Chairpersons: Mark Gorder, ceo, and Scott Longval, cfo

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May 11, 2010, 5:00 PM ET

Chairpersons: Mark Gorder, CEO, and Scott Longval, CFO

Operator: Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the IntriCon First Quarter 2010 Earnings Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. If you have a question, please press the star, followed by the one on your touchtone phone. If you’d like to withdraw your question, please press the star, followed by the two. If you’re using speaker equipment, please lift the handset before making your selection. This conference is being recorded today, Tuesday, May 11, 2010.

I would now like to turn the conference over to Scott Longval, Chief Financial Officer. Please go ahead, sir.
Scott Longval: Thank you, Operator. Joining me on today’s call is Mark Gorder, IntriCon’s CEO. Before we begin, I’d like to preface our remarks with the customary Safe Harbor Statement. Today’s conference call contains certain forward-looking statements. These statements are based on current estimates and assumptions of IntriCon’s management and are subject to uncertainty and changes in circumstances. Given these uncertainties, you should not place dual [ph] reliance on these forward-looking statements. Actual results may vary materially from expectations contained in today’s call. Important factors that could cause such differences include, among others, those set forth under the heading Risk Factors in Management’s Discussion and Analysis of financial condition and results of operations in our 10-K filing for the year ended December 31, 2009.
With that, I would now like to introduce Mark for a strategic look at IntriCon’s first quarter.
Mark Gorder: Thank you, Scott, and thank you, everyone, for joining us today. I would like to begin by reviewing our 2010 first quarter results and key highlights for the company. Next, I will discuss our strategy and growth plan. After that, Scott will cover the financials in more detail and then we’ll open up the call for questions.

By this time, most of you have had a chance to review our first quarter press release. In what is typically a weak quarter due to seasonality, IntriCon not only delivered significant year-over-year growth, we also grew revenue sequentially from the 2009 fourth quarter. The 20-plus percent increase is coming from all three of our core businesses. This is a positive start to 2010. Economic uncertainty remains, but we’re cautiously optimistic as we see customers beginning to re-engage.

For the third consecutive quarter, our medical business delivered record revenues, growing 23% from the prior year period. Medical gains were driven by continued sales of wireless glucose monitors and the addition of our proprietary cardiac monitoring device sales.

On the medical front, we continue to make progress with our new cardiac diagnostic monitoring device. A prototype model was called the Mobile Patient ECG Telemetry System, or MPETS. However, we have formally named the system Centauri. Centauri is a next generation wireless outpatient monitoring tool which uses a proven automatic arrhythmia detection algorithm. A primary focus remains bringing Centauri to market. We are beginning to work with the FDA to secure necessary approvals for the device and anticipate it will be available for sale in late 2010.
In biotelemetry, IntriCon remains active with its strategic partner, Advanced Medical Electronics. This relationship allows us to develop new biotelemetry devices that better connect patients and caregivers, providing critical information and feedback.
Looking at hearing health and professional audio communication, revenues rose 22% and 25%, respectively, from the first quarter of last year. These increases were due primarily to higher demand from our existing customers.
In hearing health, we recently unveiled our new Scenic DSP amplifier and Overtus DSP amplifier at AudiologyNOW!, the annual convention of the American Academy of Audiology held in San Diego. The Scenic DSP amplifier is a high performance hearing aid amplifier with advanced capabilities, including impulsive noise suppression, wind noise suppression, steady state noise reduction, and improved adaptive feedback cancellation.

The Overtus DSP amplifier is designed to optimize open in-the-canal type fittings. The amplifier algorithm contains two patented features, an advanced adaptive feedback canceller optimized for open ITC fittings and an acoustic switch, eliminating the need for a mechanical switch and allowing for further miniaturization. We anticipate these products will have a positive impact beginning in the third quarter of 2010.

