CardioDynamics Q3 2007 Earnings Call Transcript

by: SA Transcripts

CardioDynamics International Corporation (CDIC)

Q3 2007 Earnings Call

October 9, 2007 4:30 pm ET

Executives

Michael Perry - CEO

Steve Loomis - CFO

Rhonda Rhyne - President

Analysts

Daniel Owczarski - Belmont Harbor Research

Operator

Welcome to the CardioDynamics third quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Michael K. Perry. Sir, the floor is yours.

Michael Perry

Thank you, Dave. We welcome everyone to this afternoon's call. With me is Steve Loomis, our Chief Financial Officer; and also Rhonda Rhyne, our President.

Let me turn it over to Steve before we get started.

Steve Loomis

Great. I'd like to quickly walk through the Safe Harbor language before we get started here. Obviously we're precluded from disclosing any material non-public information, but we're happy to discuss our progress to-date.

Our discussion may contain predictions and estimates and other forward-looking information. The use of the words estimate or estimates, expect, project and similar expressions are intended to identify these statements. These statements represent our current judgment on what the future holds, and we certainly believe them to be reasonable. However, these statements are subject to risks and uncertainties that could cause the actual results to differ materially from what we expect. Important factors relating to our business are described in the risk factors section of our annual report.

Michael Perry

Steve, thank you very much and good afternoon. We appreciate all of you joining us for today's call. As you can see from the press release, we achieved 8% growth in the ICG business during the quarter. Year-to-date, this business has grown 12%, so we were pleased with that level of growth. We also completed the sale of the Vermed business at the end of the quarter, so the operating results and comparisons that are shown in the press release and what we will discuss on today's call are for the ICG business only.

This was the third consecutive quarter of year-over-year revenue growth that we've seen during the past three years. The growth in the ICG business was driven by continued productivity improvements by our domestic direct sales force. That was up 13% in the quarter.

Also, strong results in our proprietary ICG sensor business. During the quarter, our recurring sensor revenue grew 15% and also improved 5% sequentially over the second quarter. When you compare to the first quarter of 2007, the sensor business was up 19% during the third quarter.

Our clinical application specialist team continues to be very successful in driving improved customer satisfaction and the appropriate use of our devices through the BioZ Assessment Process, or what we call the BAP. There are now presently over 1,600 customers that have initiated the BAP process and approximately 250 of those have fully implemented this process. The way we define that is they have demonstrated improved sensor utilization for two or more months versus the baseline sensor utilization that was in place prior to the initiation of the BAP.

These early customers that have fully implemented this process are improving their average utilization in the 20% to 25% range, some much greater than that. So again, we continue to believe this is a successful program and we'll continue to implement it across our customer base.

Our ICG gross margin improved 11 percentage points to 72% in the quarter. That was driven by an increased average unit selling prices and increased mix of our recurring sensor revenue; 32% in the quarter versus 30% last year. We also had reduced indirect manufacturing cost allocations that Steve can speak to later during the call.

Our operating loss improved 22% during the quarter, continuing that trend. It was $1.2 million, or $334,000 better than the third quarter last year. Our overall net loss -- which does include the discontinued Vermed operation -- in the quarter was $853,000 or $0.02 per share and that was compared to net income of $665,000, or $0.01 a share in third quarter 2006.

Now recall last year's third quarter results included a $2.2 million non-cash accounting gain that was on our convertible note. Otherwise without that gain, the loss would have been $0.03 per share in the third quarter 2006. So again, continued progress in the net loss as well.

Another measure that we're looking at is the operating loss less non-cash charges of depreciation, amortization and stock option compensation. Many of us know this as the EBITDA. For the ICG business, that was $930,000 in the quarter, or 42% below the $1.6 million that we experienced in the third quarter 2006. So again, continued progress in the operating cash loss of the business.

During the quarter, we made some good headway with the local Medicare contractors to expand hypertension coverage in Georgia, Alabama, Mississippi and South Carolina. We also developed a framework for our next hypertension research strategy, which is targeted to address the questions last fall that were raised by Medicare in the reconsideration of ICG policy or coverage for high blood pressure.

With these accomplishments, still during the quarter we know that much work lies ahead to get the business back to a sustained, profitable growth. It's certainly encouraging to see the improved results from what I would say are tireless efforts of our employees to overcome the setback that resulted from Medicare's hypertension reimbursement restriction.

Why don't we now take a closer look at the numbers and run down the P&L statement. As I mentioned, sales were up 8% in the quarter to just under $5.6 million. That was above the analyst estimate of $5.4 million in the quarter. We sold 121 ICG monitors. You can see the mix there of DX, BioZ and Medis monitors, that was up a little bit over the 119 in the third quarter of '06. Our module business, we sold 76 modules in the quarter, GE buying 50 of those, and the remainder going to our partners in China.

