Obagi Medical Products, Inc. Q4 2007 Earnings Call Transcript

Mar. 3.08 | About: Obagi Medical (OMPI)

Obagi Medical Products, Inc. (NASDAQ:OMPI)

Q4 2007 Earnings Call

March 03, 2008 4:30 pm ET

Executives

Ina McGuinness - Integrated Corporate Relations

Steven Carlson - President, Chief Executive Officer

Stephen Garcia - Chief Financial Officer

Analysts

Angela Larson

Elliot Wilbur

Operator

Good afternoon ladies and gentlemen and welcome to the Obagi Medical Products Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded today, Monday, March 3, 2008.

I’d now like to turn the conference over to Ina McGuinness. Please go ahead ma’am.

Ina McGuinness - Integrated Corporate Relations

Thank you, Nicole. This is Ina McGuinness with ICR. Earlier this afternoon Obagi Medical Products released financial results for the fourth quarter and year-ended December 31, 2007. If you’ve not received the press release, its available on the Investor Relations section of the Obagi Medical Products website at www.obagi.com. This call is being webcast and a replay will be available on the Company’s website for 30 days.

Before we begin, I’d like to remind you that today’s remark contains forward-looking statements within the meaning of Federal Securities Law. These statements do not guarantee of future performance and therefore undue reliance should not be placed on them.

We refer all of you to the risk factors contained in Obagi Medical Products 10-K filed on March 14, 2007 and subsequent 10-Qs for more detailed discussion of the factors that could cause actual results to differ materially and those projected in any forward-looking statements.

All information provided in today’s call is as of the date of the live broadcast, Monday, March 3, 2008 and Obagi Medical Products assumes no obligation to update any such information.

Participating in today’s call from the company are President and Chief Executive Officer, Steve Carlson and Chief Financial Officer, Steve Garcia.

And with that, I’d like to turn the call over to Steve Carlson. Steve.

Steven Carlson - President, Chief Executive Officer

Thank you, Ina and good afternoon everyone. 2007 was a very successful time in Obagi's history from both an operational and financial performance. We are pleased to report another year of strong sales and profitability, which both were at record levels in 2007.

Let me briefly introduce some of our key accomplishments. Our U.S. sales grew 36% fueled by momentum in each of our key product lines. Our international sales were not as strong, but they still increased by 11%. Global net sales increased 32% to $102.6 million. Due to the evenly developed and launched of six new products (inaudible) product system, CLENZIderm penetrating acne therapeutic systems or ELASTIderm systems and Condition & Enhance systems for non-surgical and surgical facial aesthetic procedures.

Each of these systems made notable contributions to our top line performance in 2007. Although we’ve invested significantly in our business, expanding our sales force, marketing activities, and administrative support functions while achieving higher operating margins with nearly 56% increase in our operating income and a 27% return on sales.

We completed a secondary offering and used the portion of the proceeds to payout outstanding debts so today with a debt-free with a very healthy balance sheet with over $14 million of cash at year end. As a result of these activities, we were more than able to double our net income for 2007 to $15.2 million.

Turning to our fourth quarter, although last quarter results were the highest revenues operating income and net income Obagi has ever achieved, our yearly performance fell short of our expectations.

In the US our sales grew 22% versus last year though we were disappointed in the last two weeks of the fourth quarter when Christmas and New Year's Day fell mid week which caused the fourth quarter sales to be lower than anticipated compared to the past experience.

Our analysis of our sales versus our expectations did not indicate that a fundamental change or slowdown has occurred within our customer base. In fact with the addition of 200 new accounts during the quarter, the strong overall experience of our 2007 product launches, the expanding foundation of our core Nu-Derm franchise and the stronger than anticipated reception to the ELASTIderm Decolletage launch, we believe we are in 2008 with the strongest platform ever.

Internationally, the overall performance of our business lagged our domestic growth in 2007. International sales for the fourth quarter were essentially flat with last year as strong performance of our licensing revenues was offset by a decline in our shipments to international distributors.

Our goal is to see the growth rate of the international sector meet or exceed our domestic growth rate for the foreseeable future. Now let me discuss performance of our key product launch and how they contributed to our fourth quarter performance.

Sales from our core product launch, which include Nu-Derm Obagi-C Rx, Professional C, and Tretinoin products once again provided solid double-digit growth increasing 13% year-over-year. We continue to build upon a database of clinical support for the efficacy and safety of Nu-Derm and Condition & Enhance Systems.

