Derma Sciences' CEO Discusses Q1 2013 Results - Earnings Call Transcript

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Derma Sciences, Inc. (NASDAQ:DSCI) Q1 2013 Earnings Conference Call May 16, 2013 11:00 AM ET


Kim Golodetz - IR, Lippert/Heilshorn & Associates

Edward Quilty - President, Chief Executive Officer

John Yetter - Chief Financial Officer, Executive Vice President, Finance

Barry Wolfenson - Group President of Advanced Wound Care and Pharmaceutical Development


David Amsellem - Piper Jaffray

Scott Henry - ROTH Capital

William Plovanic - Canaccord Genuity


Welcome to the Derma Sciences' First Quarter 2013 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded May 16, 2013.

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

Kim Golodetz

Thank you. This is Kim Golodetz with LHA. Thank you all for participating in today's call. Joining me from Derma Sciences are Ed Quilty, President and Chief Executive Officer, and John Yetter, Executive Vice President of Finance and Chief Financial Officer. Barry Wolfenson, the company's Group President of Advanced Wound Care and Pharmaceutical Development will join us for the Q&A portion of the call.

Earlier today, Derma Sciences announced financial results for the first quarter of 2013. 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, 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, product development, commercialization or technological difficulties, the success or failure of negotiations and trade legal, social and economic risks.

Also, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live call, today, May 16, 2013. The company undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call.

With that said, I would like to turn the call over to Ed Quilty. Ed?

Edward Quilty

Thank you, Kim. And thanks to each of you for joining us this morning. We have got a lot of things to cover, so we will jump right in.

I am very happy with what we achieved during the first quarter, both financially and operationally. We are reporting continued strong financial momentum with total net sales of 23%, advanced wound care or as we refer to it, AWC, growth of 67%, including TCC and organic advanced wound care growth. Excluding TCC of 33% which is right in line with our expectations for the first quarter. I do want to point out however that on a quarter-to-quarter basis both advanced wound care and traditional wound care sales tend to be seasonally soft in the first quarter. Historically, if you go back and look three years, that’s been the case every year and internally we plan for that.

So when we look at our comparisons for the fourth quarter of 2012 versus first quarter of '13, they are flat but within our expectations and within our plan for 2013. Having said that, we still full expect to meet our commitment of 30% to 40% growth in AWC during 2013. That said, advanced wound care sales during the first quarter reached 40% of total net sales. As you know that’s very important to us. That’s up versus 29% in last year's first quarter. Why that’s important is as the margins, as the sales in advanced wound care become a bigger percent of the overall sales, the margin in the company begins to shift upward. And that’s shift happened in Q1 of this year.

Our gross margins were 35.7% in Q1, and even when you exclude the contribution of TCC, gross margin was 33.6%, up from 31.9% on the same group of products last year. In addition I am pleased to report again that our both our Phase 3 trials are now underway with the DSC127, our topical drug candidate for the treatment of diabetic foot ulcers. And as announced, earlier this week we have engaged Plexus Ventures to help us explore strategic options in markets outside the United States.

In addition, we are just beginning to look at DSC127 for the prevention and reduction of scars and we are formulating our plan for further early stage research in coordination with the peptide inventors at the University of Southern California. I will go into a lot more detail on our quarter and our execution and discuss upcoming milestones that you can look for, but first I would like to turn it over to John Yetter, our Chief Financial Officer, who will give you a run down on our first quarter financial results. John?

John Yetter

Thank you, Ed. Good morning to our listeners. I assume at this point that everybody has had a chance to review the 10-Q and the press release, so I will limit my comments to the highlights of our operating performance and financial condition. Ed gave you a very good run down of the first quarter of 2013 versus '12, so I will just skip the highlights there. Obviously, net sales increased $3.5 million or 23%. Sales in the U.S. experienced consistent growth, 30% plus. Our sales in Canada declined due to carryover of loss of traditional wound care business.

International sales were up approximately 15%. I won't repeat the gross profit information and I will go right into direct expenses consisting of distribution, marketing and sales expenses and R&D expenses were higher as expected. In line with our AWC, advanced wound care growth and DSC127 development initiative. G&A expenses were also higher due to TCC related incremental overhead brought on in the past year, and intangible amortization expense and higher equity based compensation, legal, regular compensation and benefits, and other professional service expenses.

