Theragenics' CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: Theragenics Corporation (TGX)

Theragenics Corporation (NYSE:TGX)

Q2 2012 Earnings Call

August 9, 2012 11:00 am ET

Executives

Christine Jacobs - Chairman and CEO

Frank Tarallo - CFO

Analysts

Joe Munda - Sidoti & Company

Operator

Greetings and welcome to the Theragenics' second quarter 2012 earnings conference call. (Operator Instructions) It is now my pleasure to introduce the speaker, Ms. Christine Jacobs, Chairman and CEO of Theragenics.

Christine Jacobs

Good morning and welcome to Theragenics' second quarter 2012 conference call. Thank you for joining and calling in this morning. We've received positive feedback from many of you on the new conference call format that we used last quarter.

So we're going to utilize the same format this morning. We want to provide you with context and insight on our most recently completed second quarter. And we will spend less time repeating financial information that we assume you've read or you're going to read in our earnings release that we issued this morning.

So with that, I'm going to turn the call over to Frank Tarallo, our Chief Financial Officer for his comments on the results of the second quarter. Frank?

Frank Tarallo

Thank you, Chris, and good morning to everybody. 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 identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Now, I'd like to comment on our results. Our consolidated revenue of $22 million in Q2 is our highest quarterly revenue ever, and up 2% over last year. Consolidate revenue for the first half of 2012 was up 4% over last year. Our revenue is best understood by looking at our segment results, so let's do that.

Our Surgical Products revenue in the second quarter was up 3% over last year. The $15.9 million in revenue is also our highest quarterly Surgical Products revenue ever. All three of our product platforms, wound closure, vascular access and specialty needles contributed to organic growth in Q2.

For the first half of 2012, our Surgical Products revenue was up 5% over last year. And on our last call, Chris mentioned the loss of a large customer in our specialty needle business. Recovering from that loss has dampened the revenue growth, but fundamental demand is there at all three of our business units.

Turning to our Brachytherapy business, Q2 revenue was up 1% versus last year. For the first half of 2012, revenue was up 3% over last year. The acquisition of the Core customer base in February had a material impact in 2012.

Incremental sales from this acquired customer base was $1.2 million in the second quarter and $1.8 million for the first half of this year. Excluding the incremental revenue from the acquired Core customers, revenue was down, consisting primarily of our TheraSeed revenue, as we saw a slowdown in the number of Brachy procedures in Q2.

New IMRT centers continue to have an impact on Brachytherapy procedures. We also heard from physicians and others in the industry, that the recommendation against routine PSA screening, which was made by the U.S. Preventive Services Task Force earlier this year, may have also affected the number of patients being diagnosed. Even when diagnosed, it appears as though more men maybe opting for active surveillance, where the disease is simply monitored rather than treated.

It's difficult to say, whether these factors will impact the total number of prostate cancer cases that get diagnosed and treated over time, whether these factors will simply differ the procedures to some future time or whether we'll see an increase in metastatic prostate cancer, if the diagnoses come at a later stage of the disease.

I'd like to turn to profitability now. EPS was $0.02 in the second quarter compared to $0.04 last year. The drop in our Brachy profitability, which I'll address in a moment, was the reasons for the decline in EPS. For the first half of 2012, EPS was $0.05 the same as last year.

Turning now to segment profitability. Our Surgical segment recorded operating income of $588,000 in the second quarter, 18% higher than last year. Our gross profit margins were 34% in Q2 compared to 36% last year. Our sales channel mix continues to effect gross margins.

Sales to our OEM customers, which have driven much of our recent topline growth, typically carry lower margins than sales through other channels. For the first half of 2012, our gross profit margin was 34% compared to 35% last year.

SG&A in our Surgical segment as a percentage of revenue for 2012 was similar to 2011. SG&A ran at 24% in Q2 compared to 25% in second quarter of last year. For the first half of this year, SG&A was 26% compared to 25% last year.

As we continue to centralize some of our back office functions across the company, we expect to see some economies of scale and efficiencies in the SG&A area. It's difficult to predict the timing on when we'll see those economies, but we are moving towards these benefits.

R&D expenses declined in 2012 compared to last year. Although R&D expenses declined, we have not reduced the level of R&D activity. We're simply more focused and better organized in our R&D right now than we were last year at this time.

Let me turn now to profitability in our Brachy business. Operating income was $747,000 in the second quarter down from $1.5 million last year. I mentioned earlier the decline we saw in the number of procedures in Q2, this impacted sales of our TheraSeed palladium product compared to last year dropping about $1 million.

We've talked before about the fixed cost nature of this business, and how a decline in revenue like that has a material impact on profitability. The incremental revenue from the Core iodine transaction was profitable and helped offset some of the decline in palladium. But as we've mentioned previously, the iodine products are not at fixed cost driven and have less of an incremental impact on profit.