To that end, in October we published results of our study evaluating the use of Nu-Derm to help improve scar cosmesis following removal of basal cell carcinoma. We've strong clinical data indicating the use of Nu-Derm regimen does improve the appearance of scarring after the procedure compared to the current standard treatment of a cleanser and healing ointment.

Approximately a month ago at the annual meeting of the American Academy of Dermatology in San Antonio, we presented results from a wide-ranging investigator assessment study in more than 2500 patients on this fact of our Condition & Enhance System following surgical and non-surgical cosmetic procedures. They showed that our system in combination with procedure such as Botox dermal fillers and lasers improved overall skin texture, color, and overall appearance in up to 80% of patients.

This is a strong indicator that both physicians and the patients can greatly benefit from the use of condition enhances in adjunct to these various cosmetic procedures. We'll continue to conduct additional clinical studies to support the science of our penetrating therapeutic technology and the efficacy of Nu-Derm Condition & Enhance Systems in new and expanded applications. We look forward to releasing additional clinical data as it becomes available.

Thanking of CLENZIderm, our initial entry in to the therapeutic dermatology sector, we are pleased with the overall number of the clients that have purchased CLENZIderm and a stronger order rates. Sales at $1.5 million in the fourth quarter were down 15% on a sequential basis as the delay in launching CLENZIderm for normal to dry skin elevated third quarter sale.

We believe CLENZIderm is showing a slower adoption probe compared to our new products launched last year because therapeutic dermatologists are more conservative and require a longer evaluation process before adopting any new treatments.

Ultimately, we believe will dermatology will represent a meaningful segment for CLENZIderm as we have the reorder rates of 77% for Q4 2007. CLENZIderm is a significant dermatological achievement and we expect this system to continue to generate substantial sales growth in 2008.

To driver this growth, we anticipate developing and releasing further clinical data that will validate the efficacy -- solubilized benzoyl peroxide formulation and its superiority when compared to BPO clindamycin drug combinations.

Recent clinical results from the four posters presented at the AAD meeting continue to show that patients of all skin types with mild-to-moderately severe acne saw significant improvement in inflammatory and noninflammatory lesions. These patients also reported high levels of satisfactions, lower levels of dryness, and greater comfort when using the CLENZIderm MD System.

In October at the Fall Clinical Dermatology Conference in Las Vegas, we presented results from a pooled analysis of three randomized investigator-blind trials evaluating solubilized benzoyl peroxide for the treatment of acne that suggests monotherapy with CLENZIderm M.D may provide dramatic reductions in acne lesions within four weeks. In the analysis reduction inflammatory and non-inflammatory lesions was greater with CLENZIderm than a BPO clindamycin combination product. Additionally, patients reported greater overall satisfaction incomparable tolerability under MMD.

Regarding our ELASTIderm, which launched about a year ago, our fourth quarter sales totaled 2.3 million up 38% on a sequential basis. Acceptance continues to be strong with the current reorder rates reaching 74% in Q4. As we had indicated we are especially excited about the ELASTIderm Decolletage System. Our newest addition to the ELASTIderm portfolio, which is launched late this past January.

Formerly with unique combination ingredients it is the only system designed to treat mottled hyperpigmentation including age spots and freckles while reducing the appearance of fine line and wrinkles. This is accomplished by replenishing elasticity and building collagen on the chest in neck area or Decolletage. Additional clinical study data are being finalized that we anticipate will be announced in early third quarter.

Since the system is launched we experienced strong demand for the product, in fact its being on and off back water since the introduction. Based on the initial introductory success of the Obagi Decolletage system we read this new products will become one of the major contributors to ELASTIderm growth.

Additionally, this success also reinforces our belief that strong relationships we've establish with individual physician offices provide an ideal platform for the successful introduction of products that deliver compelling results. We also believe that the willingness of a significant number of physician accounts to aggressively take on a new product indicates to us that the overall economic anxiety that is prevalent today hasn't changed the growth outlook of our physicians.

During the fourth quarter we continued to grow our customer base the number of active US physician accounts increased by over 200 to over 5200 accounts, a growth more than 18% year-over-year. These 5200 active business accounts encompass an estimated 8000 physicians. With our investment in dermatology we saw a 29% increase in new dermatology accounts.

Our sales force of highly trained dedicated representatives increased to 88 from 72 a year ago. Recent market research indicates we have three times the revenues of the nearest competitor in physician dispense topical products. This has been achieved with what we estimate to be less than 50% penetration in plastic surgery and less than 10% penetration in dermatology practices.