All of the above resulted in a net loss for the quarter of $6.2 million or $0.38 per share loss versus a loss of $2.5 million in 2012 or $0.24. One way of looking at this $3.7 million increase in the net loss quarter-to-quarter, is that the increase is principally attributable to the higher R&D expense of $1.9 million, higher equity-based of approximately $1 million, and higher intangible amortization expense of $0.5 million, attributable to principally the TCC or MedEfficiency acquisition last year.

Now let's take a brief look at Q1 2013 versus Q4 2012 to see how our business is trending. As Ed mentioned, first of all it's important to understand that historically our first quarter sales have been relatively flat and our TWC sales have been down 7% to 10% versus the fourth quarter of the previous year historically. That has been the case for the last three years and this year is no exception. As expected, net sales decreased $1.3 million or 7% to $18.8 million in Q1 2013 versus $20.1 million in Q4. AWC sales were down slightly, $200,000 or 3%, $7.5 million, while TWC sales declined $1.1 million or 9% to $11.3 million.

Gross profit decrease about $0.5 million or 6% to $6.7 million. Our gross profit percentage increased slightly. Direct costs were up 13% due principally to higher equity based comp. Our national sales meeting which is a Q1 event each year, annual comp and benefit increases that take place on January 1 and some growth related sales and marketing hiring. R&D expenses increased $400,000 or 17% to $3 million, in line with our DSC127 development plan. G&A expenses increased $300,000 or 9% to $3.6 million due to principally to higher equity based comp.

All of the above resulted in loss of $6.2 million or $0.38 versus a net loss of $3.7 million or 27% -- $0.27 in Q4. Again, one way of looking at the $2.5 million increase to net loss Q1 over Q4 is that the increase is principally attributable to equity-based comp expense of $900,000, lower margin associated with a lower normal sales in the first quarter, higher R&D expenses of $400,000, and the non-recurrence of a $600,000 deferred tax benefit reported in Q4, again related to the MedEfficiency acquisition.

What's this all mean and what should we take away from these results? Let's take a moment to recap. Advanced wound care sales grew 67%, 33% excluding traditional total contact casting, in line with expectations. Advanced wound care sequential quarterly sales are down slightly in line with historical performance and again consistent with our expectations. We expect advanced wound care sales to continue to grow in excess of 30% organically on an annual basis in 2013. Traditional wound care sales grew 5% in Q1 over Q1 of the previous year, in line with expectations. Traditional wound care sequential sales were down 9%, in line with historical performance and consistent with our expectation. Sales in Canada represent a challenge for us going forward and we also have some opportunity that we are looking into and exploring.

We expect TWC sales to be flat to 2% growth in 2013. Our gross profit is presently 35.7%, we expect this percent to improve gradually going forward, due principally to favorable sales mix associated with the strong growth of our higher margin advanced wound care product coupled with a lower growth of our lower margin traditional wound care product. We have started to see a trend with the advanced wound care direct expense growth leveling off as planned incremental resources were put in place over the last couple of years. We believe we now have the infrastructure established to drive sales growth and leverage this investment. In the absence of any change in our AWC growth strategy, we look forward to seeing sequential advanced wound care segment sales and product contribution improvement going forward.

We will continue to nurture our traditional wound care business in an effort to sustain it and grow it where possible. We have had a gradual increase in the level of quarterly R&D spending in support of our Phase 3 program. This trend will escalate significantly over the next two years, now that the clinical trials have begun. Year-over-year G&A expenses have increased due to the MedEfficiency acquisition along with general and inflationary increases and higher bonus, equity based compensation, legal, board, insurance, rent, professional service expenses. We have expanded our headquarters office base to accommodate our growth. We have expanded our intellectual, information technology capabilities to cost effectively deal with the increased needs of a growing business keeping abreast with technology.

We have initiated a number of tax studies to better prepare the company for the future and completed an independent valuation of the DSC127 for diabetic foot ulcers. Just this week we announced that we have engaged to assist us with exploring our options for DSC127 outside the U.S. That having been said, we believe that we are affectively managing our G&A expenses and doing an excellent job leveraging our core G&A resources in response to the growth of the business.

Now let's take a look at liquidity. In the first quarter we used $2.2 million of cash comprised of $3.7 million used in operations, $100,000 for capital expenditure, partially offset by $1.5 million cash coming in as a result of the exercise of warrants and options, and $100,000 sourced from working capital. Keep in mind our $3 million of R&D expenses is included in the $3.7 million used in the operations figure. Keep in mind again that the $3.7 used in operations is net of $2.5 million worth of non-cash charges consisting of depreciation, amortization of intangibles, and equity based compensation. Excluding the $3 million spend on R&D, we burned approximately $700,000 from operations in the first quarter.

