, the $2.3 million capital raise and the acquisition of BioD we'll have cash, cash equivalents and marketable securities of approximately $52 million on hand. Looking forward, we believe we have sufficient capital to meet our planned growth expectations.

That having been said, now I'd like to turn the call over to Russ Olsen.

Russell Olsen

Thank you, John. First let me say it's wonderful to be officially part of Derma Sciences' and on behalf of every one of BioD I can tell you that we are very excited about this next chapter in our evolution. We're all confident that with our two companies joined together we can achieve far more together than alone.

A couple of weeks ago I described our products, uses and markets. I'd like to talk to you about the trends we are seeing in the marketplace and also the timing for development for our pipeline products and when we might expect to see commercial sales.

As we know very few current therapies in use today are capable of delivering both cost effective solutions and long-term clinical benefits. The vast majority of treatment options for chronic or acute conditions are palliative in nature. The result is a healthcare delivery system saddled with costly treatments for an increasing ailing population with few solutions reducing those costs and more importantly improving the quality of life for patients.

Regenerative medicine, specifically the advent of birth tissue products represents a new paradigm shift in healthcare with the potential to resolve critical unmet needs by focusing on underlying causes and the mechanism of actions that can accelerate healing in soft tissue injuries or wounds versus treating only their symptoms. The demand or need in the market continues to grow for regenerative products and we intend to leverage our technology platform to meet customer expectations.

To this end, Derma Sciences will be launching a number of new products going forward. We will begin with the launch of our first neurological product aimed at the reduction if not the elimination of adhesion and scarring between the door [ph] and brain in craniotomies and glioblastoma resections. We will launch this new product in the Congress For Neurological Surgeons in San Diego, California on September 24th.

The early results have been promising and we look forward to sharing more information on our foray into the neurological market as well as other surgical specialty markets in the near future. Thank you for your attention and time, and now I’ll turn the call back over to Steve.

Steve Wills

Thanks Russ. Before we open up the call for questions I’d like to turn now to 2016 financial guidance. Reflecting the acquisition of BioD and the sale of FAD, Derma Sciences is providing the following financial guidance for 2016. This is two tier, I'm going to go over the pro forma numbers and then the actual GAAP, generally accepted accounting principle numbers.

Starting with the pro forma, pro forma 2016 presumes BioD was part of Derma Sciences for the full year and excludes FAD sales for the entire year. For competitive purposes we assume the same for 2015. The results would be as follows: total net sales would be $97.3 million. This represents growth of 13% compared with net sales of $86.4 million for 2015. AWC net sales would be $71.5 million. This represents growth of 18% compared with net sales of $60.4 million for 2015.

This figure consists of $47.2 million for Derma’s standalone products, up 13% over 2015 plus $24.3 million for BioD products, up 30% over 2015. And gross margin for the AWC business would be approximately 65%.

Regarding TWC net sales would be $25.8 million. This represents a decline of 0.8% compared with net sales of $26 million for 2015. Again the pro forma numbers just combine the Derma Sciences business the net sales for 2016 and 2015 as if BioD was owned by Derma Sciences for both periods and FAD is poured [ph] out because of the pending sale.

Now switching over to the GAAP numbers. Our GAAP 2016 pro forma reselects purchase accounting and thus includes only those net sales during the period BioD and FAD were actually owned by Derma Sciences. Our guidance is as follows: AWC net sales of $57.7 million. This represents growth of 38% compared with net sales of $41.8 million for 2015. This consists of previously stated guidance of $47.2 million on Derma standalone products plus $10.5 million of BioD products.

I also want to point out that the TWC net sales cannot be calculated until the Sale of FAD has closed which is expected later this month. So as we open up the call for questions just like to remind everyone that Steve Wills, myself will be responding to questions. We also have Russ Olsen, the BioD CEO and John Yetter, the Chief Financial Officer of Derma Sciences. We also depending on the questions and the granularity, we have Maurice Donnelly, the Senior Vice President of Advanced Wound Care sales with us. So with that I’d like to open up the call to question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Scott Henry with ROTH Capital. Please go ahead with your question.

Scott Henry

Thank you and good afternoon, Steve and great job. Certainly a lot of positive things have happened over the past couple of months. I'm going to start with BioD and I know you went through a lot on the deal already in prior calls. But I was hoping you could just walk through the total potential cost of $77.8 million and what that would mean in terms of sales and product earn outs.