On a product level we estimate a market share of CLENZIderm to be less than 1% of the prescription acting market and traditionally enhance less than 2% penetration in cometic procedures. Overall, we believe this provides promising growth opportunities for 2008 and beyond.

Now we return for a moment to our international operations. As you now this past summer we restructured our international business and employed a Vice President International Sales. In October we hired a UK based sales manager and provided local presence and built our European business.

We are now looking to hire sales business managers in the Far East and Latin America. We believe having our own local employes partnering with our distributors is a better business model to substantially grow our international business. Since initiating our new international strategy I'm pleased to share we have new product registrations in Russia, Turkey and China and assigning new distribution agreements in agreements in Hong Kong and (inaudible).

Overall we believe the international markets represent under utilized opportunities and we will continue to make appropriate investments to make them a meaningful contributor to our overall finical success.

And now I'd like to turn the call over Steve Garcia.

Steve Garcia - Chief Financial Officer

Thank you Steve and good afternoon everyone. As Steve has already discussed our sales metrics, I'll focus on the other aspects of our finical performance.

Starting with the fourth quarter of 2007 net income totaled 4.5 million or $0.20 per fully diluted share on 22.8 million fully diluted weighted average shares outstanding, compared with $2.5 million or $0.14 per diluted share on 18.7 million fully diluted weighted average shares outstanding for the comparable quarter of last year.

The fourth quarter of 2007 net income included $220,000 in costs related to the October 2007 registered public offering. The load off of 203,000 in debt issuance cost upon the extinguishment of debt and 81,000 combined tax benefit related to these costs. Excluding these items and the related tax benefit our net income would have been $4.8 million. Our earnings per diluted share for the fourth quarter of 2007 would have been $0.21.

Turning to our fourth quarter 2007 operating metrics as compared to the fourth quarter of 2006, gross profit margins extended 80 basis point to 81.9% compared with 81.1% a year ago. Gross margins benefited from a strong quarter of licensing revenues versus last year, which was somewhat offset by the sales of CLENZIderm, which carried low volumes for gross margins.

Selling, general and administrative expenses including depreciation and amortization increased 21% to $13 million. However, due to sales force expansion costs associated with our secondary public offering, increased legal fees, and expenses associated with Sarbanes-Oxley compliance.

R&D expenses increased 20% to $1.4 million compared with $1.2 million for the fourth quarter of 2006. During the quarter we continued to strategically invest in R&D as we focused on enhancing our proprietary scientific platform and developing new products such as ELASTIderm Decolletage launched in February 2008.

Operating income for the fourth quarter rose 19% to $8 million from $6.7 million a year ago. Operating margins increased slowly to 29.4% compared with 29.3% for the same quarter a year ago.

Net interest expense was reduced to $200,000. This is down from $3.1 million for the fourth quarter of 2006. This reduction is primarily due to the retirement of debt during 2007 and interest income on higher cash balances.

Income tax expense increased $2.2 million to $3.3 million brining our effective tax rate to 42.5% for the fourth quarter of 2007 compared to 29.4% in the fourth quarter of 2006. Our higher effective tax rate was mainly due to certain expense offering cost not being detectable for tax purposes in the fourth quarter of 2007, and the effect of the full 2006 R&D credit being recognized in the fourth quarter of 2006.

Now turning to the full year, reflecting our success in driving operating efficiencies, operating income for 2007 increased 56% to $27.7 million. Operating margins extended 420 basis points to 27% in 2007, up from 22.8% a year ago.

Net income increased to 149% at $15.2 million or $0.69 per diluted share compared with net income of $6.1 million or $0.34 per diluted share in 2006. On a non-GAAP basis excluding the $1.1 million and costs associated with the public offering the roll off $781,000 in deferred debt financing costs and $452,000 tax benefit related to these costs. EPS on a fully diluted basis would have been $0.75.

Turning to the full year 2007 operating metrics compared with full year of 2006 were as follows:

Gross profit margin declined slightly to 82.4% from 82.7% primarily as a result of the lower gross profit margin realized on the CLENZIderm product line. Selling, general, and administrative expenses including depreciation and amortization were $51.4 million compared with $40.9 million a year ago.

As a percentage of net sales in 2007, SG&A expenses declined to 50% compared with 52% last year. R&D expenses were $5.5 million compared with $5.9 million a year ago. As a percentage of net revenue, R&D cost decreased to 5.4% compared to 7.6% last year.

