IRIDEX Corporation (IRIX) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the IRIDEX Corporation Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, February 27, 2014. And I would now like to turn the conference over to Will Moore, Chief Executive Officer. Please go ahead, sir.

Thank you, operator. Good afternoon, and thank you for joining us as we discuss the results of the fourth quarter of 2013. My name is Will Moore, and I'm the CEO of IRIDEX. I'm joined by Jim Mackaness, our CFO and COO. Jim and I will be delivering some prepared remarks related to the quarter and to the business, and then we'll open the floor for questions. Before we get started, Susan Bruce will read the required Safe Harbor statement. Susan?

Our discussion today will include forward-looking statements, including statements regarding the adoption of our products, including our MicroPulse product offering; trends in the domestic and global health care markets; planned product releases and development efforts; the success and the -- I'm sorry, the success of the reorganization of our sales and marketing teams and the results of our education, sales and marketing campaigns; sales of our consumable products and the anticipated mix of sales of consumables and capital equipment; our long-term margin goals and performance against those goals; our anticipated first quarter 2014 operating and financial results, including projected revenues, gross margins, operating expenses and operating income; and our goal to turn IRIDEX into a more commercially oriented, market-driven company and leverage the respected IRIDEX brand; and the anticipated scope and growth of our diabetic macular edema and glaucoma businesses and product offerings. Forward-looking statements are only predictions and involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our quarterly release and described in detail in our SEC filings. Forward-looking statements are made as of today's date only, and IRIDEX disclaims any obligation to update any forward-looking statements. Any future products, features or related specifications that may be referenced during today's call are for informational purposes only and are not commitments to deliver any technology or enhancements. IRIDEX reserves the right to modify or cancel future product plans at any time. I'll turn this back over to Will at this point.

Thank you, Susan. I'm pleased to begin by saying the fourth quarter of 2013 was another record quarter in terms of ophthalmology revenues. This was our fifth consecutive record quarter, and we demonstrated strong performance on all operational fronts. Our revenues for the quarter were $10.6 million, a year-over-year increase of 15% and more than 10% increase sequentially over the $9.5 million in revenue for the 2013 third quarter. Revenue for the year was $38.3 million, setting another record for ophthalmology sales during a 1-year period and up more than 10% on 2012. We believe this strong top line growth is evidence that we are gaining market share and increasing traction in the marketplace for our innovative products. As those of you who follow us closely know, since I became CEO, our primary goal has been transforming IRIDEX from a respected research-oriented company to a successful market-oriented company that moves faster and has more growth and profit potential. We now believe our new commercial model has evolved to the point where our fundamental building blocks are in place. That's a substantial accomplishment and one that gives us confidence that our strategy is sound and will continue to drive shareholder value going forward. We made some important moves over the last 18 months to get here, including some key personnel changes in product development, sales and marketing, and are making adjustments to our sales channel. As we have discussed in the past, we sought partner relationships that would help us implement quicker product development cycles. The global distribution and supply agreement with Peregrine, which we announced last April, is a great example. Working with a high-quality manufacturer like Peregrine will allow us to drive costs out of our supply chain and help us accelerate product development cycles for new disposable products, all very important parts of the new, more agile, commercially-oriented IRIDEX. We're also seeing a growing demand for our products, both in the U.S. and internationally. In the first full year of availability, we sold more than 50 of our TxCell Scanning Laser Delivery Systems. TxCell is a device capable of high-speed laser delivery. Its second version, launched at the end of 2013, addresses an additional market segment while incorporating significant performance enhancements, at a reduced manufacturing cost. A key benefit of TxCell is that it facilitates the adoption of our proprietary MicroPulse technology, a disruptive technology used to treat visually disabling ophthalmology conditions, such as diabetic macular edema or DME. By using TxCell, the physician can lay down a blanket of non-tissue-damaging laser energy. With [indiscernible], MicroPulse is combined to produce therapeutic effects in a nondisruptive manner, simulating the patient's ability to up-regulate beneficial proteins, thereby promoting the reduction of the edema and improve visual sensitivity. This structural change is believed to be responsive for the long-term durable nature of the therapy. And the longer-term durable -- durability produces the economic benefits. MicroPulse is a unique therapy, and it plays an important role in our future. We believe it's a major advance over the past year. We have made a concerted effort to educate patients and health care payers on its benefits. We are seeing those efforts pay off in terms of general interest in the marketplace, at conferences and in sales. MicroPulse is building a reputation as an extremely safe and effective procedure, providing durable outcomes at a reduced cost, compared to alternative drug therapies. Let me expand on the idea of value-based medicine, since it's an important concept for IRIDEX. Everywhere in the world where there are rapidly growing numbers of diabetic patients, including developing countries like Brazil, India and parts of Europe and Asia, it's becoming clear that repeated drug treatments for diabetic macular edema, or DME, are too expensive and not logistically possible, given the millions of patients who seek treatment, via injections, every 6 to 8 weeks. This is a global issue and part of the developing concept in value-based medicine. MicroPulse, with its single treatment efficacy and the positive, long-term durable outcomes, represents a major step in the direction of value-based medicine for the rapidly growing, global problem of DME. Our products offer a more durable and more cost-effective alternative to the literally millions of people around the world who need a new answer for this diabetic-related ophthalmology condition. This is an enormous opportunity for us, and we believe we are commercially and operationally prepared to take advantage of it. With that, I'll turn the call over to Jim to discuss the financials in more depth. Jim?