Steve Wills

Sure, Scott. Thanks for the question there. The - as we reported in the press release and on the call, a few weeks ago, the total potential payments on the BioD transaction aggregate to $77.8 million. That’s broken up into three tiers. The first tier is the upfront payment of $21.3 million. And that $21.3 million is further divided between 65% in cash, which equates to approximately $13. 8 million and 35% in stock, equates to about $7.5 million of stock value.

The next two components are the product, potential product payments and that could aggregate up $30 million. We - the way we structured this, again we have the upfront payment of $21.3 million and that’s based on a certain level of sales that we're extremely comfortable, that have no future issue from a regulatory standpoint.

The second tier of this up to $30 million, is structured in that there is significant incentives for BioD, for Derma to continue to grow the business as aggressively as possible. But there is also some risk mitigation structured there, in that if there is a potential issue regarding the regulatory landscape for these products then the payments aren’t going to be met. We structured it in a way where if there is good news or there is no issue, there is a significant reward. And if there is an issue we protected ourselves.

Our position right now is that we’d be very surprised if frankly, and we’d love to do it, if the BioD shareholders don’t get the full $30 million. There is some work to do regarding continued increasing of the sales, but Russ Olsen and his team is very confident. So we’re comfortable that they have an excellent chance of achieving the full amount. And it would be our pleasure because we think it’s a very thoughtful valuation to [indiscernible] in that regard.

Further on that potential regulatory landscape, yeah, we can’t tell you - I can’t really handicap it. There is still some internal discussions at the FDA. There is going to be public hearing in the third week in September, and it’s just a matter of – it’s wait and see. We think there is, as I said, I can’t handicap, we think there is high probability that there is no issue or that there is a limited issue. But the takeaway is that we’ve structured it where we’ve covered ourselves for both a reward and also for a risk mitigation.

The third component is pretty straightforward. That’s a net sales earn out. We, since we closed in July, the metric that we used in there are last 12 months ended say June 30th. So there are two earn outs for the BioD shareholders for net sales. And that’s what - you start with a base of stay the 6/30, 2016 numbers and based on the growth, the incremental growth over those proprietary products for the period June 30, 2017 - 2017 we would then have a multiple, already agreed upon multiple and an earn out payment would be made. And then 12 months after that, to June 30, 2018, you would be using the base of 6/30/17.

So we, in essence we have a collar for the aggregate of $77.8 million in that the $21.3 million has already been paid. The up to $30 million on the potential product payment and up to $26.5 million on the net sales earn out payments and that $26.5 million is broken out $13.25 million per year maximum for the June 30 2017 and the Jun 30, 2018 payout.

Scott Henry

Okay, great. Thank you for that color. Now a quick question for Russ. You’ve talked a little bit about the neurological product that should be launching in September. Can you talk about the regulatory pathway for that product and what - what was required to set a 510(k) product? Or what is the regulatory pathway?

Russell Olsen

Scott, what we’re envisioning here right now is that the first product that we’ll introduce here at the CNS Congress in San Diego will be what they classify as HCTP product, which will not require us to file a 510(k) or any other regulatory pathway that would entail like BLA process.

So we’re very confident that the current use of the product falls within the ATQB guidelines for homologous use and stays within the guidelines for minimally manipulated tissue being delivered to the market place. However, we do envision down the road that we will explore other regulatory strategies to bring our product, and/or to products with more specificity around indications that would require potentially a different regulatory classification. But for the first foray into the market, we will come in as a HCTP product.

Scott Henry

Okay. Great. Thank you. And then Steve you talked about sales synergies in the past. Can you give any color on how that could impact your product mix? And I know, while the reps you brought in are independent reps. I mean, how - do they get commissioned out based on widening their product range or how does all that work?

Steve Wills

Sure. I'm going to turn this one over to Maurice, and Russ may also add some color on that. Maurice?

Maurice Donnelly

Great. As was stated, the integration will be minimal. But the combined efforts of both companies make us stronger than we stood alone. I know that BioD is taking a look at our corporate accounts team for instance, where we've done a great job in getting a contract position for the Advanced Wound Care products and every GPO over the past couple of years. We're looking forward to moving ahead with the BioD, AMNIO portfolio and adding that to our contracting efforts.

With regards to their independent group, yes, BioD is bringing over 200 independent sales reps to the table and that's pretty exciting that we have 200 additional eyes and ears out there in the street to help uncover new opportunities and to close more business. In addition, we do play in different segments, but we're still in the medical arena, and that just bodes well for both groups.

Russell Olsen

Yes. The only thing else that I would add to that, Scott, is that with our current organization as they stand today, what we intend do is to make sure that we remain focused on each of our respective product lines, so that there is no disruption in our current business model.