At the end of the first quarter we had $43.7 million of cash and investments on hand and $57 million of working capital, obviously including the cash and investment. Our receivables were in excellent shape. Our inventory after growing in 2012 was down slightly and properly positioned to support our continued business growth. We expect [prepays] to come down going forward now that the R&D clinical trials have started. There has not been any appreciable change in our other current assets and liabilities other than in response to normal changes in our business. Overall, we do not anticipate a significant change in our working capital requirements throughout the balance of the year.

Based on our long-term strategic plan, we believe we have sufficient capital to sustain the planned growth of our existing business and development of DSC127 for diabetic foot ulcers without the need for further capital. At this point I would like to return the call back to Ed. Ed?

Edward Quilty

Thank you, John. So as you can see, our financial results reflect our corporate strategy as we laid it out for you. Again advance wound care, AWC, is our growth engine, and our two anchor brands, MEDIHONEY, TCC-EZ, are getting excellent reviews in the market. TWC is performing better than planned in the United States, especially in first aid products but weaker in Canada due to pressure on price especially when competing for the lower margin dressings.

The net result will be our achieving our goal of flat sales or a few percent growth on TWC in 2013. As mentioned earlier, we have now begun both of our Phase 3 pivotal studied and in future quarters our financial will reflect the increasing cost of enrolling patients and we will report to you on our progress. Lastly, we will continue to explore opportunities to add new products to our AWC portfolio. Our operating business as defined as non-R&D segments, will start to generate positive cash this year which will give us more flexibility as we look for ways to accelerate growth.

Our domestic field organization now stands at 56, focusing on the nation's 1200 plus wound care centers. We now have three executives in our corporate accounts group. Our Vice President of Corporate Accounts, (inaudible) and his team are focusing on building contractual relationships with group purchasing organizations, hospital networks, the government, and leading operators of wound clinics. These relationships will help our territory managers at the local level as they pursue new business. Our clinical team now at numbers five, led by (inaudible) our head of clinical, and they are an important support to the field selling team, educating the customers critical to our growth.

This talented group of direct sales reps, clinical specialists, corporate accounts team along with our novel portfolio, or portfolio of novel brands, is a key asset for Derma Sciences. We believe the market demographics and trends favor our AWC group and will allow us to sustain the continued growth that we indicated to you we will achieve. Specialized wound centers are becoming a more important settings wounds as the population continues to age grappled with obesity. Additionally, economic factors are driving the health care industry to look for new models with a focus on provider compensation based on driving cost out of this system while improving overall care.

Here at Derma Sciences we are confident we have the right people in the right places with the right product mix to capitalize on these market dynamics. Importantly for Derma Sciences, as our products become better know and as more clinicians continue to reach for them in both challenging and ordinary situations, and as more research is being presented at key wound care conferences, the selling job is becoming faster and more efficient with each new sales representative able to pay for him or herself sooner. This was evident at our national sales meeting when the top rep for 2012 had only started with Derma Sciences at the end of the prior year. So in one year this person, this lady, led the pack in building new sales at Derma Sciences.

Last month at the important Spring Symposium on Advanced Wound Care or the SAWC, which was held in Denver, Colorado, we again had a strong clinical presence with 15 posters covering MEDIHONEY, TCC-EZ, XTRASORB and BIOGUARD. I was there at the opening on Thursday night, the weekend of the meeting, and clearly Derma Sciences was more active than any of our competitors. We sponsored a satellite symposium on the role of TH in chronic wound healing, which is a significant topic supporting one of the important aspects of MEDIHONEY, our booth was expanded from the previous year and as the meeting went on, we hosted a number of demonstrations on our product including the very important TCC-EZ.

As we look at our AWC portfolio, our flagship MEDIHONEY continues to perform very well in the United States with the body of evidence for its wound healing properties becoming increasingly strong. Sales in the first quarter increased a robust 55% over sales in Q1 of 2012. This validates the leverage we have seen from our increased sales infrastructure, given that sales in Q1 2012 had only increased 32% over Q1 of 2011. Sales of MEDIHONEY HCS have been strong for a new line extension, and this is helping to fuel the overall 55% growth.