We expect the profitability of iodine seeds sales to increase further in Q3. Through June 30, we were supplying the acquired customers within iodine seed provided by Core Oncology under a temporary supply agreement. We were paying a fixed transfer price during the transition period.

In the second quarter we introduced our new AgX100 iodine seed which we manufacture internally. All iodine customers including the acquired customers were transitioned to our new AgX100 seed by July 1. Looking forward, this should improve margins on this revenue stream up to about 40%, more than double, what they have been during the transition and ramp up stage.

One final comment on the transition of the acquired customers. Through the acquisition, which happened in February and then the transition to a new seed, we've retained about 90% of the acquired customers. We think that's a very good result.

Looking at cash flow. Cash flow from operations was $4.9 million for the first half of the year and capital expenditures were $982,000. In the absence of any special projects or opportunity, we expect our CapEx spend for the full year of 2012, excluding the Core asset acquisition to be around $1.5 million to $2.5 million. The portion of capital spending on our new ERP system will come down in the second half of this year, as we successfully implemented the system at our one remaining location just last week.

A significant cash flow item for us is of course the acquisition of the Core customer base. Through the first half of this year we've used $4.8 million on this acquisition. Remember that the total purchase price is earn-out based and is based on actual revenue generated from the acquired customers.

We estimate we'll use another $4.6 million in cash for this earn-out based acquisition over the next 15 months. We expect to fund these earn-out payments through cash flow from operations and existing balances. Of course, the actual amount we end up paying could be materially different based on the actual revenue generate from the acquired customers.

I'd like to comment on our credit facility. We paid off our term loan in June. Over the last three years, we've paid down $10 million under that term loan.

Our revolving credit facility, which provides for maximum borrowings of $30 million, matures this October. We are currently in active discussions to renew or replace this credit facility. At June 30, we had $22 million outstanding under the facility and we have $38.7 million in cash, cash equivalents and marketable securities.

To wrap up my comments, I want to talk about the share repurchase we completed on July 17. We utilized $10.4 million in cash including transaction cost for this repurchase, and we funded the entire amount from cash on hand.

If you're modeling us, remember that this transaction is not included in our June 30 numbers, as it occurred in the third quarter. Had this transaction closed in Q2, than our June 30 cash and investment balances would have been $10.4 million lower.

This wraps up my comments. And I'd now like to turn the call back over to Chris.

Christine Jacobs

Thank you, Frank. We just had our highest revenue quarter in our 31-year history and we're certainly confident in our long-term prospects. The challenges will be, continuing changes in customer behavior, margin improvement, responding to pending regulatory pressure resulting from the medical device tax, and addressing the changing dynamics of the healthcare industry in connection with the implementation of ObamaCare.

But first, let's talk about results. I'm going to address surgical products. Specialty needles, the recession has changed our customers' behavior and expectations. Our customers are demanding, not just pricing concessions, but they want visibility into our long-term plans to enhance efficiencies. We did not see this abating, and we're actively engaged in addressing the shift. More on this a little later in my comments.

On the flipside, specialty needle has a lot of prospective projects in the planning stages. Not all of these prospects will turn into revenue, but what this mean is that we have a brisk amount of interest in our capability and the challenge is going to be to capture this with efficient operational processes.

Vascular access, new orders and healthy demand continued a positively effective business. Our customers are hungry for more and more of our products. And our new product pipeline is critical to take advantage of the opportunity.

Last quarter, we announced two new products. And I am pleased to report that the Microslide for pediatric and preemie babies continues to provide new sales, albeit small, and increased access to new accounts that we did not previously sell into. The Valved Tearaway is out in the hands of customer for approval, and is being used in clinical settings by at least one of our early adopter customers. Demand is brisk for this new addition.

Wound closure, we lost a large customer this quarter, who decided to bring the product in house. On an absolute basis, the loss is not material to Theragenics. It's less than $1 million annually in revenue, but it is a disappointment in the wound closure business. But nonetheless, other large customers continue to renew there contracts and order our product.

Now Brachytherapy, there have been some developments in the Brachy business this quarter that may have potential effects on the industry going forward. First, let me comment on the several years of decline in the industry.

Last quarter, we were hoping that these decline and industry procedures had leveled off. But this quarter our customers told us that the decline in prostate procedures continued. We saw this in the palladium sales, which are down about $1 million year-over-year, but this fact needs clarity.

We understand procedures across the U.S. have declined. Our competitors in robotic surgery even noted the decline in robotic procedures in a press release. So it appears that the decline of palladium sales is not unique to us.

