NeuroMetrix, Inc. (NASDAQ:NURO) Q1 2019 Earnings Conference Call April 25, 2019 8:00 AM ET
Thomas Higgins - SVP, CFO & Treasurer
Shai Gozani - Founder, Chairman, CEO, President & Secretary
Conference Call Participants
Jarrod Cohen - J.M. Cohen & Company
Good morning, and welcome to the NeuroMetrix First Quarter 2019 Earnings Call. My name is Demetria and I'll be your moderator on the call. On this call, the Company may make forward-looking statements which are not historical facts and are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature that depend upon or refer to future events or conditions are forward-looking statements. Any forward-looking statements reflect current views of NeuroMetrix about future results of operations and other forward-looking information. You should not rely on forward-looking statements because actual results may differ materially as a result of a number of important factors, including those set forth in our earnings release issued earlier today.
Please refer to the risk and uncertainties including the factors described under the heading Risk Factors in the Company's periodic filings with the SEC available on the Company's investor relations website at neurometrix.com and on the SEC's website at sec.gov. NeuroMetrix does not intend or undertake no duty to update the information disclosed on this conference call.
I'd now like to introduce the NeuroMetrix Senior Vice President and Chief Financial Officer, Mr. Thomas Higgins. Sir, you may begin.
Thank you, Demetria. I'm joined on the call by Dr. Shai Gozani, our President and CEO. NeuroMetrix is a health technology company with proprietary neurostimulation technology applied in chronic pain, sleep disorders and diabetes. Our primary commercial products are Quell, an over-the-counter wearable device for managing chronic pain and DPNCheck, a point of care test for diabetic peripheral neuropathy. There were several points of note in the quarter. First, we reported net income of $2.1 million or $0.26 a share. Second, we initiated a strategic review of the Quell business. This received significant attention which I will discuss. While the review was ongoing, Quell operations were maintained at lower volume levels, with significantly reduced advertising. Third, DPNCheck performed well and matched the strong Q1 of last year. Fourth, GSK related income of -- was $5.7 million, and in addition, GSK co-funded $400,000 of Quell R&D.
Lastly, we booked a provision of $700,000 for excess Quell classic inventory. This non-cash charge depressed our Q1 gross margins. Turning to the financials attached with the earnings release. Total revenue of $3.1 million was down 37% from $4.9 million in the prior year. The revenue drop was entirely Quell. Quell revenue was $1.6 million. It was down from $3.5 million in Q1 2018. Two factors affected Quell revenue. Advertising spending was reduced from $1.4 million to below $600,000, a cut of $800,000 or 60% of ad spending. In our business as in most consumer businesses, there is a direct and immediate link between promotion and sales. Q1 2018 reacted to reduced ad spending as we would have expected. Also, throughout 2018 we deliberately and steadily cut retail and direct response TV distribution channels due to their uneconomic performance. By Q1 of this year, we had curtailed nearly all retail and DRTV channels that were active four quarters earlier. Also in total revenue, DPNCheck revenue was $1.2 million. That was level with Q1 of the prior year. Sales activity for DPNCheck was strong in both our domestic Medicare Advantage markets and internationally, particularly Japan. Recall that Q1 of last year, sales had jumped 43% from the preceding year. This was a large increase in a business that tends to grow deliberately. We were able to sustain that year-earlier revenue level in the first quarter of this year.
Our legacy diagnostic revenue was $300,000, also level with Q1 of the prior year. Our older product lines are managed for cash flow, and sales volume of these products is expected to decline over time. Gross profit was $799,000 in the first quarter of this year. That's a margin rate of 26%. It compares with gross margin of $1,988,000 prior year and a prior-year margin rate of 40%. The current gross margin reflects a charge to cost of goods sold of $700,000 as I mentioned. This charge was necessary to write down inventory of the older Quell Classic to net realizable value. Quell Classic sales have been below expectations since the launch of Quell 2.0 last year. The $700,000 charge represents about 65% [ph] of the book value of Quell Classic finished goods parts and purchase commitments. Excluding that inventory charge from gross profit, our gross profit in Q1 of this year was $1.5 million and represented a margin rate of 48%, again in comparison with 40% of the prior year. Distribution management played a significant role in the margin gain. Approximately 88% of Quell sales went through e-commerce channels in the first quarter this year, and that exceeded our goal of 80%.OpEx spending totaled $4.5 million in the first quarter versus $5.6 million a year ago, a reduction of about 20%. R&D spending of $855,000 benefited from GSK co-funding certain co-development projects, which generated an offset of $400,000. Absent GSK, gross R&D spending was flat. Sales and marketing spending of $2 million dropped from $2.5 million prior year. I've mentioned the reduction in Quell advertising spending of $800,000 that was partially offset by $300,000 incremental spending related to the Quell strategic review. G&A spending of $1.6 million was down from $1.8 million prior year, primarily on lower professional fees and equity compensation.
