INTRICON CORPORATION Business Overview
Headquartered inArden Hills, Minnesota ,IntriCon Corporation (together with its subsidiaries referred herein as the "Company", or "IntriCon", "we", "us" or "our") is an international company engaged in designing, developing, engineering and manufacturing miniature interventional, implantable and body-worn medical devices. In addition to its operations inMinnesota , the Company has facilities inIllinois ,Singapore ,Indonesia , andGermany . OnJune 25, 2019 , the Company's officers, pursuant to delegated authority from the board, approved plans to discontinue the operations of itsUnited Kingdom (UK ) subsidiary within our body-worn device segment. For all periods presented, the Company classified this business as discontinued operations, and accordingly, has reclassified historical financial data presented herein. The consolidated financial statements include the accounts of the Company and its consolidated subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. The Company evaluates its voting and variable interests in entities on a qualitative and quantitative basis. The Company consolidates entities in which it concludes it has the power to direct the activities that most significantly impact an entity's economic success and has the obligation to absorb losses or the right to receive benefits that could be significant to the entity. The Company's significant accounting policies are detailed in "Note 1: Summary of Significant Accounting Policies" of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Information contained in this section of this Quarterly Report on Form 10-Q and expressed inU.S. dollars is presented in thousands (000s), except for per share data and as otherwise noted. In addition, information in Item 2 excludes discontinued operations unless otherwise noted.
COVID-19 Pandemic and Uncertainties
The COVID-19 (coronavirus) outbreak has created unique and unprecedented challenges. The outbreak of the novel COVID-19 has evolved into a global pandemic. COVID-19 has spread to many regions of the world, includingNorth America ,Asia andEurope . The full extent to which COVID-19 impacts our business, operating results and financial condition will depend on future developments that are highly uncertain, cannot be accurately predicted and may be beyond our control. Uncertain factors relating to COVID-19 include the duration of the outbreak, the severity of the virus, and the actions, or perception of actions that may be taken, to contain or treat its impact, including declarations of states of emergency, business closures, manufacturing restrictions and a prolonged period of travel, commercial and/or other similar restrictions and limitations. 22
The Company's priority remains the health and safety of its employees, its customers and their patients, as well as the communities we serve. As the unprecedented threat of COVID-19 emerged,IntriCon began implementing measures in an effort to address and prioritize the health and safety of its employees and their communities, while at the same time continuing to support customers and partners. These measures included the following:
? Health and Safety: Based on the expertise and recommendations from federal and
local government and health agencies,
flexible work arrangements for employees wherever possible. We have also
implemented other measures, such as restricting travel, to protect the health
and safety of our customers, their patients and our employees.
? Maintaining Operations: Consistent with applicable exceptions, we aremaintaining streamlined manufacturing, assembly and other related operations
at all sites in order to continue providing products to our customers and
partners. For our employees involved in such operation-critical processes, we
have implemented several other recommended best practices to protect the
health and safety of our workforce. In addition, we have modified the shifts
of employees involved in other operation-critical processes to minimize risk
for these employees.
? Clinical: We have postponed our anticipated "
trial until such time as we can ensure the health and safely of trial
participants.
? Expense Reduction: Given the current business climate, executive management
has taken steps to strengthen our balance sheet and reduce our cost structure
including the deferral of non-strategic investments as well as furloughs and
salary reductions. These measures are expected to be temporary in nature and
only in effect until their objectives have been accomplished.
Although our operating facilities remain open as of March 31, 2020 , the effects
of a COVID-19 outbreak could include the temporary shutdown of our facilities in
the United States , Asia or Europe , disruptions or restrictions on the ability to
ship our products to our customers as well as disruptions that may affect our
customers and suppliers.
Further, as a result of COVID-19 and the measures designed to contain its
spread, our sales could be negatively impacted as a result of disruption in
demand by our customers, which could have a material and adverse effect on our
business, results of operations and financial condition. Similarly, our
suppliers may not have the materials, capacity, or capability to supply us
according to our schedule and specifications. If our suppliers' operations are
impacted, we may need to seek alternate suppliers, which may be more expensive,
may not be available or may result in delays in shipments to us and subsequently
to our customers, each of which would affect our results of operations. The
duration of the disruptions to our customers and to our supply chain, and
related financial impact to us, cannot be estimated at this time. If such
disruptions continue for an extended period of time, the impact could have a
material adverse effect on our business, results of operations and financial
condition.