AudiologyNOW! gave hearing aid manufacturers an opportunity to experience firsthand how our latest DSP technology can help people suffering from hearing loss. Both the Scenic amplifier and the Overtus amplifier are the direct result of our company’s sustained focus on research and development, and they offer end user superior hearing clarity.
We also premiered our physioLink technology at AudiologyNOW! PhysioLink consists of a 2.4 gigahertz radio, communications protocol processing, and miniature antenna packaged into a compact module suitable for ear-worn and body-worn applications of audio and data streaming over distances of up to five meters. We demonstrated this technology for the first time at the convention. We intend to leverage physioLink in hearing aids, professional audio products, cardiac diagnostic monitors, and other biotelemetry devices, including situational listening devices. This platform technology really spans all of our core businesses.
Looking at other new devices that we have in development, situational listening devices, also known as SLDs, are intended to aid hearing impaired people in noisy environments and help them listen to television and music by direct wireless connection. These devices are intended to supplement conventional hearing aids that don’t handle noisy situations well. IntriCon expects to launch a line of SLDs, including our companion microphone and television adapter in late 2010.

As you can see, we’re very active in R&D to differentiate our product offerings. The Scenic amplifier, the Overtus amplifier, and our line of SLDs are just a few examples.

I’ll now touch briefly on a plan for the remainder of 2010. While we are pleased with first quarter performance, we also realize that we have more work in front of us. More than ever, we’re focusing our resources and capital on our core strengths while continuing to prudently invest in new initiatives that we believe will fuel long-term growth. This strategy centers on enhancing the mobility and effectiveness of miniature body-worn devices in creating entirely new technology-driven products.

Now, I’d like to turn the call back to Scott for an in-depth look at our financial performance.
Scott Longval: Thank you, Mark. I would like to echo Mark in saying that we are encouraged by our first quarter performance. For the quarter, we reported net sales of 14.6 million, an increase of 23% from net sales of 11.8 million for the prior year period. In what has historically been our weakest quarter, first quarter sales grew nearly 3% sequentially over the 2009 fourth quarter. This also marks the fourth consecutive quarter of increased sales and is the highest since the second quarter of 2008.
Two thousand ten first quarter income of $18,000, or $0.00 per diluted share, versus a net loss of $989,000, or $0.19 per diluted share, for the prior year period. The turnaround was due to the factors Mark just mentioned. We reported a 2010 first quarter income from continuing operations, which includes the company’s core body-worn device businesses, medical, hearing health, and professional communications, of $178,000, or $0.03 per diluted share. First quarter results include a net loss of 160,000, or $0.03 per diluted share, from discontinued operations.
In December 2009, we announced plans to divest IntriCon’s non-core electronics business, Anaheim, California based RTI Electronics. As a result, RTI Electronics results are now classified as discontinued operations. As we previously disclosed, we anticipate the divestiture will be complete in mid 2010.

Gross profits for the 2010 first quarter were 25.3% compared to 18.4% in the prior year period. Sequential gross margins were slightly better in the 2009 fourth quarter. The primary drivers of the increase were higher volumes and the impact of various gross profit improvement initiatives. IntriCon continues to implement gross profit initiatives, including production transfers to lower-cost manufacturing facilities and the rollout of lean manufacturing initiatives.

As Mark mentioned earlier, we’re beginning to see signs of customers re-engaging, particularly in hearing health and professional communications. While the duration of the economic downturn and its continued impact on our business remains difficult to predict, we are encouraged by our most recent quarter’s performance. That said, our focus remains on the long term. Our continued commitment to prudently invest in key research and development initiatives are what we believe will drive new products into future growth.
Turning to other financial metrics, IntriCon generated approximately $1 million in positive operating cash flow during the first quarter, due largely to tight working capital management. IntriCon’s total cash cycle days at March 31, 2010, was 72 days, a marked improvement from 92 days for the comparable 2009 period. Cash cycle days are comprised of days sales outstanding, which was 43 days, plus inventory outstanding, which was 69 days at the end of the quarter, less days payable outstanding, which stood at 40.
As a result of the improving business and prudent cash management, the company has reduced its funded bank debt to 7.7 million at the end of the first quarter compared to 8.8 million and 8.4 million as of September 30, 2009, and December 31, 2009, respectively.
I would now like to turn the call back over to the Operator so we can take your questions.
Operator: Thank you, sir. We will now begin the question-and-answer session. As a reminder, if you have a question, please press the star, followed by the one on your touchtone phone. If you would like to withdraw your question, please press the star, followed by the two. If you’re using speaker equipment, you will need to lift the handset before making your selection.