As we have discussed previously, we are pursuing MEDIHONEY HCS as an over the counter product in the United States, and we are optimistic for a launch later this year. We believe that this will be an ideal OTC dressing for certain burns and wounds that are typically treated at home. TCC-EZ, total contact casting system, continues to perform extremely well. Sales were up 9% in the first quarter over the fourth quarter of 2012. TCC-EZ is becoming an anchor product in our AWC portfolio. Yet with market penetration below 2% for this treatment, there is plenty of room for upside growth.

Our sales and marketing team have done an excellent job reigniting the conversation about the effectiveness of total contact casting, which has been around for quite some time and due to its 89% healing rate for diabetic foot ulcers, is widely considered the gold standard for offloading or to remove the pressure from these ulcers. Even with this excellent clinical efficacy, traditional total contact casting is severely underutilized as I mentioned with that 2% usage. Most clinicians feeling that it takes too much time, requires too much training to apply correctly, and is simply not worth the effort given the risk and the level of reimbursement for time spent during application.

Clinicians are finding that with TCC-EZ, everyday our reps are introducing them to a completely novel total contact casting system that removes all of the barriers that I just mentioned, from utilization. We have high expectations for this product and we are working on some programs that we believe at some point may result in even higher changes in utilization rates. We will report on our progress of these programs by the end of the year.

Regarding AWC sales outside of the United States, we continue to show great progress. Q1 2013 was our best quarter yet for sales in Latin America/Asian territories. Growth versus prior year was 77% and versus prior quarter was 15%. This was mostly attributable to the initial sales in our newest international distributor in South Korea. Sales to our Latin American distributor are also the highest they have ever been at this time of the year. As you may recall, at the end of Q1, we hired Mario Neto, VP of International Business Development to focus on these territories. And he is doing a great job in engaging and supporting our current distributors while also pushing for conversions and looking for new potential distributors in key territories.

We hope that news to report by the end of this year, on new exclusive distributors that will continue to drive our international expansion. The story in Europe/Middle East is somewhat mixed with a slower growth rate in the UK than we had hoped, but good growth as planned elsewhere in continental Europe. We also continue to see strong growth in the Middle East with key contracts recently won in Saudi Arabia that could provide some meaningful growth moving forward. Overall sales to customers in the EMEA region increased 14% in the first quarter versus prior year.

As mentioned previously, in March we acquired the long-term global exclusive rights to the casting element within TCC-EZ. At the symposium on advanced wound care last month in Denver, we held a global TCC-EZ launch meeting with our key business heads, and this information has now been passed along to our international distributors. As expected, there is much excitement from our distributors about launching this novel product. Diabetic foot ulcers, amputations associated with them, and the dire mortality rate subsequent to these amputations, are not just a U.S. phenomena. It is estimated that globally there are over 1 million amputations associated with diabetic foot ulcers each year. Over 900,000 of those outside of the United States.

Prevalence data from 2011 suggest that globally there is amputation associated with a diabetic foot ulcer every 20 seconds, and unfortunately as most of you have heard us speak about in our presentation, the mortality rates at five years if you have an amputation associated with a diabetic foot ulcer are staggering. Total contact casting will be new treatment modality in many countries outside the U.S., so the potential impact on patients' lives is enormous. We expect initial training to begin in the coming months, product trialing by customers within Q3, and sales to potentially begin as early as fourth quarter of this year.

Let me turn now to our traditional wound care products where sales grew nicely over the prior year. As I said earlier, our first aid products led by our VP [Steve Gussing] and he is leading the charge helping us achieve our traditional wound care goals. As we also said earlier, sales in Canada have been impacted by the loss of some business in a very competitive marketplace. Luckily for us, the business that we did lose for price was business that was the lower margin business to begin with. Similar to advanced wound care, first quarter sales traditionally are softest than the other quarters of the year.

As I said earlier, we expect growth of TWC to be between 0% and 2% in 2013. This reflects the level of investment that we made. Recall that this segment tends to be cash flow positive, and although it has lower gross margins than AWC, it is a very good source of cash flow for our company. You will recall that in the last quarterly call I mentioned the reorganization we did at the first of the year, splitting TWC and AWC and Bob Cole and Barry Wolfenson were named respective Group Presidents. We have also added resources to advance our private label sales in traditional wound care in the United States. And already this is beginning to work and these initiatives will help us to continue to achieve our traditional wound care goals

So let me turn to DSC127, our potential blockbuster drug that certainly could change the lives of many patients around the world and certainly make Derma Sciences the major player in treating diabetic foot ulcers. The two Phase three trials are now underway with site initiations ongoing. The first trial which is a two-armed study with 211 patients in each arm commenced in February. The second trial which is the three arm study again with 211 patients in each arm commenced in April. While it is too early to comment on the number or randomizations in the study, I can say that we are encouraged by the interest among investigators and look for data readouts from both these trials as we have told you before, during the second quarter of 2015.