We won't exactly know the reasons for this. But we can surmise that the New York Times stories and widely distributed press on PSA screening, and anti-radical prostatectomy recommendation have reduced screening and consequently reduced new prostate cancer diagnosis and case is treated.

And we have an inkling that some of these patients may be cautious or bit worry of treatment in general. But overtime, we think that men diagnosed with prostate cancer won't be satisfied with the wait and see approach. And they're going to want to seek some sort of treatment.

Now, on another front we had three major positive events in the Brachy segment. The first is a recent article at a William Beaumont Hospital saying, "Brachytherapy is the most cost-effective treatment for prostate cancer."

This is wonderful news and it adds to our growing dossier of support for our products. The second event is the launch of our own AgX100 iodine seed and the successful conversion of both our previous existing and our newly acquired iodine customers to the new seed.

This has significant impact for a long-term prospect. We now have a new book of business with the former Core customers. We've got a complete product offering, and we have the ability to manufacture both leading types of Brachytherapy treatment seed. Making our own iodine seed gives us profit potential. So we're going to be able to capitalize on immediately and this is all good news for us.

Lastly, year-after-year we have discussed the non-level playing field as it pertains to the reimbursement by CMS for various prostate cancer treatments.

Our physician customers have long complained of over-utilizations of IMRT and as a result of CMS reimbursement, which unfairly rewards doctor for steering patients to more expensive treatment. And that's been unfortunate, for both patients and for the Medicare system in general. But the good news is that recently released CMS prospective payments for 2013 have reduced payment for IMRT and proton therapy.

In an unusual move CMS even cited public press and pressure from MedPAC and severely cutting reimbursement for IMRT and proton therapy. Now, we can't forecast when or the extent to which this change is going to positively effect the industry, but we suspect something is coming in the months, and the years that follow.

Now I'd like turn our attention to the big picture where we have a policy of not forecasting revenue and profit. We have a fresh commitment to enhance discussion of our strategy, positioning or challenges both macro and micro prospects and our goals.

So in Brachytherapy, we have many, many changes over the past years. In the past six to seven years, we've witnessed a decline in Brachy procedures. We reorganized our Brachy business back in ' 05 in order to address the decline that we saw coming.

Since then, we've focused on maintaining profitability and cash flow, and we look forward to attractive opportunities to pickup market share when they presented themselves, so that we will be well positioned when condition is changed.

This strategy has served us well in addressing the churns in Brachy business over the past few years. The Core transaction last February has contributed nicely. And it helped offset some of the declines that we've experienced in Q2. The advent of our new iodine seed and that additional revenue in profit are positive events for the segment.

The new data on Brachy cost effectiveness has us perfectly positioned in the phase of healthcare reform. And lastly, CMS changing the reimbursement scheme for competing technologies has fresh potential for us. So on a go forward basis be mindful, there are still opportunities in the Brachytherapy sector, and when they make sense for us we're going to take advantage.

Now for our Surgical Products the assets that we've amassed since 2005 continue to deliver. They deliver revenue now representing 71% of our business. The assets represent our future and a long term prospects as a medical device manufacturer of Specialty Devices. The investments we've made over the years have positioned us for organic growth, as we showed up our infrastructure.

To thrive in the dramatically shifting healthcare business, we're going to undertake new initiatives to increase profitability and to integrate further in the months to come. What this means is, we're going to make up original changes to approve efficiencies and reduce cost in order to get ready to implement the medical device tax and ObamaCare.

And make no mistake the advent of the healthcare reform act increases our expenses. It brings new taxes and complexities to us, as an employer trying to provide benefit to its employees. So what does all this means, well over the past year, we've experimented with offshore manufacturing of Surgical Products. The first experiments went well. And we're going to entertain expanding this for products that we feel could safely be outsourced.

Remember my comments about customers demanding a path to long-term efficiencies. Well, this is one experiment of many, that here we will take to keep and to attract our customers. The reality of additional taxes and increased expense adds to the urgency. And please note that I said, we're going to expand our offshore experiments, not abandon U.S. manufacturing, and there is big difference.

In addition, the Surgical Product businesses that we bought are currently, and in some cases two to three times the size of when we bought them. We now have the scale and the infrastructure, for instance our ERP system to enhance and improve efficiencies. And we're actively addressing this. For example, we don't need full accounting and finance staff at every single site, and we can consolidate processes fee and in some case vendors.

In the product development pipeline, over the years I've talked about wanting more pipeline products. While we've centralized our R&D activities and as Frank mentioned, we're spending less but seeing the same level of activity. Now this is exactly the type of projects that we're working on. There is a myriad of activities and plans underway to affect to more in-depth integration of our Surgical Product business.