One moment, please, for our first question.

Our first question comes from the line of Sam Bergman with Bayberry Asset Management. Please go ahead.

Sam Bergman: Good afternoon, Mark and Scott. How are you?

Mark Gorder: Good, Sam. How are you?

Sam Bergman: Good. Nice revenue increase for the quarter. It looks like things are continuing to improve. The question I have is on the bottom line. The bottom line number, I’m looking at a big increase or an increase in R&D. Should we expect the expense line included in the R&D to be ahead of the revenue increases in the upcoming quarters and therefore, keep the bottom line number lower than one would expect or not?
Scott Longval: Yes. Sam, this is Scott. That’s a good question. We have two factors that are impacting the R&D line. The first is we experienced lower customer reimbursement than historic orders. So that reimbursement normally offsets some of the expense. So that was lower in the first quarter. We anticipate that’ll pick up a little bit, but not quite to our historical experiences.
The second is we are making a push in research and development, as you know, to develop these new technologies, and we’re going to continue to do so as, you know, we’ve stated in the past. This is what’s going to be the driver of the future. You know that being said, we have to be prudent about those investments and each significant investment that we make we do so under a careful eye. So I think what you’ll see is a continued growth in expenses throughout the year.

Mark Gorder: If I could add to that, Sam. This is Mark. At the recent American Academy of Audiology show, the AudiologyNOW!, we introduced more products there than we’ve ever introduced before. And that’s a direct result of the much larger investment in R&D that we’re making. And as you know, a lot of the results—the revenue from that will not come until later this year and next year. And that’s also true in the case of the Datrix acquisition, where we’re developing a number of new products, including this new Centauri device where a lot of upfront investment has to occur long before we’ll get that revenue. So I guess in making a long story short, the answer to your question is yes, there’s a leading R&D expense before we get the result.

Sam Bergman: So if there is that type of an expense, are we looking at $300,000 added to the amount that’s this quarter, or will it level off? Can you give us some internal dollar amounts that were forecast for the year?
Scott Longval: It’s our historical practice not to give any forward-looking guidance. But what I can say is I think the first quarter is probably a good barometer of where we’ll be out for the rest of the year.
Sam Bergman: Okay. In terms of the lean manufacturing and moving production to lower-cost facilities, has that been completed or is that a work in progress?
Speaker: Tom [ph]?
Mark Gorder: That’s a work in progress, Sam. We’ve got two initiatives there, one where we’re expanding our Singapore facility to handle more medical-grade products. And then in parallel to that, we’re looking at a facility potentially in a lower-cost region like Indonesia, which is in a close proximity to Singapore, which will allow us to drive costs out of Singapore into a lower-cost area. So we’ve got two initiatives. One is to move some higher-cost medical programs from the United States to Singapore and then move some of the work that’s done in Singapore into Indonesia where we get a double whammy there, if that makes sense.
Sam Bergman: Okay. And when is that going to be complete? Do you have any idea?
Mark Gorder: The initiatives—we have to choose the facilities within the next six months. And probably within the next 12 to 18 months, those moves will be complete.
Sam Bergman: And if we talk about the glucose monitor, or the medical division, that includes the new division from Datrix, right?
Mark Gorder: Correct.
Sam Bergman: How much was the Datrix sales for the quarter? Was it 300,000 or was it as much as 400,000, or am I totally off base on the…

Scott Longval: No, you’re close. It was right around 300,000.