Moving down the income statement. Collaboration income under GSK performance milestones totaled $5.7 million in the quarter versus $4.8 million year-ago quarter, an increase of about $1 million. Remaining GSK milestones total about $6.5 million.Net income of $2.1 million compares with $1.2 million net income prior year. On a per share basis, Q1 earnings per share of $0.26 basic, $0.15 diluted, compares with $0.18, $0.08 diluted year-ago quarter. Cash was $7.2 million at quarter-end. Our capital structure remains simple, equity-only, debt-free. Common shares outstanding are currently 8.8 million. Assuming convertible preferred shares are recognized on an as converted basis, the common share count is approximately 14 million, unchanged during the quarter. Dr. Gozani will now address our overall strategy.
Thank you, Tom. I will be covering three topics in my comments. First, an update on our Quell strategy review. Second, the status of our GSK collaboration. And third, an update on our DPNCheck business. So starting out with our Quell strategy review. As we noted during our fourth quarter and year-end earnings call in February, we are not satisfied with the Quell customer acquisition costs and profitability of the Quell business in general. As a result, we initiated a [indiscernible] analysis project with a leading global consulting firm. Their analysis evaluated market segmentation, competitive position and pricing, promotional strategy and product configuration. The project recently completed and we are digesting the findings and considering potential changes to the Quell business model.
Overall, our perspective is that there were no major surprises. But a number of recommendations and observations have been made that may be beneficial to the business. Also, in connection with this research, we have been conducting various in-market tests. We expect to complete our review and, if necessary, implement business model changes during this quarter. In the meantime, we continue to receive positive feedback on Quell 2.0, and our ASP and gross margins are up substantially compared to the original Quell. We're also encouraged by the growing body of evidence indicating strong user engagement with Quell 2.0 that we believe could lead to attractive long-term aftermarket sales of electrodes.
Recent publications in peer reviewed journals and scientific presentations at pain medicine conferences have further confirmed the clinical benefits of Quell in people suffering from chronic pain. As one particularly good example, the chronic low back pain study conducted at the Brigham & Women's Hospital Pain Management Center in Boston and published in Pain Practice recently, reported statistically significant reductions in pain intensity, pain interference with function and reduced pain catastrophizing in the Quell group in comparison with control.
Brigham & Women's recently initiated a randomized sham-controlled trial of Quell in patients with fibromyalgia. The study schedule indicates that we might see clinical results on this trial in the second half of 2020. The combination of user reviews and expanding body of clinical feedback causes us to remain quite bullish about the commercial prospects for Quell as we complete this review. While we are reviewing our strategy, we have reduced advertising spending, as Tom noted, to modest levels to preserve our cash while maintaining brand momentum.
Moving on to a GSK update. We continue to focus on our collaboration with GSK in support of their market launch of the Quell technology outside the U.S. We view the GSK relationship as a major asset of the Company certainly for the funding that we receive, but also the learning value inherent in working closely with one of the leading global companies in consumer healthcare and in pain in particular. In the first quarter, we achieved a major development milestone for which we received a payment of $4 million. We're actively collaborating on R&D with GSK under our 2019 joint development agreement, which incorporates ambitious objectives for Quell 2.0 and beyond that span both functionality and cost reductions continuing with our DPNCheck update. The DPNCheck business continues to perform well.
The Medicare Advantage segment of the business added several major new accounts, where we initiated product shipments in the first quarter and expect further activity this year and beyond. We're also pleased with the progress made by Fukuda Denshi, our partner in Japan, since they took over the business from Omron Healthcare last year. We also remain quite optimistic and bullish about opportunities in Mexico. However, we also recognize that the timing of potential sales is now unpredictable as a new central government establishes priority and allocates funding. We are in close touch with our Mexico partner during this transition. We have initiated an R&D project to upgrade the DPNCheck technology and reporting capabilities. This product refresher should facilitate adoption in new markets and may encourage a device replacement cycle among existing users. The timing for completion of this project is expected to be late 2019 or early 2020. We foresee continued growth of the DPNCheck business, which achieved revenues of $4.2 million in 2018, and we expect operating margins to be maintained at levels above 60%. DPNCheck is a valuable, although often unrecognized asset in our business. Our sense is that is not adequately reflected in our market capitalization.