U.S. GAAP requires management to make estimates and assumptions that affect the amounts and disclosures of certain assets and liabilities. These estimates and assumptions utilize historical and forward-looking assumptions that the Company believes are reasonable, including but not limited to the potential impacts arising from the recent coronavirus pandemic. As we learn more about the extent and duration of the pandemic, the Company's estimates and assumptions may evolve. Actual results could differ significantly from those estimates. In summary, while our business is likely to be impacted in the coming year by global business conditions, including the delay of non-essential medical procedures, device upgrades and new product launches, we have a strong balance sheet that we believe will allow us to maintain our operations and preserve our ability to realize future growth. Market OverviewIntriCon serves as a joint development partner ("JDM") to leading medical device original equipment manufacturers ("OEMs") by designing, developing, engineering, manufacturing and distributing micro-miniature products, microelectronics, micro-mechanical assemblies, complete assemblies and software solutions, primarily for high growth markets, such as diabetes, drug delivery, surgical navigation, hearing health and the professional audio communication market. Revenue from these markets is reported on the respective diabetes, other medical, hearing health value based direct-to-end-consumer, value based indirect-to-end-consumer and legacy OEM, and professional audio lines in the discussion of our results of operations in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 17 "Revenue by Market" to the Company's consolidated condensed financial statements included herein. 23
Diabetes, Drug Delivery, and Surgical Navigation Markets
The Company manufactures microelectronics, micro-mechanical assemblies, high-precision injection-molded plastic components and complete devices for leading and emerging medical device manufacturers. The medical industry is faced with pressures to reduce the cost of healthcare. Driven by its core technologies,IntriCon helps shift the point of care from expensive traditional settings, such as hospitals, to less expensive non-traditional settings like the home.IntriCon currently serves this market by offering medical manufacturers the capabilities to design, develop, manufacture and distribute medical devices that are easier to use, are more miniature, use less power, and are lighter. Increasingly, the medical industry is looking for wireless, low-power capabilities in their devices.IntriCon currently has a presence in the diabetes, drug delivery and surgical navigation markets. For diabetes,IntriCon works with Medtronic to manufacture their wireless continuous glucose monitors (CGM), sensor assemblies, and accessories associated with Medtronic's insulin pump and CGM system. InSeptember 2016 , the FDA approved Medtronic's current generation insulin pump system, the MiniMed 670G system. The MiniMed 670G is the world's first hybrid closed loop insulin delivery system and we are excited that our components are designed into and support such a revolutionary diabetes management system. InJune 2017 , the 670G was launched in theU.S. and Medtronic began fulfilling orders from patients enrolled in their Priority Access Program. InMarch 2018 , the FDA approved the Guardian Connect, Medtronic's standalone CGM system that allows patients to stay ahead of high and low glucose events. Looking ahead, we believe there are opportunities to expand our diabetes product offering with Medtronic, as well as move into new markets outside of the diabetes market. In late 2019, Medtronic received approval and began distributing the 670G system in select European countries.IntriCon has a suite of medical coils and micro coils technology that it offers to various OEM customers. These products are currently used in surgical navigation markets, such as interventional pulmonology and electrophysiology. OnMay 18, 2020 IntriCon acquired privately heldEmerald Medical Services Pte Ltd. (EMS). EMS, based inSingapore , provides joint engineering and manufacturing services for complex medical devices, including catheters covering a range of applications for cardiology, peripheral vascular, neurology, radiology and pulmonology. EMS's production capability consists of design, development, manufacturing, testing and non-sterile packaging services. The acquisition expandsIntriCon's medical coil and micro-miniature medical device engineering and manufacturing capabilities in surgical