Sam Bergman: Right around 300,000. Was there any growth in that business right—on the existing products?
Scott Longval: We are now starting to see some growth on the existing products that we have. You know we’ve only had the business now for about seven or eight months, so we’re still working through that. But we are now starting to see some indications that the legacy business is picking up.
Sam Bergman: So the Centauri product once it comes out, is that going to cannibalize the legacy products, or not?
Mark Gorder: That’s in a new category, Sam. The Centauri is considered a Mobile Cardiac Outpatient Telemetry device, and it goes into a new category of reimbursement. And the legacy products are called Holter Monitors and Event Recorders. And they will—the Holter Monitors will not be affected at all. The Event Recorders to some extent. However, we don’t sell many Event Recorders. We sell mostly Holter Monitors.
Sam Bergman: Is it true, though, the Centauri product was slated originally for March/April of this year and it’s four to six months late in its arrival?
Mark Gorder: That’s correct. It’s taken us longer to develop the software than we anticipated.

Sam Bergman: And how comfortable do you feel that this product will take hold and be in the marketplace, knowing there’s been some software problems or software glitches in late fall?

Mark Gorder: They weren’t so much glitches, it’s just—our time estimate was poor. We had underestimated the amount of time it was going to take to—number one to develop the software, and then also the FDA approvals. But this is a new market segment. It’s still emerging. So we don’t feel that we’ve really lost any momentum. There’s a lot of demand for the product as we’ve gone out to talk to all the key customers. Everybody is interested in getting samples of the product once we can provide them.

Sam Bergman: What product would that compete against, if any, in the marketplace?
Mark Gorder: There’s—Braemar [ph] has a product out there. They’re part of the Biotel group. And I can’t remember what the name of it is, but they have an MCOT device—the Fusion, I think it’s called.
Sam Bergman: Okay. And just the last question and I’ll let somebody else get on, on that second product that was mentioned on the last conference call regarding Datrix, what’s the new timeframe of that product and what does that product do?
Mark Gorder: I think we were probably talking about the 12-lead ECG, or was it the—we also—we talked about two of them, I think. One of them was a 12-lead wireless ECG module that would be used in stress testing and resting ECG applications. And the second one was a second generation Mobile Cardiac Outpatient Device, would kind of be a multi-purpose Holter Monitor, Event Recorder, and MCOT device all in one. Those are the two new ones that we’ve got on the product roadmap. We’re still anticipating having those products in the market by approximately the end of the year. That depends a little bit on the FDA. The FDA cycles have been increasing, approval cycles.
Sam Bergman: Right.
Mark Gorder: And we’re just not sure what that’s going to take. So it could slip into the first quarter of 2011, depending on the FDA approvals for those two.
Sam Bergman: Is the software for those two products off the same platform as the Centauri?

Mark Gorder: The one is. The second generation would be the same basic platform as the Centauri. But we basically have the software working. And the basic difference between the new project, which we’re calling the Hammer [ph], and the old one is that it’s significantly miniaturized from the current version. It’s the first time we’ve been able to take some of our new technology like the physioLink radio that we talked about. The physioLink radio would be incorporated into this Hammer project, making it much smaller. Did I answer that question?

Sam Bergman: Yes. Thank you.
Operator: Thank you. Our next question comes from the line of Alvin Hoffman with Benning & Company. Please go ahead.
Alvin Hoffman: How will your SLD differ from the TV Ears?
Mark Gorder: The TV Ears is based on a magnetic loop technology, where you wear a—kind of a medallion loop around your neck. And that picks up a signal from the TV and then magnetically couples that to your earpiece. Our SLD is based on a digital FM radio. So we—it’s a much higher performance device. We would simply plug a transmitter jack into the TV, and it would transmit directly to your earpiece via wireless FM, using our physioLink radio technology. So it’s a…
Alvin Hoffman: So you have to have a hearing aid in the [inaudible].
Mark Gorder: Could you repeat that, Alvin?
Alvin Hoffman: You’d have to have hearing aids that are wireless to match the transmitter.
Mark Gorder: Well, the situational listening device that we are going to provide would be a complementary device to your hearing aid. It would be a receive-only device that you’d kind of wear on your ear, and it would pick up the transmission.
Alvin Hoffman: You wouldn’t remove your hearing aids?
Mark Gorder: In this case, you would.
Alvin Hoffman: Oh.
Mark Gorder: You basically would use it for like TV listening or if you were in a noisy restaurant. As a hearing aid user, you would be aware how poorly hearing aids work in a noisy restaurant. Well in this case, we could provide a companion microphone where somebody if they had a hearing loss could communicate in a noisy restaurant by a close-talking microphone transmitting directly to the earpiece.
Alvin Hoffman: [Unintelligible] in a restaurant, one of your eating partners would have the microphone.
Mark Gorder: Correct.
Alvin Hoffman: I see. I guess it’s—when do you expect to have this to market?