And that represents our prepared comments. We would be happy to take questions at this point.
[Operator Instructions]. And our first question comes from Jarrod Cohen with J.M. Cohen & Company. You may proceed.
Just a more strategic question. In terms of your review of the Quell with your consulting firm, what were some of the feedback in terms of the customer acquisition because you do get good reviews from -- I see from the customers, sort of the user base of the customers. Is it -- is the acquisition more just -- the customers that you have seems to be people who've tried other things, mostly surgeries, and it seems like they go to the -- try the Quell after trying different things to solve their chronic pain. So it's a last resort. Is it so? [Indiscernible] trying to go to those types of customers you need to? Or what type of review did you get?
Thanks for the question, Jarrod. The review was quite broad. I think we're not in a position right now to give the full accounting of the review, although we will share that with the shareholders and investors shortly. I think the -- what really we're trying to do with this review is understand the market and segment the market into an -- and sort of in line with what you're asking, identify those segments, those characteristics which are most apt to adopt and most ready to adopt Quell. So we looked at really all the demographics and psychographics, so the profile of the individuals and also their prior kind of medical history and experience of chronic pain. So all of that went into the analysis and identified segments of the chronic pain population and in particular identified several segments that are most, I think, attractive for us to focus our marketing energy and resources on. So I wouldn't say specifically those that are in a last resort kind of mindset, but definitely kind of what they've tried and their experiences to date in terms of managing their chronic pain do enter that analysis.
Okay. Yes, it kind of -- it seems like people want to try surgery before doing anything else. They think that will solve it. And it turns out it probably doesn't, and then they go on to other things.
Yes, I think that's well-stated. I mean, we have seen that -- in general, people -- either people with chronic pain or suffering from chronic pain have either failed surgery or don't want to go down that path, and that does represent part of the -- part of our focus. So that sort of insight is coming out of this analysis.
Okay. And then the last thing. Do you still get people resistant to the product because of price? Or is that, sort of, people aren't as resistant anymore?
Well, there's definitely a -- there's a strong price elasticity. We've known that since before we launched the product. We did a pretty detailed pricing study. And so obviously at lower price points more people are going to acquire the technology than at higher price points. I think in the course of doing this particular extensive market analysis, we have good quantitative data now to understand that price elasticity curve and the implications of different price points. But -- yes, price is an important -- very important consideration in adoption, and I think now we have the datasets that allow us to understand that a lot better.
Okay. All right. Thank you.
Thank you, Jarrod.
And our next question comes from Robert Blemisher with Blemisher Asset Management [ph].
Can you tell me what the terms are on those publicly traded warrants that you got hanging out there? Expiration and exercise price?
Give us just a minute here. We may be able to get that to you. Those warrants were issued, I believe, four years ago. So there is probably about 1 year left in terms of the term. Exercise price of those warrants -- and I may be wrong on this, but I believe that it's $40 exercise price. So that's just been burned [ph] internally.
Okay. And then -- my next question just had to do with the R&D spending of $850,000. I know you said that GSK was in the neighborhood of about $400,000 on that. Can I kind of deduce from that that about half of your R&D spend was on Quell and the other half on DPNCheck?
No. It will be heavy -- more heavily DPNCheck. I would say in the first quarter, it was -- it was more -- there was definitely DPNCheck spending, but it was -- it was more heavily tilted than 50/50 towards Quell. Not everything in our R&D is offset by GSK. A large portion of it -- answer: Not everything that is Quell necessarily is offset by GSK, although a significant portion of it is.
Okay. That was it for my questions. Thanks, and have a great day.
Thank you. So do you.
[Operator Instructions]. Thank you, and that now concludes our Q&A portion of today's conference. I would now like to turn the call back over to Dr. Gozani for any closing remarks.
Well, thank you for joining us on the call today, and we look forward to updating you over the balance of the year.
Ladies and gentlemen, thank you for attending today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.