During 2006 we incurred an additional $400,000 in cost under a non-compete agreement with Dr. Zein Obagi a former officer and director that was included in the 2006 R&D costs.

Net interest expense decreased to $2.2 million from $8.2 million in 2006. This decrease is primarily due to the retirement of the long-term debt.

Moving to our balance sheet, as of December 31, 2007 our cash and cash equivalents totaled $14.1 million, up from $11.3 million in December 31, 2006. As of December 31, 2007, we had eliminated our debt under a senior secured credit facility as a result of debt payments made during 2007 totaling $25.7 million.

Working capital totaled $34.2 million and stockholders' equity totaled $49.7 million. This compares with $25.8 million in debt, $21.9 million in working capital and $17.9 million in stockholders' equity as of the end of December 31, 2006.

Let me conclude by providing our financial guidance for 2008. Based on the current trends in our core business and the sales trends for recently introduced products, we estimate that sales for 2008 will be in the range of 120 million to $125 million, representing a year-over-year growth of 18 to 22%.

We believe that 2008 will more likely track our historical growth rates and seasonality with the strongest growth reflected in the second half of the year. Earnings are expected to be between $0.94 and $0.98 for fully diluted share, based on approximately 23.2 million fully diluted weighted-average shares outstanding.

We believe our overall gross margin will be slightly lower as we wrap up sales volume of our CLENZIderm product line. We expect to incur additional operating cost such as professional fees, insurance cost related to the growth of our business. However, we believe selling general and administrative expenses will slightly decrease as a percentage of net sales in 2008. We believe that R&D expenses as a percentage of net in 2008 will generally be inline with 2007.

And now I will turn the call back over to Steve Carlson.

Steven Carlson - President, Chief Executive Officer

Thank you, Steve. To conclude, we expect to see continuing growth across all of our product lines. With growing product value (inaudible) growing portfolio of compelling clinical data, supporting our products efficacy, we believe we’ll continue to gain market share and successfully leverage our infrastructure across a growing revenue base in 2008.

With that I’d like to open up the call to questions.

Question-and-Answer Session

Thank you. Ladies and gentlemen, at this time we will begin the questions-and-answer session. (Operator Instructions). Our first question comes from the line of Angela Larson. Please go ahead.

Angela Larson

Good afternoon and thank you for taking the question. The trends on the international sales have been generally overall weaker than the overall business, but with the restructuring you have seen, you are looking for them to be inline with the US business. So tell us a little bit more about why you are actually expecting, accelerating growth from that franchise?

Steven Carlson

Thanks Angela. When you are going to clinic, you may change the international structure, but local representatives and the local regional times zone and then more effectively partner with our distributors in building their business. What we have also seen is we are having that local presence and partnering with the more identified appropriate distributor pool, we are seeing faster, new distributor agreements better new distribution agreements and then acceleration of key product registrations within those countries. So we actually expect to see international sales towards the back half of the year meet or exceed our US growth rates.

Angela Larson

That’s helpful. Could you give us all the EBITDA on the tax rate outlook for 2008?

Stephen Garcia

From the tax rate perspective, we believe that we will get back to what we had experienced and in prior years, more in the range of 38 to 40%. Of course, we are exploring ways that we can look to leverage our infrastructure or any advantage we may have we’ll be able to lower that rate. But this year was kind of anomaly for us, and again it was reflective of the class associated with the RF offering that were not deduct able.

Angela Larson

Thank you. And my very last question. Looking at the number of reps, you did not add any reps in the fourth quarter, should we view that as a negative sign or an opportunity that you are expanding the leverage of the existing sales force?

Stephen Garcia

When we look at the fourth quarter, and as we look at sales reps overall, we add reps based on the demand that we have within new accounts. We don’t try to get in front of growth by adding reps pre materially. So in the fourth quarter the decision was made in order to focus on our business, we still see strong new account growth and you can anticipate 3 to 5 additional reps per quarter have been added throughout 2008.

Angela Larson

Great. Thank you.

Stephen Garcia

Thank you.

Operator

(Operator Instructions). Our next question comes from the line of Elliot Wilbur. Please go ahead.