We said repeatedly that DSC127 has the potential to be a $900 million global product with $300 million of that in the United States. These estimates are based on typical adoption rates of well utilized 510(k) wound dressings since there has never been a small molecule pharmaceutical drug approved for the treatment for diabetic foot ulcers. It is possible that utilization rates for such a drug, especially the heal rates in our Phase 3 study mimic the one seen in our Phase 2 study, will be even higher. Presuming the FDA approval, we expect that DSC127 will fit seamlessly into our dedicated sales organization here in the United States.

Outside of the United States where we have minimal direct sales resources, we have determined it is in our best interest to explore options for the growth candidate. Towards that end, as you know earlier this week we announced that we have engaged Plexus Ventures to explore strategic options for DSC127 outside the United States. We went through a very extensive review of business development companies and chose Plexus Ventures after spending a lot of time looking at who would be the best people to work with us. The process is expected to take 9 to 15 months and to culminate with one or more agreements covering specific geographies or countries in Europe, Asia and emerging markets.

As I said earlier, we are very pleased to work with Plexus and we think they are a fine organization. They have more than a 20 year track record of working with companies both large and small, on in-licensing, out-licensing, acquisitions, divestitures, and strategic partnerships. Some of their more recent work has included divesting products for such names as Novartis and AstraZeneca. We are looking forward to determining our options to maximize shareholder value for this important asset.

In addition to pursuing an indication for diabetic foot ulcer healing, as I mentioned in my opening remarks, we are closed to finalizing an initial pre-clinical development plan with the University of Southern California for a post-surgical scar reduction and prevention program with a new formulation utilizing the API within the DSC127. Our goal is to have roughly six to nine months of initial activities that would point towards a decision regarding whether or not to pursue an investigational new drug application with the FDA on this indication at some point during 2014. Scar formation following surgery is not only a cosmetic concern but it also is a significant clinical problem that can lead to disability and disfigurement.

According to the CDC estimate, in 2010 there were about 51.4 million inpatient surgical procedures performed in the United States. About 1.5 million aesthetic procedures and about 1.2 million reconstructive surgical procedures. The market for an effective scar reduction treatment likely dwarfs that of the diabetic foot ulcer market and could be as much as $4 billion. That being said, we are only in the beginning stages of considering any advanced program for this indication and we will update you as we make progress and as appropriate.

Our current cash position, as John mentioned, is $43.7 million and we are comfortable that this is more than enough to fund our DFU trials through the conclusion. Again, this gives us great leverage as we start the process of working with Plexus Ventures on partnering activity because we don’t have -- we are not in a position that we have to take a transaction or do a deal with someone. Gives us much more flexibility in dealing with people and making the right decision long-term for the company and its shareholders. In addition, given that we expect the other two segments of our business to be generating positive cash flow this year, Derma Sciences has never been in a stronger financial condition.

Of course, should we successfully conclude one or more of the transactions on DSC127 outside the United States, this would bring in additional cash and this cash could be used to help fund our other R&D activities, acquisitions, new AWC assets or increasing the number of people that we have selling and marketing our products and will bolster the value sales and profits of Derma Sciences. We have invested in research, products and talent to make Derma Sciences a leader in advanced wound care. Our financial results and sales momentum are proving the soundness of our strategy and our expectations are for continued growth well into the future.

When combining the value of DSC127 with what we are building each quarter in advanced wound care, the future here at Derma Sciences and for our shareholders is very bright. With that I will open it up for questions. Operator?

Question-and-Answer Session


(Operator Instructions) Your first question is from David Amsellem with Piper Jaffray. Please go ahead with your question.

David Amsellem - Piper Jaffray

I have just a few. First on TCC-EZ. Can you talk about what are the major barriers in your view to further penetrating that market? You talked about market penetration begin below 2%, so where do you think are the biggest barriers and what are you doing to sort of win over hearts and minds?

Edward Quilty

David, it's good to speak to you. I am going to let Barry Wolfenson, the Group President of Advanced Wound Care take that question.