The sensor business we mentioned $1.8 million, or 32% of sales, with a 15% growth; very solid in the quarter, good sequential growth. The average sensor revenue per unit per year was up 9% in the quarter to $1,666. That was driven by an average selling price that was up 3% or $0.19, in the quarter, to $6.78 per sensor set. We now have just under 6 million ICG sensor sets that have been shipped since 1998. So again, good progress in our recurring sensor revenue.

Another highlight in the quarter was our direct sales channel. We achieved $4.8 million in sales in the third quarter. That was up 12% from the same period a year ago. Particularly encouraging was the average capital sales per territory manager. That was up 13% in the quarter. You may recall a while back we had talked to you about beginning what we call the Phoenix Growth Initiative, a program that's really driving new sources of revenue, accelerating the growth in revenue that we have become experienced over the last several quarters.

What I'd like to do now is ask Rhonda to provide a quick update on some of our early results of this program in the third quarter.

Rhonda Rhyne

Certainly, Mike. The two major programs that were launched in late Q3 under the Phoenix initiative were the Legacy partnership program and the Yes program, and both were highly successful. The Legacy partnership program was focused on early BioZ adopters whose devices had become inoperable. We offered to exchange their devices that weren't working with a factory-certified BioZ. Then we placed them on a BioZ Assessment Process and/or a discount sensor program. We retrained the physicians and the staff on the appropriate utilization and the clinical studies.

We established three major goals for this program. One, once we did the exchange with the early adopter, we would receive an immediate contribution to recurring revenue because they would start to use their device again. Secondly, we felt over the next six to 12 months we would be able to obtain referrals for new, potential accounts. Third, have the potential to upgrade these accounts from a BioZ to a DX over the course of the next 12 months. We operationally had planned to place about 25 systems in August and quickly exceeded that number. In all, we placed 28 systems and deferred the rest to September.

The way that we analyzed this potential revenue impact was that we projected that each account could contribute upwards of $50,000 in revenue over the next 12 months after we did the exchange. August placements alone have the potential to contribute approximately $500,000 in incremental revenue over the next 12 months. More than anything, our customers were extremely pleased and impressed that we would offer this level of customer service. That's the Legacy partnership program.

The second major program launched under the Phoenix initiative was a program entitled the Yes program. This program was designed to overcome the major customer objections that are encountered in the sales cycle. The program addresses concerns related to the financing rate, cash flow, long-term sensor pricing, warranty and reimbursement. Again, this program was highly successful and helped to accelerate the sales cycle of approximately two-thirds of the sales in August.

So overall, we were very pleased with these two programs and we'll have more coming under the Phoenix umbrella.

Michael Perry

Thank you, Rhonda. Let's continue on. If we look at our cumulative market penetration, something we watch closely, we are about 88% in the domestic market, 12% international. We also have about 90% of our domestic units continue to go into the physician office, 10% in the hospital. Overall, we are 5.3% penetrated in the domestic outpatient market. Our biggest opportunities are 19% penetrated in congestive heart failure clinics, 15.5% in cardiology offices and then about 4.2% internal medicine and 2.8% in family practice.

The mix of systems continues to be pretty consistent. The three major markets: cardiology about 25%; 35% go to internal medicine; 28% to family practice/general practice; so, 12% to the remaining other areas. We continue about 0.5% penetrated in the domestic hospital market; so obviously a long, long way to go and a big opportunity there.

Gross margin was up nicely in the quarter, 72%, from 61% in the third quarter of '06. We mentioned increased selling prices, increased mix of sensor revenue. Also, the allocation methodology of some of the indirect manufacturing overhead; it did move out of cost of sales, about a $275,000 impact, which actually improves cost of sales by 5 percentage points. Those allocations principally end up over in the sales and marketing line and we'll talk about that in just a moment.

Operating expenses were up 11% in the quarter to $5.2 million. Again, without the change of this allocation methodology, that increase would have been closer to 5% in the quarter. Sales and marketing was up 17%. Much of this was due to increased headcount in our salesforce, up approximately 13% over the levels of a year ago. Also, the allocation methodology, if that had not occurred, the increase would have been about 9% in the quarter.

So again, we continued to make investment in sales and marketing to drive top line sales. Our sales team, about 43% of the individuals in our domestic salesforce currently have six months or less experience. It's a young team, a team that we are looking forward to improving in its productivity and sales results over the next several quarters to come. That is experience, by the way, with CardioDynamics. These folks come very experienced from other companies and positions in the medical sales industry.