Our goal is to position our assets in the phase of an unseemingly fairer tax, increase compliance expense and changing customer behavior. None of this is a change in our strategy. We will remain a specialty medical device manufacturer.

Now, we are excited about these operational changes and our future potential. Our long-term strategies are providing high-quality medical devices continuing to deliver results, just like what we saw this quarter with record revenue.

Organic topline growth remains the focus. Operational tweaks like the once that I've just mentioned above in the phase of new taxes present unique challenges, yet certainly they're not in surmountable.

So the wrap up, I want to say a bit about our recently concluded Modified Dutch Auction. This event was the first of its kind in the 31 year history of Theragenics. And we were thrilled to be able to provide additional liquidity for you, our shareholders. Almost 5 million shares were repurchased with the premium-to-market for selling shareholders.

Your calls and comments into the company were overwhelmingly positive. And we thank you for the calls. And know that your suggestions and comments are always heard. After all the repurchase was impart a result of shareholder feedback. So we appreciate your support. Thank you for your attention this morning and will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Joe Munda of Sidoti & Company.

Joe Munda - Sidoti & Company

Real quick on the Brachy side, how much of the growth that you guys saw year-over-year was organic versus the acquired customers?

Frank Tarallo

It all came from the acquired customers, Joe. I think as Chris mentioned, as well as I did in my comments, we were down about $1 million with, let's call it the existing customers. So the growth all came from the acquired customers.

Joe Munda - Sidoti & Company

I mean, that can't sustain, what are your plans going forward with Brachy? I know your comments were very cautious, but with IMRT and procedures coming down, what are your plans going forward in that business?

Christine Jacobs

As I've said in the past, Joe, we've been brutally honest about our positioning with Brachy. That is done, a very profitable cash flow contributor to the operations of the company.

As I've also said in the past, I did not expect Brachy procedures to ever go to zero. We don't know what the study stated, and I think in the coming months now with this reimbursement issue, we might see it dance around for a little bit. So my comment on future prospects for Brachy is steady as she goes.

And I'll tell you, the nice upside that we're experiencing with the new customers with Core and now an opportunity to manufacture a second seed with attractive margins, I think we want to let the dust settle on all of this, and also remember that there are additional opportunities for profitable, accretive market share that I don't want us to miss.

Joe Munda - Sidoti & Company

And then on the med device tracks, first, how are you going to count forward? And second of all, are your plans to raise prices to offset some of that?

Christine Jacobs

Well, I will let Frank take this as well. I could be totally candid given this environment and what I described about customer behavior, Joe. I think it would be irresponsible for me to sit and plan to say we're going to have a price increase, and we're going to pass it along to our customers. That is not the environment that we're in today. And I think it would be a dangerous strategy.

What I've said and what my gist of my comments today are; is that we've got some plans to remain extremely competitive, going forward. But I don't think to assume that we can pass on a price increase is prudent.

I also think on additionally, Joe, I'm a little cautious waiting to see this influx of 23 million new patients and what that means for us. Those of us in the device industry, I don't think are figuring that that is going to materialize. So we're dealing with hardcore realities of our environment back here.

Now, as far as the impact financially, I'll let Frank jump in.

Frank Tarallo

Joe, I think your question was how we're going to count forward, right?

Joe Munda - Sidoti & Company

Yes.

Frank Tarallo

We haven't decided. To be honest with you, from what I have seen and what I've read, there is many companies that are saying they're going count forward is SG&A. As at least the one, I think it's been Medtronic, who recently said that they're going to count forward below the line if you will as another expense item.

So we haven't decided how we're going to do it. We have to see what the final regulations look like. How material it's going to be which we clearly expect it to be material. And then we'll decide how we're going count forward. Either way, we will obviously, highlight it, and what those numbers are and where it appears in our P&L going forward, beginning next year.

Christine Jacobs

And Joe, I'll add one thing, we're planning for it. And everything you heard from us today is our strategy to get ahead. But it's not over yet. Depending on what happens with elections. I do need to say, that I believe it was the House of Representatives put forth a bill and voted on a bill to repeal this device tax. So in the device tax specifically, I'm not talk it about the whole Affordable Care Act just, the device tax because there are several congressmen and senators who have huge device manufactures in their districts that are very active. So we're planning for it, but I do have to say it's not over.

By the way, I'm very surprised you didn't hop on the CMS reimbursement. You're always all over with this. And I mean this is the first time we've add some really good news in a while.

Joe Munda - Sidoti & Company

Yes, that's probably, why.

Operator

(Operator Instructions) I have no others coming into queue at this time.

Christine Jacobs

Well, Joe, thank you for your questions. Thanks for given us an opportunity to talk about the device tax. We will look forward to talking with you again next quarter. Thank you all. That ends the call.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time.

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