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Theragenics Corporation (NYSE:TGX)

Q3 2012 Earnings Call

November 8, 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 Third Quarter 2012 Earnings Conference Call. It is now my pleasure to introduce Ms. Christine Jacobs, Chairman and CEO of Theragenics. Thank you, Ms. Jacobs, you may now begin.

Christine Jacobs

Thank you, Christine. Good morning, and welcome to Theragenics Third Quarter 2012 Conference Call. Thank you for joining us this morning. In a few minutes, I’ll provide you with some context about the quarter. But first, I’m going to turn the call over to Frank Tarallo, our Chief Financial Officer, for his comments on third quarter results.

Frank Tarallo

Thank you, Chris, and good morning, 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 in the third quarter was $19.9 million, down 5% from last year. Year-to-date revenue of $63.5 million is up 1%, compared to 2011. Let’s look at revenue by segment, as this is the best way to understand our results. Our surgical products revenue was $14.2 million in the third quarter, down 7% from last year. Nine months revenue of $45.7 million is up 1%, compared to 2011. We saw customer behavior become more erratic in Q3. We believe this is because of macroeconomic uncertainties that are cutting across not only our industries, but the entire economy. Chris is going to comment more on this in a few minutes.

Turning to our brachytherapy business. Q3 revenue was $5.8 million, down 4% versus last year. Nine-month revenue was $18.5 million, which was up 1%, compared to 2011. The acquired core customer base generated revenue of $1 million in Q3 and $2.8 million in the nine-month period. Excluding the incremental revenue from the acquired core customers, brachy revenue was down, consisting primarily of our TheraSeed revenue, as we saw a continued slowdown in the number of procedures in Q3.

Based on what we’re hearing from our customers and what is being reported by others, it seems clear that the recommendation against routine PSA screen made by the U.S. Preventive Services Task Force earlier this year has affected number of patients being diagnosed. It also appears as though more men are being counseled to opt for active surveillance, where the disease is simply monitored rather than treated. And it’s not just brachytherapy being effective. From what’s being reported, it appears that all treatment modalities are seeing declines in procedures.

While we’ve seen a material impact on procedures here in the short-term, 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 defer 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.

Turning to profitability, diluted EPS was $0.02 in the third quarter compared to $0.03 last year. For the nine-month period, diluted EPS was $0.07 this year compared to $0.08 in 2011. You may recall that we repurchased approximately $4.8 million shares in our modified Dutch auction tender in July. This reduction in shares had no effect on the diluted EPS we reported in the third quarter or year-to-date period of 2012.

Turning now to segment profitability. Our surgical segment reported operating income of $243,000 in the third quarter compared to $780,000 last year. Contributing to the decline in profitability was a reduction in our gross margin to 34% in Q3 this year from 37% last year. Our gross margin for the nine-month period was 34% in 2012 compared to 36% in 2011. Our sales channel and product mix continues to affect gross margins. We also continue to experience pricing pressure.

R&D expenses declined compared to last year. Although R&D expenses declined, we’ve not reduced the level of R&D activity. We’re simply more focused and better organized in our R&D activities right now than we were last year at this time, as evidenced by the launching of our third new product this year, which we announced just a couple weeks ago.

Let me now turn to profitability in our brachy business. Operating income was $906,000 in Q3, down from $1.2 million last year. I mentioned earlier the decline we saw in the number of procedures in Q3. This impacted the sales of our TheraSeed palladium product dropping about $1.2 million. We’ve talked before about the fixed cost nature of this business and how a decline in revenue has a material impact on profitability.

During the third quarter, we did successfully transition the acquired core customers to our new AgX100 iodine seed. As we expected, this had the effect of improving the profitability of that revenue stream. The profitability of this incremental iodine-based revenue helped offset some of the decline in palladium, but as we’ve mentioned previously, the iodine products are not as fixed cost driven and have less of an incremental impact on profit.

Our year-to-date operating income in the brachy segment was affected by the same trends that we saw in Q3, declining from $3.8 million in 2011 to $3 million this year. Looking at cash flow – cash flow from operations was strong at $9.3 million for the first nine months of this year compared to $7 million last year. Our capital expenditures were $1.4 million in the first nine months of 2012. We implemented our new ERP system at our one remaining location in the third quarter, so capital spending on the ERP implementation is now completed.