Mark Gorder: We expect to have a—the first version out by the end of the year.

Alvin Hoffman: Uh-huh. Your Holter Monitor, in listening to you today, this is a put-it-on and take-it-off at the discretion of the doctor or hospital. This is not a permanent monitor.
Mark Gorder: That’s correct.
Alvin Hoffman: Will it monitor atrial fibrillation?
Mark Gorder: Yes, the Holter Monitors pick up all heart signals for a period of time. And then when you have completed the allotted time prescribed by the doctor, you bring the Holter Monitor or send it back in to the doctor or the scanning service and they will then pull the data out of the device. And then they have their own software on a PC or a computer where they can read in the data or do the analysis and determine if afib—atrial fibrillation occurred or some other non-standard heart condition.
Alvin Hoffman: This isn’t being real-time transmitted back to the hospital?
Mark Gorder: Not the Holter Monitor, but the Centauri is a real-time transmitter back to the hospital or clinic.
Alvin Hoffman: Oh. And that will pick up atrial fibrillation.
Mark Gorder: Yes, it will.
Alvin Hoffman: Will it sound an alarm when it happens?
Mark Gorder: It will.
Alvin Hoffman: Oh. All right, I think that handles me.
Mark Gorder: Thank you, Alvin.
Scott Longval: Thanks, Alvin.
Alvin Hoffman: You’re welcome.
Operator: Thank you. Once again, ladies and gentlemen, if you’d like to ask a question, please press star, one at this time.
Our next question is a follow-up question from the line of Sam Bergman with Bayberry Asset Management. Please go ahead.
Sam Bergman: Hi. I just have two follow-up questions, one regarding the glucose monitoring product line. When is the next upgrade or new product coming out from that particular line for your customers?

Mark Gorder: The—in that particular case, the upgrades are heavily dependent on the customer’s own development cycle. It’s truly a partnership with that OEM. And they have been bringing out new versions on a continuous basis. We have a couple in the development cycle right now that are going through qualification and FDA approval, and the process of doing that is very long, as these are considered Class III devices. But there are—there usually are—is always a new version of some type in the pipeline. And that product line has grown nice—in a nice, steady fashion over the last three years.

Sam Bergman: Has it grown sequentially from quarter-to-quarter?
Scott Longval: Yes.
Mark Gorder: Yes, it has.
Sam Bergman: It has. And the last question I wanted to ask you is basically going back to the R&D and the spend on the Datrix division. When do you think the volume and the revenue will come back to you, take a hit from the R&D that’s being spent on these new products? Will it be after the Datrix products come to market, or is it after the new hearing aid products hit the third quarter? What are we looking at timeframe-wise?
Mark Gorder: I think that the hearing aid products will have a more immediate impact in Q3 and Q4. The Datrix products, due to the FDA cycles, will be a little bit longer. That’s probably—you’re looking at probably late Q4 or early Q1 next year for Datrix.
Sam Bergman: Is that basically where the increase in R&D is, or is there any other programs that you have that hasn’t been talked about that other R&D money is spent on?
Mark Gorder: I think if you—in the press release, we covered probably 70 to 80% of it. If you look at the hearing aid products, the Datrix products, and the physioLink products, that’s probably about 75% of our effort. We still have initiatives going on with that nanoLink radio that we have talked about in past press conferences, and that one we’re working on regulatory approval. It’s a radio technology we’re quite excited about. And it’s even lower power than our physioLink. And we have initiatives going on both in Europe with their equivalent of the FCC which they called FC [ph]. I’m not sure what that ETSI stands for. And then we also have an initiative going on with the FCC to get regulatory approval for the nanoLink radio. So there are some initiatives that we have that are leading to R&D costs that will be even longer term before they start generating revenue.