navigation and accelerates diversification into potential new end-markets.IntriCon manufactures bubble sensors and flow restrictors that monitor and control the flow of fluid in an intravenous infusion system as well as a family of safety needle products for an OEM customer that utilizesIntriCon's insert and straight molding capabilities. These products are assembled using full automation, including built-in quality checks within the production lines. The Company is committed to increasing investments to support its medical business development efforts. In early 2019, the Company hired a vice president of medical business development, and in connection with the EMS acquisition, has engaged a corporate development consultant aimed to leverage our core competencies and diversify our medical revenue base. The Company believes it has significant opportunities to serve the emerging home care markets through its already developed core competencies and capabilities to develop devices that are more technologically advanced, smaller and lightweight. Hearing Healthcare Market
Inthe United States alone, there are approximately 40 million adults that report some degree of hearing loss. In adults, the most common cause of hearing loss is aging and noise. In fact, by the age of 65, one out of three people have hearing loss. The hearing-impaired population is expected to grow significantly over the next decade due to an aging population and more frequent exposure to loud sounds that can cause noise-induced hearing loss. It is estimated that hearing aids can help more than 90 percent of people with hearing loss, however the current market penetration into theU.S. hearing-impaired population is approximately 20 percent, a percentage that has remained essentially unchanged for the last four decades. The primary deterrents to greater penetration are cost and access. Along with this, the legacy hearing aid distribution channel is an oligopoly of six large hearing aid manufacturers who utilize brick-and-mortar and licensed audiologists to sell devices while controlling the channel dynamics. As a result, the average cost of a hearing aid sold in the US market today is over$2,400 per device, more than double the cost from fifteen years ago. Approximately 70 percent of the hearing-impaired have hearing loss in both ears (referred to as a binaural loss), driving the total cost to almost$5,000 on average for a set of hearing aids. Today in the US market, the legacy channel pushes all hearing-impaired through the same inefficient, costly channel. However, a very large portion of the hearing-impaired market - mostly notably those with mild to moderate losses - could be properly served with the proper combination of high quality, outcome-based devices, advanced fitting software and consumer services/care best practices - all at much lower cost. We believe fundamental change is needed and are excited about the opportunity that we created through thoughtful hard work and planning: a chance to deliver superior outcomes-based affordable hearing healthcare, by combining state-of-the-art devices and software technology, along with best practices customer service and at a much lower cost directly to consumers across the country, many of whom have not been able to afford care previously. 24 We believe several factors have come together over the last few years to enable the emergence of a market disruptive, high-quality, low cost distribution model. These factors include the continued consolidation of retail (causing escalating hearing aid prices), consumer outcry, consumer education, advancements in technology (such as behind-the-ear devices, advanced digital signal processing, low-power wireless, and self-fitting software) as well as regulatory actions and pronouncements by theU.S. Food and Drug Administration (FDA), the President'sCouncil of Advisors on Science and Technology and the National Academies of Science, Engineering and Medicine. OnAugust 18, 2017 , PresidentDonald Trump signed into law H.R. 2430, the FDA Reauthorization Act of 2017, which includes a section concerning the regulation of OTC hearing aids. The law is designed to enable adults with mild to moderate hearing loss to access OTC hearing aids without being seen by a hearing care professional. The law requires the FDA to create and regulate a category of OTC hearing aids to ensure they meet the same high standards for safety, consumer labeling, and manufacturing protection that all other medical devices must meet. Today,IntriCon serves both the value-based hearing healthcare channel and the legacy hearing health channel.