A significant cash flow item for us during 2012 has been the earnout based acquisition of the core customer base. Through the first nine months of this year, we’ve used $5.2 million on this acquisition. Remember that the total purchase price is earnout based, that is based on the actual revenue generated from the acquired customers. The earnout period goes through August of 2013. Now, this acquired revenue stream is of course being affected by the industry-wide decline in procedures I discussed earlier. So currently, we’re expecting to pay less than another $500,000 for this transaction through the earnout period. Of course, the actual amount we end up paying could be materially different based on the actual revenue generated from the acquired customers.

Another significant cash flow items this year was our modified Dutch auction share repurchase in July. We repurchased approximately 4.8 million shares, representing about 14% of the outstanding shares at that time. We used $10.4 million in cash for that repurchase and this was funded entirely from cash on hand. That repurchase is now completed and we have no plans for additional repurchases at this time.

Turning to our financing. We recently announced the renewal of our credit facility. The new three-year facility increases our maximum borrowings from $30 million to $40 million and lowers our interest rate from LIBOR plus 2.25% to LIBOR plus 1.75%. All other terms and conditions of our new facility, including the financial covenants, are substantially similar to our previous facility.

To wrap up, we finished the quarter with $31.8 million in cash, cash equivalents, and marketable securities. We have $22 million outstanding under our credit facility for a net balance of $9.8 million.

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

Christine Jacobs

Thank you, Frank, and good morning again. As I said in our press release from this morning, all four of our business units faced headwinds in this last quarter. The medical device sector is facing a triple threat of healthcare reform, the pending device tax, and macroeconomic uncertainty. Rather than spending our time this morning complaining about things that we can’t change or elaborating on how uncertain the customers are behaving, I’d choose to separate my comments into two sections. The first will be outlining some facts about our businesses and things that we’ve accomplished this quarter. And the second is addressing how we’re going to deal with the facts.

So to begin, I’d start with the medical device tax. We don’t think that the medical device tax will affect all of our products. We’ve been focusing in and trying to handicap the effects, perhaps between a half and three quarters of our product sales will be affected. Of course, these regulations continue to evolve and we’re going to continue to analyze the impact.

Our customers – yes, the activity that we discussed in prior calls is erratic, but they haven’t abandoned us. We still have our largest and our most prized customers who continue to call us and place orders. Our open orders remain a healthy $13.5 million at the end of third quarter. In the past couple of years, we have noted that our legacy customers have reduced or eliminated their R&D headcounts and expenditures. This represents opportunities for us in our surgical products segment, because we can help our customers with extensions in new products.

When our customers’ internal functions have been so far cut that they can’t handle any new workload, we’re going to be there for them. Our brachy business continues to have both exciting and sobering trends. The sobering trend is procedure declines. We believe that recent press recommending no PSA screening has dampened demand across all treatment options. The exciting trend is the continued opportunities for us to gain market share, as this is the case with the core transaction.

So on a go-forward basis, please don’t overlook the fact that we still have very profitable opportunities for market share. And even providing related services that could shore up the brachy business in both the short and the long-term.

Now this past quarter we had an opportunity to provide shareholders with a liquidity event in the form of a modified Dutch auction that we completed during the summer. This was the first time in our 31-year history that we did something like this. And we did so using cash on hand and did not severely cripple our balance sheet. Many of you were complimentary in your calls and your communications with us this summer. So thank you for that.

We have another event that we are pleased to report. We renewed our credit facility on more favorable terms and with greater borrowing capacity. Having negotiated these terms in these macro climates was a positive for us and a testimony to our fiscal conservatism. Especially when the auction was complete – or when the renewal was completed after the Dutch auction, the new facility will continue to provide us with flexibility and opportunities to capitalize on activities which help us grow organically and/or through modest acquisitions as attractive opportunities are presented.

Also this quarter we reorganized and expanded our distributor network for surgical products. And we now have wider coverage and more geographic reach in the United States. With more boost on the ground, we’ve experienced some early wins selling across the entire surgical line.

This year, we have launched three new products. The most recent being the Centeze line of drainage catheters. Selling and providing more products into our OEM and newly expanded surgical products distributor network is a high priority for us. Remember the Microslide for babies and premature infants that we launched this summer? This product was recently spotlighted at a poster session during a pediatric convention. And while sales are modest, demand and excitement around the innovation continues to escalate.