Scott Longval: And I just want to add one other thing to what Mark said. The focus here is really to move more towards developing some of our own proprietary devices and technologies. And that’s one of the reasons why the customer reimbursement levels are down slightly in the first quarter. The goal is to develop these proprietary technologies that will reap higher margins going forward. That’s really where we need to be in the medical device space. So the focus for our spend is more in those areas of proprietary devices, which unfortunately in the short term you don’t get the reimbursement. But we know over the long term this is the right direction and the right decision for the company so we can expand our margins.

Sam Bergman: That makes good sense. Thank you.
Mark Gorder: Thank you, Sam.
Scott Longval: Thanks, Sam.
Operator: Thank you. Our next question is a follow-up from the line of Alvin Hoffman with Benning & Company. Please go ahead.
Alvin Hoffman: Yes. You referred to an acoustic switch for turning the hearing aids on and off.
Mark Gorder: Yes. That’s one of the new features of our Overtus amplifier, DSP amplifier.
Alvin Hoffman: How does that—I’m wearing hearing aids and somebody makes a lot of noise. That turns the hearing aids off?
Mark Gorder: The way an acoustic switch works is there is a—when you wear an in-the-ear type device, there is a feedback path that’s generated between the microphone and the speaker. And in the absence of a very sophisticated adaptive feedback canceller, your hearing aid will squeal. Now with these new feedback cancellers, you don’t hear the squealing but the amplifiers are measuring the feedback path. And the way the acoustic switch works is if you put your hand over your ear, it changes the feedback path. The system detects that and will use it as an indication to switch. So it’s—it obviously has to be very robust because you can’t have your hand accidentally pass by and have it switch, or you can’t have it switch because there’s a lot of noise. So the patented technology is what we’ve come up with to make that mechanism very robust.
Alvin Hoffman: It switches off and then it switches back on by itself?
Mark Gorder: No, you have to put your hand up to your ear to switch it.
Alvin Hoffman: Oh.
Mark Gorder: Sort of tap your ear.
Alvin Hoffman: So some learning’s involved.
Mark Gorder: A little bit of learning, but it’s pretty simple once you try it.
Alvin Hoffman: Uh-huh. Have many of the—of your customers with the upscale hearing aids on suggested they’d like to use this?

Mark Gorder: We’ve gotten very good feedback. It was just introduced on April 16th, so we’re in the process of lining up people to send samples to. So there’ll be some training on our part to show them how to use it. But initially, the reception has been very good for both the better feedback canceller that’s in that device, as well as the acoustic switch.

Alvin Hoffman: [Inaudible] your customers going to have to integrate it into their already working circuitry?
Mark Gorder: That’s correct. Or into a new hearing aid line.
Alvin Hoffman: Are they more likely to put it in a new line than adapt an old line?
Mark Gorder: Yes.
Alvin Hoffman: Okay. Thank you.
Mark Gorder: You’re welcome, Alvin.
Operator: Thank you. Ladies and gentlemen, if there are any additional questions, please press star, one at this time. As a reminder, if you are using speaker equipment, you’ll need to lift the handset before making your selection. One moment, please.
Once again, ladies and gentlemen, if you have a question, please press star, one at this time.
I’m sorry, no further questions in queue. I’d like to turn the conference back over to management for closing remarks.
Mark Gorder: Thank you very much, Operator. Once again, thank you for taking the time out of your day to join the call. As a company, we remain focused on developing our core technologies across multiple product platforms and running and efficient and nimble organization. Our efforts are driving performance, and we look forward to updating you on our progress in the future. Thank you very much for participating in the call.
Operator: Ladies and gentlemen, this concludes the IntriCon First Quarter 2010 Earnings Call. If you’d like to listen to a replay of today’s conference, please dial 800-406-7325. Again, that number is 800-406-7325. And enter the access code 4291984. ACT would like to thank you for your participation and you may now disconnect.

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