The Company believes the value-based hearing healthcare (VBHH) market offers significant growth opportunities. In contrast to the legacy channel dynamics, the VBHH market channel is flexible and able to serve the end consumer through a variety of modalities which may include self-fitting, remote programing and adjustments, customer support call centers and brick-and-mortar stores. The average price of a hearing aid sold through this channel is less than twenty-five percent of the average$2,400 device price typically sold through the legacy channel. In 2018, the Company commissioned an ethnographic research study, which identified a $3+ billion annual VBHH market opportunity. To best approach this market opportunity, the Company has sharpened its Indirect-to-end-Consumer (ITEC) focus to identify potential high-profile partners that value its ability to deliver superior hearing aids, self-fitting software and customer care to the U.S. market. Moreover, the Company has refocused its Direct-to-End-Consumer (DTEC) efforts towards supporting product development and as a testing platform. Over the past decade we have invested in the manufacturing footprint, product technology and fitting software to provide individuals access to affordable, quality outcomes-based hearing healthcare. The Company is also focused on serving its current value-based ITEC customers, who also sell products and services directly to the end consumer. We have established ourselves as a leader in supplying this portion of the market with advanced, outcome-based products and accessories. The Company has formed strong relationships with various customers in the channel, including geriatric product retailers and other indirect-to-end-consumer hearing aid providers. InJanuary 2019 , the Company purchased the source code for the Sentibo Smart Brain self-fitting software from Soundperience, positioning the Company to capitalize on the pending over-the-counter (OTC) hearing aid regulation. Sentibo Smart Brain self-fitting software is designed to improve both channel productivity and the quality of first-time fittings, resulting in lower prices, greater access and increased customer satisfaction. This software is being used in the German market today, most notably through Signison, the Company's joint venture with the owner of Soundperience. 25 We strongly believe that incorporating self-fitting technology is a critical step in creating our high-quality, low-cost hearing healthcare ecosystem. The Sentibo Smart Brain self-fitting software technology has the potential to drastically reduce the price of hearing aids, drive greater access and increase customer satisfaction.
Legacy OEM Hearing Health Channel
We also believe there are niches in the legacy hearing health channel that will embrace our outcomes-based products and technologies inthe United States andEurope . High costs of legacy devices and retail consolidation have constrained the growth potential of the independent audiologist and dispenser. We believe our software and product offering can provide independent audiologists and dispensers the ability to compete with larger retailers, such as Costco, and manufacturer owned retail distributors. 26
IntriCon entered the high-quality audio communication device market in 2001, and now has a line of miniature, professional audio headset products used by customers focused on emergency response needs. The line includes several communication devices that are extremely portable and perform well in noisy and/or hazardous environments. These products are well suited for applications in the fire, law enforcement, safety, aviation and military markets. In addition, the Company has a line of miniature ear- and head-worn devices used by performers and support staff in the music and stage performance markets. Core Technologies Overview Over the past several years, the Company has increased investments in the continued development of critical core technologies: Microminiaturization, Miniature Transducers,Ultra-Low-Power (ULP) Digital Signal Processing (DSP),ULP Wireless andFitting Software . These core technologies serve as the foundation of current and future product platform development, designed to meet the rising demand for smaller, portable, more advanced devices and the need for greater efficiencies in the delivery models. The continued advancements in this area have allowed the Company to further enhance the mobility and effectiveness of miniature body-worn devices.
Microminiaturization
IntriCon excels at miniaturizing miniature interventional, implantable and body-worn medical devices. We began honing our microminiaturization skills over 30 years ago, supplying components to the hearing health industry. Our core miniaturization technology allows us to make devices for our markets that are one cubic inch and smaller. We also are specialists in devices that run on very low power, as evidenced by our ULP wireless and DSP. Less power means a smaller battery, which enables us to reduce size even further, and develop devices that fit into the palm of one's hand.
Miniature Transducers
IntriCon's advanced transducer technology has been pushing the limits of size and performance for over a decade. Included in our transducer line is a suite of medical coils and micro coils technology that are currently used in surgical navigation markets, such as interventional pulmonology and electrophysiology. The recent EMS acquisition expandsIntriCon's medical coil and micro-miniature medical device engineering and manufacturing capabilities in surgical navigation and accelerates diversification into potential new end markets.
ULP DSP
DSP converts real-world analog signals into a digital format. Through our nanoDSP™ technology,IntriCon offers an extensive range of ULP DSP amplifiers for hearing, medical and professional audio applications. Our proprietary nanoDSP incorporates advanced ultra-miniature hardware with sophisticated signal processing algorithms to produce devices that are smaller and more effective. The Company further expanded its DSP portfolio including improvements to its Reliant CLEAR™ feedback canceller, offering increased added stable gain and faster reaction time. Additionally, the DSP technologies are utilized in the Audion8™, our eight-channel hearing aid amplifier, the Audion16™ and Audion16+™, our wide dynamic range compression sixteen-channel hearing aid amplifier. The amplifiers are feature-rich and are designed to fit a wide array of applications. In addition to multiple compression channels, the amplifiers have a complete set of proven adaptive features which greatly improve the user experience with proven outcomes.