We will explore cross-selling opportunities as we enter into Q4 of this year. The preponderance of our activities in Q3 will be focused on identifying common areas of interest, bringing our marketing team out into our respective organizations to educate and train our different sales representatives that we have to make sure that when we do explore opportunities to cross sale that everyone is more than properly trained and ready to address any clinical questions or needs that may come up in the market.

Scott Henry

Okay. Great. And I guess, the final question for Steve, just on the business development front. Do you see any opportunities to, perhaps sell some of the other TWC businesses? And as well, what would be the typical profile or what you'd be looking for to acquire on the AWC side?

Steve Wills

The - let me correlate what we've done with TWC or how we assess the TWC business with the First Aid Division, FAD. As you go through the components that make up our TWC business, frankly, the only segment that was - what I would consider clean is the FAD. And what I mean by clean is that, I don't have a lot of infrastructure overlap. I don't have manufacturing where at the same facility I'm manufacturing Advanced Wound Care products and TWC products, where it's affecting the efficiencies, productivity, the overhead allocation, things of that nature.

So when I say clean, with FAD we had a separate supplier, separate manufacturer in China. We had a separate distribution unit in Houston. It was a 100% dedicated to FAD as was the manufacturing facility in China. And the employees associated with FAD, they were 100% associated with the FAD business. So we were fortunate that we were able to find a company, where this was synergistic for them. And just because of capacity limitations, they were - they wanted everything, not just our net sales and few other customers and the products, but they picked up the supply agreement in China, they picked up our Houston lease and all the personnel.

And that was actually quite nice from a senior management standpoint that we knew there would be no reductions to any of the employees. But when you look across the rest of the TWC business we don't have any those other types of segments. So my expectation is that I don't anticipate doing another segment sale like that regarding rest of the TWC business.

That doesn't mean we are not going to try and make it more efficient where we can increase contribution margins. We are going to do that. And to be clear what I talked earlier about the segment contributions the AWC we've narrowed the business segment contribution for AWC down to $400,000 and the second quarter of 2015 was actually a $3.8 million loss.

So again that's a 3.4 million improvement. The TWC business segment actually has always been positive. So it's a matter of how can we make that more efficient. While we talked about a little bit is if you take a step back where we netted out the strong balance sheet. I mean it's actually a very strong balance sheet. When you look at some of the metrics there it's as of June 30 and I can walk you through a little bit post the transaction, we had cash or current assets which is the cash, the receivables, the inventory of $72.6 million and our current liabilities are only $8.7 million at the ratio greater than 8 to 1.

We have no long term debt and even post the deal I mean prior to the deal again that's an 8.1 ratio just on current assets and current liabilities. If you add in our marketable securities of $15.8 million gets us up to $88.4 million of current assets and marketable securities for a ratio of greater than 10.1. These are excellent metrics that they teaching in accounting 101, in finance 201 to try and strive for. Even post the deal we talked about $13 million of cash coming out, $2 million coming in from the equity or so.

Even net of those numbers we still what have approximately $75 million of current assets plus marketable securities and no debt, the same liabilities, current liabilities of $8.7 million. That still gives us a ratio of greater than 8.6 to 1. And what that does is it gives us the flexibility to reduce things. We don't have to - in the nice way we can be more thoughtful and I think the BioD acquisition is - that's our poster chart it's what we are looking at here. Things that are horizontal and vertical in nature and accretive, positive cash flow. I mean that's on the acquisition side.

On the licensing side we are looking for products that we can layer right into the salesmen kit for the same call points. And that balance sheet gives us that flexibility, in the nice way to be thoughtful and disciplined and opportunistic when the occasion arises.

Scott Henry

Okay, great. Thank you Steve for taking all the questions as well, Russ.

Steve Wills

Okay. I believe the operator was going to come in and say that's it for the questions.

Operator

Yes, that is all the time we have today. Mr. Steve Wills, please proceed with your presentation or any closing remarks.

Steve Wills

Okay. Thank you. So in closing it has been an active and highly rewarding few months at Derma Sciences. I trust that this morning we have conveyed our enthusiasm and commitment for continued execution. I'd like to express my - actually education also, but I meant to say execution. I'd like to express my thanks to Derma's talented and passionate employees for all their efforts and to all of our shareholders and stakeholders for your support advice and encouragement. And once again welcome BioD employees and shareholders to the Derma family. We look forward to keeping you apprised of our progress and success. In the mean time thanks for joining the call and have a good day.

Operator

Ladies and gentlemen that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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