Our research and development expenses were up just 1% in the quarter. We've got a stabilized headcount working on internal projects; not a lot of external development effort and cost occurring at this time. Our general and administrative expenses were down nicely in the quarter, 7% versus the same period a year ago, driven principally by reduced headcount; about 15% fewer individuals than a year ago. Also, reduced accounting fees, about $87,000 less than what we experienced a year ago.

That brings the operating loss, as we mentioned, to $1.2 million, improving $334,000. The EBITDA loss of 930, down about 42%, so again, steady improvement in those operating loss categories.

I would like to add that our income from discontinued operations, $496,000 a big chunk of that was made up by the Vermed unit. They posted operating income of $221,000 in the quarter, up 14%. I certainly want to knowledge Rich Kalich and his team for sprinting across the finish line with us. This was the last quarter that Vermed was part of the CardioDynamics team, and the group certainly turned in a very respectable quarter. We're going to enjoy a great, long-term relationship with that organization.

Finally, net loss at $853,000 versus a net income of $665,000. Again, the $2.2 million accounting gain last year. Otherwise, a substantial improvement over the same period a year ago.

When we turn to the balance sheet, $8.4 million in cash was up $4.5 million. The Vermed sale was the big driver there. You may have seen that we paid off all of our bank debt, including a $1 million balance on our credit line, also $492,000 on our term loan. So presently, the debt that we have in the capital structure is the convertible note, $5.25 million, and a small mortgage on our building in Germany.

We continue to manage very well our working capital line items. Accounts receivable were down 18% versus the same period a year ago to $3.8 million. Collections remained strong. We collected 101% of our trade accounts receivable from the prior quarter. Our inventory was also down about 9% from the same period a year ago. Much of this was due to a reclassification of demo inventory. That occurred, actually, during the second quarter and we've already discussed that. But again, that line item was down as well.

That is it for the P&L statement, our operating results for the quarter. I'd like to spend just a couple of moments giving you a sense of our thoughts and expectations for the fourth quarter and also a glimpse into our game plan for fiscal 2008.

Our objective remains to continue to make steady progress in growing top line revenue and reducing the operating loss for the business. We've seen this occur over the past three quarters, and believe that trend will continue in the fourth quarter and throughout next year. As projected, we're still tracking toward 10% growth for fiscal 2007 and we would look to a similar growth plan for 2008.

Our Q4 revenue growth will likely be less than 10%, given we have a comparison against a strong fourth quarter in 2006. The operating loss in Q4 should continue to improve over the level we saw in the third quarter.

We have recently announced a plan to accelerate the return to profitability. Really none of the effects of that plan flowed through the third quarter, and very little effect will be seen in the fourth quarter. Nearly all of the benefits of those actions will begin to bear fruit and occur throughout 2008.

Since we experience a little more than $200,000 each quarter in non-cash expenses for depreciation, amortization and equity compensation expense, we should see our operating cash loss below $1 million again in the fourth quarter of 2007.

Now, as we look out to 2008, we are looking toward a 10% revenue growth objective. Full year ICG revenue should be in the range of the low $23 million to $24 million. We are planning with that revenue level to improve our operating loss by approximately 30%, and the EBITDA loss by about 40% for the year.

We are really pushing hard to return the business to positive EBITDA and operating cash flow as quickly as possible. The best opportunity for this to occur on a quarterly basis would be during the fourth quarter of 2008.

I can absolutely assure you that everyone in our company is focused on achieving that goal. We've really got the organization very focused around getting back to financial health. We now have $8 million in cash. We've got renewed spirit, focus and dedication to improving our financial performance, and really have some great assets across the company: our direct sales team, our clinical application specialists, our installed base of customers. All of these are strong assets that are really supported exceptionally well by our corporate office employees.

Our plan is really to better utilize each of these assets to continue to grow the ICG business. It's been a tough last three years; I know all of you know this. We believe we've taken the right actions, both in the short term and also over the longer term, to improve the growth of the business and to increase shareholder value.

I would now like open it up to questions.

Question-and-Answer Session

Operator

Your first question comes from Daniel Owczarski - Belmont Harbor Research.

Daniel Owczarski - Belmont Harbor Research

Thanks and good afternoon. Mike, you talked about penetration numbers. For heart failure clinics I've got 19%, and for internal medicine 4.2%. For the cardiology, could you repeat that number? Was it mid-teens?

Michael Perry

It's 15.5%, Dan, and CHF clinics are 19.3%, internal med 4.2% and family practice 2.8%.

Daniel Owczarski - Belmont Harbor Research

Those are creeping up slightly, if I recall?

Michael Perry

They continue to creep up every quarter.