Wireless connectivity is fast becoming a required technology, and wireless capabilities are especially critical in new body-worn devices.IntriCon's BodyNet™ ULP technology, including the nanoLink™ and PhysioLink™ wireless systems, offers solutions for transmitting the body's activities to caregivers and wireless audio links for professional communications and surveillance products, including diabetes monitoring and audio streaming for hearing devices. Fitting Software
The ability to efficiently and effectively fit hearing aids is critical to building a value based eco-system of hearing healthcare. By developing more advanced fitting software systems, individuals can benefit from fittings that conform to their specific loss, while eliminating the need for an in-person appointment. In addition to the traditional fitting software, AccuFit, used in the conventional channel,IntriCon has made significant investments in various advanced fitting software solutions, including its purchase of the source code for the Sentibo Smart Brain self-fitting software, that can enable remote and self-fitting solutions.IntriCon believes these advanced fitting solutions, along with the other components of the eco-system, will drive access, affordability and superior customer satisfaction to the millions of individuals that cannot receive care today, primarily due to high cost and low access.
27
Forward-Looking and Cautionary Statements
Certain statements included in this Quarterly Report on Form 10-Q or documents the Company files with theSecurities and Exchange Commission , which are not historical facts, or that include forward-looking terminology such as "may", "will", "believe", "anticipate", "expect", "should", "optimistic" "continue", "estimate", "intend", "plan", "would", "could", "guidance", "potential", "opportunity", "project", "forecast", "confident", "projections", "schedule", "designed", "future", "discussion", "if" or the negative thereof or other variations thereof, are forward-looking statements (as such term is defined in Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933, and the regulations thereunder), which are intended to be covered by the safe harbors created thereby. These statements may include, but are not limited to statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to the Company's Consolidated Condensed Financial Statements" such as estimates of future results, the expected results and impacts of the Emerald acquisition, statements regarding the estimated costs and expenses of the restructuring and estimated annual expense savings, net operating loss carryforwards, the ability to meet cash requirements for operating needs, the ability to meet liquidity needs, assumptions used to calculate future level of funding of employee benefit plans, the adequacy of insurance coverage and the impact of new accounting pronouncements and litigation. Forward-looking statements also include, without limitation, statements as to the Company's expected future results of operations and growth, strategic alliances and their benefits, government regulation, potential increases in demand for the Company's products, the Company's ability to meet working capital requirements, the Company's business strategy, the expected increases in operating efficiencies, anticipated trends in the Company's markets, estimates of goodwill impairments and amortization expense of other intangible assets, the effects of litigation and the amount of insurance coverage, and statements as to trends or the Company's or management's beliefs, expectations and opinions. Forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. In addition to the factors discussed in this Quarterly Report on Form 10-Q, certain risks, uncertainties and other factors can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements, including, without limitation, the following:
? the adverse economic conditions associated with the COVID-19 global
health pandemic and the associated financial crisis;
? stay-at-home and other orders, which could cause material delays and
cancellations of elective procedures, curtailed or delayedspending by
customers and result in disruptions to our supply chain, closure of
our facilities, delays in product launches or diversion of management
and other resources to respond to the COVID-19 pandemic;
? the impact of global and regional economic and credit market
conditions on healthcare spending;
? the risk that the COVID-19 pandemic disrupts local economies and
causes economies to enter prolonged recessions;
? our ability to identify, complete and integrate acquisitions,
including integrating our acquisition of Emerald MedicalServices, and
any unknown liabilities of Emerald Medical Services that may arise;
? our ability to successfully implement our business and growth
strategy, including our restructuring strategy;
? the volume and timing of orders received by the Company, particularly
from Medtronic;
? changes in estimated future cash flows;
? our ability to collect our accounts receivable;
? foreign currency movements in markets that we serve;
? changes in the global economy and financial markets;
28
? weakening demand for our products due to general economic conditions;
? changes in the mix of products sold;
? our ability to meet demand;
? changes in customer requirements;
? FDA approval, timely release and acceptance of our products and the
products of our customers;
? competitive pricing pressures;
? pending and potential future litigation;
? cost and availability of electronic components and commodities for our
products;
? our ability to create and market products in a timely manner and
develop products that are inexpensive to manufacture;
? the loss of one or more of our major customers;
? effects of legislation and regulation, including the timing and terms
of the final OTC regulations;
? effects of foreign operations;
? our ability to develop new products;
? our ability to recruit and retain engineering and technical personnel;
? the costs and risks associated with research and development
investments;
? our ability and the ability of our customers to protect intellectual
property;
? cybersecurity threats;
? loss of members of our senior management team; and
? other risk factors set forth in our most recent Annual Report on Form
10-K or any prior Quarterly Report on Form 10-Q, which are
incorporated by reference into this Report.