Elliot Wilbur

Thank you and good afternoon guys. And Steve I apologies, I missed the first couple of minutes of your comments and I guess and thinking about performance in the fourth quarter versus your expectations versus the Streets expectation, obviously a little bit shorter, but everybody was hoping for, would it be fair to characterize this as more of a macro issue obviously, you are, I am sure well aware of financial community concerns over decelerating discretionary consumer spending or is this really something you think that’s still you know, very much within your controls, so still more of an execution issue?

Steven Carlson

I think we have experienced and what we saw as we walked into last weeks of the year we had very strong momentum in our business across our product lines, as we had throughout 2007. What was unexpected for us was with mid week Christmas and New Years simply a number of our accounts were closed and we didn’t see that normal overflow that we have seen certainly over the last four years where Christmas and New Years was blocked in within the weekend or an extended weekend. As all I see the fundamentals of the business, we heard that is already plastic surgeons as it relates to higher expense procedures such as facials, we already have seen a macro slowdown in our business or the fundamentals within our business. I think some of the evidence of that and the incredible success in the launch Obagi ELASTIderm Decolletage system, which has been stronger than we expected out the door. I think it also indicative of an indication of we have come of the face and we have compelling and product out on chest and neck to the rest of our product lines which focus on the face. And overall if we still have substantial market penetration and growth opportunities, as you know, we had discussed before, we have less than 50% penetration in plastic surgery, less than 10% in derm, but on a product basis 2007 was a 1% penetration within the prescription acne, and about 2% penetration in cosmetic procedures. Again, those products in 2008 will just be heading first full year on the market place and we fully expect and our confident to see them continue to see growth.

Elliot Wilbur

Okay. And I guess with respect specifically to CLENZIderm, I mean looking at basically four quarters, if I remember roughly flattish years. So I mean, I guess in terms of moving that product up the curve, you think it’s a function of having more bodies out there or you think is a more function of having the right bodies and are you comfortable with the current competition of the sales forces, the dermatology sales force?

Steven Carlson

We see and I think this is new for us and CLENZIderm and the acne market place, which is focused on the therapeutic dermatologist, clearly there is a slow adoption curve and I believe that is really driven by the amount of the clinical data and the clinical experience that physicians need in that segment, before they knew about new therapy. As indicated in the recent academies both for various and San Antonio for American Academy of Dermatology, we are seeing an ever increasing depth and breadth of clinical data that can allow that at the early adopters in this segment continue to be very enthusiastic about the product and as we look at Q4 albeit it was down sequentially after the product launch of the system in Q3 from normal to dry. We saw 77% the earlier rate, so those who have gotten through the a lot of this data, I want to try that, I want to have my patients' experience in my own hands, are really seeing a success of CLENZIderm and are seeing those very high in the re-order rates even within the quarter. So we believe CLENZIderm actually has a really great potential in its overall clinical data flow and experience. We will continue to add additional headcount to support the demand as CLENZIderm ramps up.

Elliot Wilbur

Okay. One final question for you as well if you didn't see it immediately (inaudible) was pointed out to you very quickly, but obviously large competitors of yours somewhat south of your current geography is looking to enter the static market placeyou’re your partnership with clinic. So just want to kind of get maybe your perspective on the Allergan Inc. partnership and sort of what you think that means to your position in the marketplace?

Steven Carlson

I appreciate that Elliot. We do not comment on competition, but in this case everyone has seen the release. We believe much as Allergan does this may have a strong expansion on the physician dispense market as Allergan market to consumers that and recommend they really should go from the department store to see their physician for the best skin care options.

We will further evaluate our Condition & Enhance strategy that we came out with and the re-branding and re-positioning of those systems this past summer. So a lot of them are following those cosmetic procedures. I think third what the previous pricing strategy stated, it’s even a strongly indicated on Allergan and clinic that they are worried about discretionary spending in this targeted customer segment. I think further the release states that (Clinic) will be responsible for the cosmetic formulations. And as such no matter no what organic prescription products they have or they are working on. And I think this plays well for us, as we have such a substantial strong market Obagi brand in positioning is really the gold standard with prescription products in facial rejuvenation and really driving the patient satisfaction. And into last for us is, we have an incredibly strong relationships with our accounts our reps are more business consultants than they are detailed representatives and we think this is an opportunity for us as more consumers see their physician and potentially expand our overall marketplace.

Elliot Wilbur

Alright, thank you Steve.

Steven Carlson

Thank you, Elliot.

Operator

Thank you. And at this time, we have no more questions. Please continue.

Ina McGuinness

This concludes the call. Thank you very much and you can disconnect your lines now.

Steven Carlson

Thank you all.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!