Daniel Owczarski - Belmont Harbor Research

Rhonda, at the end of your comments you had talked about accelerating the sales process by two-thirds in August. Did I write that down right in my notes? Could you talk about that acceleration? It sounds like you were trying to quantify it there.

Rhonda Rhyne

We felt that in about two-thirds of the sales in August we were able to accelerate the sales cycles by utilizing the Yes program.

Daniel Owczarski - Belmont Harbor Research

You're not shortening the sales process by two-thirds, but in two-thirds of the accounts you felt there was some shortening?

Rhonda Rhyne

Correct.

Michael Perry

Just a benefit that the Yes program was able to make a contribution to that sale.

Daniel Owczarski - Belmont Harbor Research

How sustainable is the 72% gross margin rate? It sounds like you're going to continue the accounting of those indirect costs, so should that number stay relatively in line with the low 70s?

Michael Perry

There's a little bit of a one-time adjustment, and I'll let Steve speak to that. I think there's a full 5 point advantage, but we won't see that every quarter moving forward.

Steve Loomis

Just to give you a little bit of background, obviously when you change auditors you go through and look at a lot of the things, the estimates and valuation assumptions and so forth. One of the things that we looked at this last quarter was moving from a single overhead rate for our inventory overhead application to a dual rate where we apply a different rate to manufactured products versus products that we really just bring in and sell. For instance, the sensors, where those are no longer manufactured by us, were purchased from Vermed.

With the sale of Vermed and other changes in our business, that overhead pool, we reallocated some of the expenses. In doing that, we had to do a three quarter adjustment to get the year-to-date allocation correct.

So Mike is right in that you've got about a $275,000 effect on the margin this quarter. Probably one-third of that would be more the ongoing rate that you'd see. So probably a 70% gross margin would be a more sustainable margin rate at the current revenue levels.

Michael Perry

Dan, as you know, that has been our steady-state margin projection for many, many years, to be right in that 70% range.

Daniel Owczarski - Belmont Harbor Research

As far as the Medicare changes that you addressed for the southern states here, is that a material portion of your business, or at least within hypertension? Is there any way to quantify that?

Michael Perry

Hard to really pin down an exact number. We are just pleased to see efforts at the local level that you can make your case and people sort of buy into the logic. It just gives you confidence to go out and keep doing it. In terms of the systems that have been placed in those territories and the revenue that they would generate from the expansion, it's going to have modest impact.

Daniel Owczarski - Belmont Harbor Research

Any other states that are close behind some of these other states in making those changes?

Michael Perry

It's probably too early to really comment on any of those, Dan. We have a hit list, but there's just not enough to talk about.

Daniel Owczarski - Belmont Harbor Research

Maybe about a year or so ago, or even more than that, amongst some in the investment community there was some worry about incoming competition, better systems doing something similar to you, but making it a more competitive sale as your salesforce is out there. Can you give us any update as to whether you're bumping into competitor salespeople in the same accounts? Whatever happened with that, with all these incoming competitions that people worried about a year or so ago?

Michael Perry

Honestly, we've just not seen a whole lot of competition. There was a company, Analogic, that we discussed. They actually license our algorithm from Medis, the company we bought in Germany. It's an older version of the Medis technology, so it's a couple generations behind our own. We receive a license report every quarter based on their sales. I can tell you they are very, very low.

So we've not run into really any direct competition. There was another company that used to be called Sarba, and became part of another company, Vasomed. I believe that company is no longer out there actively selling, or perhaps not even in business.

So again, it's sort of the same pattern we've seen really the last eight, nine, ten years. You have small companies come and go and try to make an impact, and so far, not a whole lot. Again, we would welcome a few other people out there talking about ICG.

Operator

There appear to be no further questions. Do you have any closing comments you would like to finish with?

Michael Perry

Again, I really appreciate everyone's participation on the call today. We were pleased with the continued progress in our key operating metrics, including steadily improving the top line revenues and steadily reducing operating loss. We were also very pleased to complete the sale of Vermed. You can imagine that takes a lot of time and energy away from the standard things that we work on, but it was completed as planned with an efficient process.

We now have increased financial resources to invest in our recovering ICG business. Our goal is to accelerate the return to profitability as quickly as possible. We've begun to develop some new, innovative sales and marketing programs under the Phoenix initiative; that work is definitely going to continue. So we really look forward to completing a solid 2007; a nice improvement over 2006, and to carry those improving trends into 2008.

To wrap up, our team definitely has some renewed energy and commitment to continue growing the business, also getting back to profitability. We really appreciate all the support we receive from all of our shareholders.

If anyone has additional questions, please feel free to contact Steve, Rhonda or myself. The number here is 1-800-778-4825. Everyone have a great afternoon, and we thank you.

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