Barry Wolfenson

Good question, David. Utilization rates again are based on the traditional total contact cast which has been out for years. And while you get some very good rates, there are some drawbacks to the application of this system that have held that utilization rate very low. In fact most of the utilization of traditional total contact cast are sort of homemade kits that are made in the facility themselves, grabbing the 17 various components from different parts of the facility. Rolls of tape and rolls of fiberglass and what not. So really at this point for us it's just a matter of, as Ed said, sort of reignite the conversation with our customers. We have got a great system, it's totally novel and it really does get away from the barriers that have held utilization rates low. So there is obviously the scale of our sales force as part of them and that’s Ed in his comments says that, as we keep on hitting our numbers this year, we are going to be analyzing any further investments into the size of the sales force. But getting out there and telling the right story is going to drive sales. We actually had a meeting with, I think eight of the top key opinion leaders in the space back in March, the results of which will be a consensus document that again will remind clinicians the significance of total contact casting. The evidence supporting its use and the availability of our novel product.

David Amsellem - Piper Jaffray

And then my second question is just a follow up on the seasonality commentary. I just wanted to be sure that I understand what are the sources of the seasonality in both the advanced segments and the traditional segments? Is it just order patterns that typically are soft in the beginning of the given calendar year? Are there other considerations that I should be thinking about there?

Edward Quilty

I think there is -- first of all, it's historical and it occurs every first quarter. And there are some reasons why it occurs. You know the fourth quarter is always traditionally the strongest quarter and it has to do with as you mentioned, the ordering patterns. You know there are contracts that we have with distributors that are incentive contracts and some of those people that they haven’t met those incentives in the fourth quarter, they tend to make sure that they do because those are what drives their pricing and future negotiating with Derma Sciences. So there are ordering patterns and just certain things certainly when we look at the first aid part of the business which is a big one, that one is very simple. Less bandage are used in the middle of winter than are used in middle of summers. And first aid is a big factor in seasonality, although as I mentioned in my remarks, we are really doing very well in that business not only in sales but our margins have been improving.

So it's just certain things, David, and to be frank with you, we achieved what we budget for in the first quarter. So we have a pretty good feel for the business and we expect that we will still achieve in advanced wound care that 30% to 40% guidance that we had given you previously.

David Amsellem - Piper Jaffray

Okay, that’s helpful. And then a couple of questions very quickly. DSC127, if I may, how are you satisfied with the patient enrollment thus far in the Phase 3. And then regarding scar reduction, any specific color on what the next clinical development step would be, what the next trial would look like in scar reduction? Thanks.

Edward Quilty

Good questions. With regard to scar, I really can't give you all that much guidance at this point, I will be frank with you. There is some clinical activities that we are going to be doing and some intellectual property activities that we will be doing as well. Not a major expense but the clinical stuff sort of builds on the pre-clinical work that was done back in early 2000 with USC which showed very very promising results. But this will just be sort of new formulation sort of work and kind of revalidation that the clinical efficacy is going to be there. With regard to enrollment in the study, the realty is simply that it's just too early to really start commenting. What I can say to you is, our sort of 2015 second quarter read out is based on our charts, very detailed charts per week on randomizations per the two arm study and for the three arm study. And as of this week we are probably a couple of weeks behind on O1 study and I think a weekend ahead on the O2 study with regard to randomizations. But the [end] is so small, it's just not even worth talking about.

We are trending exactly, basically spot on to where we thought we would be at this time. Certainly as we move forward, we will be able to provide more guidance on that.


Your next question is from Scott Henry with ROTH Capital. Please proceed with your question.

Scott Henry - ROTH Capital

Guys, a couple of questions. I thought your prepared remarks very thorough and I appreciate that. For starters, the base wound care business, I believe in 2012 your guidance was 2% to 4% growth. Have you set guidance for that business in 2013, just noticing that the first quarter was ahead of that?

Edward Quilty

We have. We have said that we would from flat to 2%. I have mentioned -- Scott, it's good to speak to you by the way. I mentioned in my remarks that the sales were down in Canada and we lost some business in Canada. We are not -- we can't be the low cost provider and give the level of quality and regulatory support that we give our customers. And frankly in Canada some of the groups up there made a decision that that wasn’t important to them. So they switched to somebody that was a lower cost provider that doesn’t, in my opinion, provides a level of support that we do. And that costs us some business. Fortunately, it was lower margin dressings and we maintained some of the more important business in that country.

So we took that, we had to take that into consideration when planning TWC for 2013. We always expected that we are going to lose pieces of business here and gain others. One of the things that Bob Cole has done is hire and individual to be the head of private label sales and this gets this, this management would adjust for couple of months. And he has been out knocking on doors and he is already starting to change and generate interest in making new private label products in our plant in Canada. That helps in a couple of ways. One, it will give us sales at margins similar to business that we lost, and it will also absorb overhead in our facility and help us to be more effective as a manufacturer.