For a description of these and other risks, see Part I, "Item 1A. Risk Factors"
in the Company's Annual Report on Form 10-K for the year ended December 31, 2019
and the Company's Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 8, 2020 , and other risks described elsewhere in this
Quarterly Report on Form 10-Q, or in other filings the Company makes from time
to time with the Securities and Exchange Commission . The Company does not
undertake to update any forward-looking statement that may be made from time to
time by or on behalf of the Company.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expense during the reporting period. Actual
results could differ from those estimates particularly as it relates to
estimates reliant on forecasts and other assumptions impacted by the COVID-19
pandemic.
Certain accounting estimates and assumptions are particularly sensitive because
their significance to the consolidated condensed financial statements and the
possibility that future events affecting them may differ markedly. The
accounting policies of the Company with significant estimates and assumptions
include the Company's revenue recognition, inventory valuation, goodwill, and
certain long-lived assets. These and other significant accounting policies are
described in and incorporated by reference from "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and Note 1 to the
consolidated financial statements contained in the Company's Annual Report on
Form 10-K for the year ended December 31, 2019 .
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Strategic Restructuring Plan
As previously announced, on May 15, 2020 , the management of the Company
committed the Company to, and began executing on, a strategic restructuring plan
designed to accelerate the Company's future growth by focusing resources on the
highest potential growth areas. The plan, which was supported by the Company's
Board of Directors, is expected to be completed by the end of the 2020 second
quarter.
Following the Company's decision last quarter to no longer pursue a
direct-to-end-consumer approach to the hearing health market, we recently made
the decision to transition our remaining direct-to-end-consumer operations at
Hearing Help Express to solely support our partnership initiatives. In addition,
while continued uncertainties remain from the COVID-19 pandemic, we are taking
many significant steps to decrease our expenditure profile and current spending
run-rate. The following are significant items included in our strategic
restructuring plan:
? We completed a global net workforce reduction of approximately 35 positions,
including many of the previously furloughed positions, resulting in an annual
cost savings of approximately
? We changed our focus to seeking partners in the hearing health market,
resulting in approximately
consumer advertising expense in 2020 as compared to 2019
? In connection with the strategic restructuring plan, we anticipate incurring a
ending
impairment charges and other operations-related expenses. Results of Operations Revenue, net Below is a summary of our revenue by main markets for the three months endedMarch 31, 2020 and 2019: Change Three Months Ended March 31, 2020 2019 Dollars Percent Medical: Diabetes$ 13,530 $ 17,164 $ (3,634 ) -21.2 % Other Medical 2,828 3,629 (801 ) -22.1 % Total$ 16,358 $ 20,793 $ (4,435 ) -21.3 % Hearing Health: Value Based DTEC$ 1,173 $ 1,630 $ (457 ) -28.0 % Value Based ITEC 744 2,577 (1,833 ) -71.1 % Legacy OEM 1,964 2,803 (839 ) -29.9 % Total$ 3,881 $ 7,010 $ (3,129 ) -44.6 %
-28.5 % Total Net Revenue$ 21,503 $ 29,570 $ (8,067 ) -27.3 % 30 For the three months endedMarch 31, 2020 , we experienced a decrease of 21.2% in net revenue in the diabetes medical market compared to the same period in 2019 driven by the timing of certain international orders filtering through various local regulatory requirements as well as a delay in orders due to uncertainty surrounding the COVID-19 pandemic. Although we cannot predict the specific extent or duration of the impact of COVID-19 on our financial and operating results, we anticipate a notable reduction to inventory levels for our largest customer in the second quarter and the potential for future impact on various product lines in our medical diabetes market. We continue to closely monitor revenue, particularly in states that have implemented more restrictive stay-at-home executive orders or recommendations. We have proactively communicated with customers to understand their needs and forecast the financial implications from these conversations. All other medical net revenue for the three months endedMarch 31, 2020 decreased 22.1% compared to the same period in 2019. The decrease was driven by a one-time revenue adjustment, partially offset by medical coil demand. During the quarter endedMarch 31, 2020 , we recorded a cumulative adjustment of$1.2 million to reduce revenue within our other medical market to correct an error related to prior periods as a result of our determination that a portion of our sales being recognized over time needed to be recognized at a point in time. The adjustment included a reduction of the related cost of goods sold of$0.8 million and related impacts to reduce the contract asset and an increase to inventory. The adjustment was not material to our Consolidated Financial Statements for any quarterly or annual period.