And finally, last quarter I mentioned outsourcing of manufacturing in our surgical products business. I’d like to expand and provide additional information. Last year, we began to explore this option and we ran an experiment with an outsourced molded product in Costa Rica for one of our surgical products. The experiment worked. Indeed, it was a near flawless execution.

This quarter, we decided that Costa Rica is an area for outsourcing in which we would like to expand. We have also identified several legacy products needing margin improvements. Margin improvements are critical for us to remain competitive in the long term. While this is new for Theragenics, it’s not new to our customers, and preliminarily has been overwhelmingly embraced by some.

So what then can we expect? Well, we’re not going to build or lease in Costa Rica right now. We prefer to get some provisional wins under our belt before we jump into the complexities of owning and managing offshore operations. We’ve identified the outsourcing of certain production functions which had substantially reduced our costs. So we will not be buying or leasing real estate. We do expect to incur capital expenditures for the program.

In the past, we have guided our investors in the area of CapEx spend and this practice won’t change. In his comments earlier, Frank mentioned that our CapEx so far this year has been $1.4 million. We expect to start to incur CapEx related to this outsourcing expansion as early as Q4 of this year. This year’s 2012 CapEx spend is expected to be $2 million to $2.5 million, a portion of which will include CapEx attributable to our outsourcing efforts. Right now, we expect that in 2013, CapEx will be $2.5 million to $3 million, including CapEx spending for outsourcing efforts. These amounts can change, of course, and based on opportunities and how quickly some of these programs ramp up. As I mentioned, we started with a small experiment last year and we will take further outsourcing steps in a controlled and a measured way.

So for perspective, we are not planning to abandon our U.S. manufacturing heritage, but we are preparing to meet the challenges of a new environment in a device sector that we believe is irrevocably altered and changed.

To conclude my remarks, I’d like to share our assumptions for the future. This then will lead you to our strategic initiatives. We believe that the landscape of healthcare and its delivery in the United States is irrevocably changed. We believe there is no normal anymore, whether we include capital markets, macro or microeconomics. We believe that healthcare reform is going to happen, whether it’s in the form of Obama Care or an amended reform.

We believe that softness in demand for our products and those of our customers will continue. We just don’t know for how long. We believe our customers are in a very tough environment right now and we intend to support them to the best of our ability. And we’re not going to compromise on quality standards no matter what the future. Our customers demand it and patients have a right to expect it.

And lastly, we believe that the medical sector, the medical device sector, will improve and grow. Demand for medical devices will recover. We just don’t know when. And remember that all the demographics that are in our favor, whether that includes the $69 million plus or minus baby boomers or the $23 million newly insured coming on as a result of Obama Care. So with these assumptions as backdrop, Theragenics is going to meet the challenges by continuing to seek margin improvement through eliminating redundancies, paring operations, and outsourcing the manufacture of certain legacy products offshore.

We have opportunities in both our surgical products and our brachy segment. Brachy has life in that, number one, we cure cancer. We have an industry with too much capacity and some competitors who are no longer as healthy as in years past. Our surgical products division is our growth engine. We intend to continue expanding sales channels, providing broader reach in the international markets and products. Our R&D is going to continue with prudent use of funds to license, purchase tuck-ins and to create our own extensions or products.

And finally a word about cash. Cash has and never will be a fad for us. Cash flow from operations was strong this past quarter. And while we have some variation quarter-to-quarter, we’re going to continue our prudent use of cash. In uncertain times as these that we have today, we believe that cash from operations should be considered a critical lever used to weather any storm. And cash provides the fuel when opportunities present themselves. And we also intend to continue to manage the balance sheet so it supports the future growth.

Now with that, Christian, we’ll open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Joe Munda with Sidoti & Company. Please proceed with your question. Your line is live.

Joe Munda – Sidoti & Company

Good morning, guys.

Frank Tarallo

Morning, Joe.

Christine Jacobs

Hi, Joe.

Joe Munda – Sidoti & Company

Real quick, Frank, when it comes from the device tax, how are you guys going to account for that? Is that going to come out of cost of goods or is there going to be a separate line item, an outline?

Frank Tarallo

Yeah, I think it’s probably – I don’t know that it’ll be cost of goods per se, Joe. We haven’t concluded on that. But regardless of where we account for it, we will highlight it, as a separate line item somehow so that you can see it in modeling.

Joe Munda – Sidoti & Company

Okay. And Christine, thank you for going into some detail on the CapEx and what your plans are as far as Costa Rica. I’m just wondering, since you said you’re not going to be leasing land or buying a place, are you going to be outfitting the place in Costa Rica with the machinery necessary to manufacturer? I’m just wondering how that’s going to work.