So we are taking steps to get new TWC business where we lost it and the net results we believe will be zero to 2%. Having said all that, my personal opinion is that I believe we have a very good chance to do better than that and certainly the efforts that we are putting in place this year are going to help us in 2014.

Scott Henry - ROTH Capital

Okay. So we should expect perhaps even a negative comp at some point in 2013 for the base wound care business, if we are going to get down to 5% to 2% or perhaps at the higher end of that [gun]. Shifting gears, if I could -- if you want to respond?

Edward Quilty

Yeah, you may see the second quarter in the traditional wound care is going to be probably a little bit of a tough one for us. We had some projections on what's going to happen on Canada, so it will be a bit of a tough one but we will meet our commitment for the year based on the new things that we have going on.

Scott Henry - ROTH Capital

Okay, great. And then as well, any thoughts on SG&A for the year? Is first quarter reflective, I know you do have your launch cost in first quarter but you also make decent expansion in the rest of the year. Should we be thinking about kind of $39 million $40 million for SG&A for 2013.

John Yetter

Yes, it's John Yetter. Scott, I think that’s a very good forecast on your part. I think our expenses there we have made some modest incremental investment in some of our sales and marketing, R&D. But in terms of overall expenses I think Q1 is a good representative of expectations for the balance of the year.

Scott Henry - ROTH Capital

Okay. Thank you. That’s helpful. And then in terms of hiring Plexus to look at out-licensing the O-U.S. rights for DSC127, how should be think about a timeline on that process? I mean is it a six month process, any kind of color that can kind of set expectations for that?

Edward Quilty

Speaking with them as we went through the process of interviewing other potential firms to represent us, I think 9 to 15 months is probably a timeframe that you can look at for getting a conclusion to that process.

Scott Henry - ROTH Capital

That’s helpful. I think that’s just about it. I just want to confirm I had this correct. On the scar prevention timeline, we should be looking for pre-clinical data, I believe in 2013 and then a decision on whether it's going to the clinic in 2014. Is that the correct way to think about it?

Edward Quilty

Yeah, I think that’s accurate. I mean the clinical data might push us slightly into 2014 but it's sort of going to be coming together of IP activities and clinical activities that give us some (inaudible) down in 2014 to look forward.


Your next question is from with Bill Plovanic with Canaccord. Please go ahead with your question.

William Plovanic - Canaccord Genuity

Just a couple of questions here. You talked about, you know we saw some of the operating expenses bump up a little and some in sales and marketing. Ed, where are you in terms of the number of reps that you are carrying in the [USC] space?

Edward Quilty

We have 38 territory managers. And then in addition to that, those 38 territory managers are supported by regional managers, there's four of those. We have four specialists, one in each region. We have three corporate accounts people. One person in-charge of distribution. Five clinicians that work in field to support our customers from a training standpoint. We have a head of private label sales, head of distribution sales, I think they all total up to about 56, if I haven’t missed anybody. But the actual territory managers are at 38 territories.

William Plovanic - Canaccord Genuity

And any plans on extending the number of territory managers this year?

Edward Quilty

Not this year. Our plan is to take a look at that. We do our planning meeting at the end of October. We will have more data then. We will have a better feel for how the sales reps we hired last year have done. How long it's taken them to start to make a positive contribution. And based on our growth rates, we will make that decision. The good news for us as I mentioned, the operating business, non-R&D we will start to this year, generates some positive cash flow. And as you know because of the R&D program we are not going to make any money in the next and so we complete that program in 2015, if the growth is there and we can fund those people out of the cash flow of the business, we are going to take a look at pretty more rest of where we need them, if we have to.

William Plovanic - Canaccord Genuity

Okay. And then we have talked about, it's a little too early to make the call on the metrics for enrollment. When do you think we will have enough history that you can gauge exactly where you are versus the bogey timeline?

Edward Quilty

I think at the next call we will start to have a real feel. It will still be kind of ramp up time. At the end of the year the numbers and randomization should be under it and we should have did more of a terminal monthly rate that we could confidently report to

William Plovanic - Canaccord Genuity

Okay. And then, I know I might be jumping the gun, but you have an analyst day come up in the next couple of weeks. Is there anything we could expect from that or we should be focused on that, think about calling to that?