Net revenue in our hearing health value based direct-to-end-consumer (DTEC)
business for the three months ended
Net revenue in our hearing health value based indirect-to-end-consumer (ITEC) business for the three months endedMarch 31, 2020 decreased 71.1% compared to the same period in 2019. The revenue decline was largely attributed to the absence of hiHealthInnovations revenue in 2020. Net revenue in our hearing health legacy OEM business for the three months endedMarch 31, 2020 decreased 29.9% compared to the same period in 2019 due to sales mix and decreased demand, due in part to the impact of COVID-19. As it relates to our overallHearing Health business, we believe that the FDA could be delayed in promulgating regulations regarding OTC hearing aids due to COVID-19 priorities at the FDA, which delay will likely have an adverse impact on hearing health markets over the course of 2020. Net revenue to the professional audio device sector decreased 28.5% for the three months endedMarch 31, 2020 compared to the same period in 2019 due to order delays as a result of COVID-19.IntriCon will continue to leverage its core technology in professional audio to support existing customers, as well as pursue related hearing health and medical product opportunities. Gross profit
Gross profit, both in dollars and as a percent of revenue, for the three months
ended
2020 2019 Change
Percent Percent
Three Months Ended
of Revenue Dollars Percent Gross Profit$ 4,572 21.3 %$ 8,558 28.9 %$ (3,986 ) -46.6 % Gross profit for the quarter endedMarch 31, 2020 decreased over the comparable prior year period primarily due to lower revenues, changes in product mix, excess capacity related to the recent manufacturing expansion to meet the higher volume requirements of our existing and future customers as well as inefficiencies and excess capacity due to COVID-19. 31
Sales and Marketing, General and Administrative and Research and Development Expenses
Sales and marketing, general and administrative and research and development expenses for the three months endedMarch 31, 2020 and 2019 were as follows: 2020 2019 Change Percent Percent Three Months Ended March 31, Dollars of Revenue Dollars of Revenue Dollars Percent Sales and Marketing$ 1,993 9.3 %$ 3,389 11.5 %$ (1,396 ) -41.2 % General and Administrative 3,416 15.9 % 3,186 10.8 % 230 7.2 % Research and Development 1,201 5.6 % 965 3.3 % 236 24.5 %
Sales and marketing expense for the three months ended
General and administrative expenses were greater than the prior year periods primarily due to increased other outside services, support costs, non-cash stock compensation and severance expense. Research and development increased over the prior year periods due to increases in outside service and support costs as well as continued production efforts related to our self-fitting software enhancements. Interest income, net Interest income, net for the three months endedMarch 31, 2020 was$184 compared to$215 for the comparable three month period in 2019 due to an overall reduction in our investment balance. The investment balance has decreased as we have deposited proceeds of maturing securities into a money market account in order to maintain liquidity until the impacts of COVID-19 become more certain. Other expense, net
Other expense, net for the three months ended
Income tax expense Income tax expense for the three months endedMarch 31, 2020 was$18 compared to$131 for the same period in 2019. The change in income tax expense relates to a reduction of foreign income taxes paid in the current period.