Christine Jacobs

There are several companies down there – I had an opportunity to spend a week down there. There are several companies where we’re probably going to be providing equipment. They provide infrastructure, talent, supervisors, quality, et cetera.

Joe Munda – Sidoti & Company

And you’re happy with the quality of work there?

Christine Jacobs

Oh, yes, that’s why the experiment. Like I said I’ve been – we send a product, we send a piece of equipment down there because I am worried about the quality. And because that is such – it’s not only high on our list of priorities, it’s what makes us special. And the other thing is that I want accountability for quality. And so we gave the project to a company and they passed with flying colors, like I said, and then we went and interviewed others. There is no one company down there who could meet needs across a lot of process functions, but for now, I am comfortable.

Joe Munda – Sidoti & Company

Okay. And then I’m just little confused. You guys used the $10 million obviously for the Dutch tender and then refinanced the debt. Why not instead of doing that buyback, use some of that cash to pay down the debt further.

Frank Tarallo

In the past year, we’ve always said we wanted some dry powder because we had some things sort of in the works from an acquisition or investment standpoint. And of course you saw us do the core deal, right, earlier this year and then we talked earlier this year about how we weren’t so much focused anymore on the larger acquisitions, but the tuck-ins and the licensing, et cetera, again, similar to the core deal.

And so given that, strategically, our board and we thought it was a good idea to provide that liquidity event in the form of the share repurchase for shareholders who chose to tender. I think where our circumstances right now are still similar where we still want some dry powder. And so we don’t really want to pay that debt down right now. Strategically, we’re still looking for tuck-ins, smaller deals, core type deals, licensing deals and we just like to have that ability.

Joe Munda – Sidoti & Company

Okay. So that leads me to my next question. Which side of the business are you guys looking on acquisitions on? Is it more on the brachytherapy client, customer list acquisition or is it more new products on the surgical side?

Frank Tarallo

Yeah. That’s a great question. And I think the answer is both.

Christine Jacobs

Yeah. We’re like a minesweeper right now.

Frank Tarallo

We think – but the opportunities are different in both parts of the business. In the surgical part of the business, you’re absolutely right. We’re looking for products that maybe we can buy or license or smaller operations that we can tuck-in where we’ve got available capacity or we can get some leverage. On the brachytherapy side, we think there’s opportunities to gain share because of some of the difficulties that there’s too much capacity in this space. And so some competitors are going to be running into some difficulties and there’s going to be opportunistic acquisitions similar to what you saw with core. So the answer is both sides of the business. But each one’s got a little bit different take on it.

Joe Munda – Sidoti & Company

I mean, would it still – would it be an OEM capacity or would it be a proprietary product that you’re looking at?

Frank Tarallo

It could be – on the surgical side you’re talking about, right? And so, it could be either. It could be either. It’s probably more likely a little more proprietary and something that might be complementary to our current family of products, but it could be either.

Joe Munda – Sidoti & Company

Okay. And I mean is there a range that you guys are looking at? Is there like a $5 million to kind of let’s say $10 million, or are you looking a little bit below that?

Christine Jacobs

I think that’s a sweet spot.

Frank Tarallo

Yeah, I think that could be a sweet spot. And I think you’re kind of looking at...

Christine Jacobs

When we look for these products and step up to also say – we’ve got a pretty strict set of criteria in that they got to be FDA-approved. We prefer they be a 510(k). We’re not interested in developmental-type companies and it’d really be nice if they needed distribution channel, sales channel. But they had that product ready to go and/or small sales that were already profitable. And if you look back at all of our acquisitions, that’s pretty much the criteria that we’ve had to date. We’re not interested in developmental companies at this point.

Joe Munda – Sidoti & Company

Okay. All right. Thanks, guys.

Frank Tarallo

Thanks very much.

Christine Jacobs

Great. Thank you. Christian, any other questions?

Operator

There are no further questions at this time.

Christine Jacobs

All right. Joe, anything else at your end? All right, he’s off.

Frank Tarallo

Yeah.

Christine Jacobs

Okay. Thank you very much. Christian, we appreciate it. And thank you all for listening.

Operator

Ladies and gentlemen, this does conclude today’s conference. You may disconnect your lines at this time. And we thank you all for your participation. Good day.

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