Edward Quilty

I think it's going to be a really good analyst day. We are going to have both the investors of DSC127, the individual TCC-EZ cast. We are going to have one of the key MEDIHONEY users in the country will be there, from one of the largest institutions in the country. We are going to have some other scientists there. There will be other users of the products will be there, in addition to management. So I think you will get a lot of good information about -- one thing we hope to walk away with that meeting is, for the analyst to really understand not only the potential of DSC127 which I believe you do, but the value of these brands that we are building, specifically MEDIHONEY and TCC-EZ cast and what value they can create or should be creating in your mind as we hit our goals every quarter. And as you and I have discussed our goal by the time we get the results of DSC127, we want to drive this sales and marketing process of these key brands, so that we have a very valuable business outside of DSC127. And that’s going to be driven by achieving our sales goals. So we want you the analyst to come away with the potential that exists to generate cash and profits from that business.


(Operator Instructions) Your next question is from (inaudible). Please proceed with your question.

Unidentified Analyst

Ed, I continue to be very impressed with the breadth of rather complex activities that you have been able to manage over the last couple of years and with this latest thrust on looking at scar reduction, it just adds one more to that impressive list. I would like to follow up on the issue of sales reps. As we look at the 38 direct territorial reps you have, what is the target of, what level of production in terms of gross revenue per sales person do you start to feel that they are supporting their weight.

Edward Quilty

First of all thank you for your kind comments. All of us appreciate it and it’s a team effort and the teams are doing a great job. You know it costs about $200,000 to put a rep out there, so it's about $450,000 or $400,000 that they have to sell just to cover that or more than $450,000. So that’s when they start to make a positive contribution. That of course does not cover all the overheads of the company. When a territory -- one of the keys to building the advanced wound care business is growth within the same account. So there maybe, one of these wound center may see 150 patients a week and all those 150 patients with many of them are going to be candidates for one of our key product. So the more that rep can be in the same center working with different positions and clinicians, better they can grow the business. So we like to do that. We would rather have our reps building an account than running to ten different accounts in the same day. Unfortunately they have to do that because, in many cases because people want to see them and it's demand and they want to start a new account.

So when a rep starts to achieve about $1 million of territory, it becomes a little difficult for them to do a great job servicing that business. So that’s about the point that you start to look at, does it make sense to add some people. And we expect this year many of our territories to show several hundred thousand dollars of growth. So we will look at that, as we said earlier, towards the end of the year.

Unidentified Analyst

Assuming you make the kind of progress that you are anticipating in 2013 and you said you are not going to add more reps this year. But as you look to ramp to the potential introduction of DSC127, which I guess would be where, early in 2016, somewhere in that timeframe?

Edward Quilty

Yeah. Some....

Unidentified Analyst

So you have got the 2014-2015 for additional ramping. Is there some kind of number that we should be thinking of assuming, again, that things go well, that you are trying to achieve?

Edward Quilty

I think, Harvey, a lot of it depends on what we do. Certainly we ramp, and if the product is approved and get to 80 to 90 people, that’s probably around -- 80 or 90 people seems to be a good number for where we call where our reps spend the majority of their time. A lot depends on whether we would partner with a bigger sales force that’s spending in time in general practitioners' offices and podiatrists, and it's very likely that we would do that, because it will help us penetrate the markets faster and we are going to be good where we specialize. So, yes, we would ramp up our selling organization to around that 100 and then we will look for different ways to get distribution into other channels where the product can be used. And I believe, and I know Barry believes, that these GPs and these podiatrists will be a big subscriber of DSC127 because they are the first people we go to. And when somebody who has a diabetic foot ulcer likely they wind up their podiatrists or at their doctor and the ability to write a prescription and help that patient very quickly. And so both the wound clinics and the physicians' offices.


There are no further questions, please proceed with your closing remarks.

Edward Quilty

Well, we want to thank everyone for your time today. As I mentioned, we continue to be very pleased with the progress of the company and we hope that you are. I continue to be very proud of our organization, our company. Seems we are getting bigger and bigger is better for us because it gives us more opportunities. I know many of our employees come to me and say, how proud they are to be part of Derma Sciences and the good work that we are doing to help patients with these chronic non-healing wound. And it’s also nice to be part of an organization that is growing because in the past few years a lot of organizations haven’t. So right now Derma Science is a very good place to be and we will continue to work every day to improve shareholder value. And we look forward to coming back and reporting our second quarter progress to you. With that, have a nice day. Thank you.


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

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