Liquidity and Capital Resources
During the COVID-19 pandemic, we continue to maintain adequate liquidity to operate our businesses. As ofMarch 31, 2020 , we had$15,177 of cash on hand as well as$16,889 of short-term investment securities maturing within the next twelve months. Sources of our cash for the three months endedMarch 31, 2020 have been from our investing activities, as described below. The Company's cash flows from operating, investing and financing activities, as reflected in the statement of cash flows, are summarized as follows: Three Months Ended March 31, 2020 March 31, 2019 Cash provided by (used in) continuing operations: Operating activities $ (1,239 ) $ 712 Investing activities 8,005 4,871 Financing activities (158 ) (179 )
Effect of exchange rate changes on cash 20 32 Net increase in cash from continuing operations 6,628 5,436 Cash provided by (used in) discontinued operations, net
3 (293 )
Net increase in cash $ 6,631 $ 5,143
32
The most significant items that contributed to the $1,239 of cash used in
operating activities were increases in inventory primarily related to order
delays due to the uncertainty surrounding COVID-19. The increase in inventory
was partially offset by add backs for non-cash depreciation and amortization,
stock-based compensation and increases to accounts receivable and other assets.
Net cash provided by investing activities of $8,005 primarily consisted of
proceeds from maturing investment securities partially offset by purchases of
machinery and equipment. We have temporarily ceased reinvestments of maturing
investment securities in order to maintain liquidity until the impacts of
COVID-19 become more certain. The purchase of machinery and equipment primarily
relates to automation equipment purchased in relation to the supply agreement
with our largest customer.
Net cash used in financing activities of ($158 ) was comprised primarily from the
withholding of shares from vesting RSU awards to pay withholding taxes and the
payment of financing leases partially offset by cash received from the exercise
of stock options and employee stock purchase plan shares.
The Company had the following bank arrangements:
Domestic Credit Facilities
The Company and its domestic subsidiaries are parties to a credit facility withCIBC Bank USA . The credit facility, as amended through the date of this filing, 2020, provides for a$12,000 revolving credit facility, with a$200 sub facility for letters of credit. Under the revolving credit facility, the availability of funds depends on a borrowing base composed of stated percentages of the Company's eligible trade receivables and eligible inventory, and eligible equipment less a reserve. The credit facility matures onDecember 15, 2022 .
On
? Increased the Company's revolving loan borrowing capacity to$12.0 million from its then current capacity of$7.0 million ;
? Added provisions addressing interest rates following the unavailability
of the London Interbank Offered Rate or LIBOR;
? Waived a default in the fixed charge coverage ratio covenant as of March
31, 2020;
? Eliminated the funded debt to EBITDA ratio and fixed charge coverage
ratio for the quarter ending
? Added a financial covenant requiring that at all times until September
30, 2020, the borrowers maintain at least
calculated as the sum of (a) cash on hand, plus (b) cash equivalent
investments, plus (c) available borrowing capacity under the revolving
credit facility.
After giving effect to the waiver in the Fourteenth Amendment, the Company was
in compliance with all applicable covenants under the credit facility as of
Foreign Credit Facility In addition to its domestic credit facilities, the Company's wholly-owned subsidiary,IntriCon ,PTE LTD. , has an international senior secured credit agreement with Oversea-Chinese Banking Corporation Ltd. that provides for an asset-based line of credit. Borrowings bear interest at a rate of .75% to 2.5% over the lender's prevailing prime lending rate. 33 Capital Adequacy We believe that funds expected to be generated from operations, funds maintained in liquid investments and funds available under our revolving credit loan facility will be sufficient to meet our anticipated cash requirements for operating needs for at least the next 12 months. While management believes that we will be able to meet our liquidity needs for at least the next 12 months, no assurance can be given that we will be able to do so. As ofMarch 31, 2020 , andDecember 31, 2019 , the Company had a total borrowing capacity of$9,446 and$9,589 , respectively, with no borrowings outstanding at each reporting period.
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