Thanks, Will. As we noted in our press release and in Will's comments, we had a record quarter in Q4, as revenues reached $10.6 million, up 15% from Q4 2012 revenues of $9.2 million, and up 11% sequentially from Q3 in 2013, where revenues were $9.5 million. System sales in Q4 2013 were $6.0 million, up from $5.0 million in Q4 2012, with significant increases in system sales both domestically and internationally. On a sequential basis, system sales were up from $4.7 million reported in Q3 2013, similarly driven by both domestic and international sales. The successful launch of our TxCell device has been a key contributor to this growth and it has significantly increased the ASPs of our system sales. And we continue to see increased unit sales of our MicroPulse-enabled lasers. And again, we are seeing good sales momentum as we entered the beginning of 2014. Recurring revenues increased to $4.5 million in Q4 2013, compared to Q4 2012 recurring revenues of $4.2 million, a 9% increase, and we're down $0.2 million sequentially from Q3 2013. The increase in recurring revenues over last year was primarily a result of the contributions of our independent U.S. sales channel. And the dip from Q3 was the result of timing of some orders from Alcon, a distribution partner for one of our system [indiscernible] products. Even with this growth, as a result of the significant increase in system sales previously mentioned, recurring revenues dropped to 43% of the aggregate revenues in this year's fourth quarter, a reduction from 45% reported in Q4 2012 and a reduction from 50% for Q3 2013. You can see the impact of the change in product mix from recurring sales to system sales in our gross margin performance, notably from Q3 2013 to Q4 2013. Gross margins for Q3 2013 were 49.6%, with system sales comprising 49% of total revenues. Gross margins for Q4 2013 were 48.6%, with system sales comprising 57% of total revenues. Compared to the fourth quarter of 2012, gross margin improved from 47.0% to 48.6%, which we view very positively, because we achieved this improvement through overhead efficiencies and cost reductions, and these improvements outweighed the product mix shift from 54% system sales last year Q4 to 57% system sales this year Q4. These improvements are a good start, and we have additional projects under way to improve our gross margin. The recent launch of our second version of TxCell has a reduced cost base, and a major project in 2014 is the cost reduction program for the IQ platform that supports MicroPulse-enabled lasers. Furthermore, we continue to see positive results and improved pricing leverage with the growing adoption of MicroPulse. These efforts, together with our consumable product development plans, are all part of our strategy to work our way up to our longer-term goal of 55% gross margin. Operating expenses for Q4 2013 were $4.6 million, up from $4.0 million in Q4 2012. The year-over-year growth is due to additional selling expenses associated with the independent U.S. sales channel brought on in Q2 of 2013, and increases in G&A expenses due to enactment of the medical device tax and increased compensation expenses, including profit-sharing bonus accruals. Operating expenses for Q3 2013 were $4.1 million. The sequential growth in expenses were driven by increased selling and marketing expenses. AAO is our biggest trade show, which occurs in our fourth quarter. And increased revenues for both the quarter and year drove increased regular and bonus commission expenses. Operating income for Q4 2013 was $0.6 million, up from $0.3 million in last year's fourth quarter. We did report a $0.2 million noncash other expense in the quarter. This was the result of increasing the contingent earnout liability on our balance sheet, as the outlook for revenues generated from certain acquired product improved. Excluding this item, our earnings per share on a diluted basis would improve by $0.02 for the quarter. Including this expense, as we did in our P&L, our net income from continuing operations for the quarter was $0.4 million or $0.04 per diluted share, compared to $0.3 million or $0.03 per diluted share for Q4 2012. Our full year results help provide a broader illustration of the progress we have made in 2013. Revenues for the full year 2013 were $38.3 million, up 13% over 2012. Gross margins improved from 48.3% to 48.6%, a small uptick, but given the change in product mix I referenced earlier, a good result. Operating expenses decreased from $17.2 million to $16.0 million. And operating income was $2.6 million, compared to an operating loss of $0.9 million. Net income from continuing operations for 2013 was $2.2 million or $0.22 per diluted share, compared to a net loss of $0.2 million for 2012 or a loss of $0.02 per share. Looking to the first quarter of 2014, we're projecting revenues between $9.8 million and $10.1 million, representing growth of between 9% and 13% over the prior year period; gross margin is anticipated to come in between 48% and 50%; operating expenses, between $4.3 million and $4.5 million; and the company anticipates generating operating income. We did have some activity in the stock repurchase program during the first -- fourth quarter. We bought approximately 38,000 shares at an average price of $6.03 during the quarter. And today, the board approved extending the plan through February 2015. And currently, we have $2.6 million available for stock repurchases. And with that, I'll turn the call back over to Will. Will?

Thank you, Jim. We accomplished our goals for 2013 and are extremely excited about 2014 and beyond. We believe our MicroPulse solution for DME generated momentum for our business in 2013, and the momentum around DME will continue to accelerate in 2014. I need to highlight, the application of our proprietary MicroPulse technology is not limited to DME. It also has applications in glaucoma. During 2013, we started the process of promoting the IQ 532 MicroPulse laser for MLT procedures, the process that improves fluid draining, thus reducing IOP. In 2014, we'll focus on making further inroads in the therapeutic treatment of glaucoma. The IQ 532, with its combination treatment for DME and glaucoma, is very appealing to the comprehensive ophthalmologist, who represents a new market opportunity for us. In addition, we are repositioning our G-Probe for earlier-stage glaucoma treatments. And towards the end of this year, we expect to introduce an additional bundle of single-use glaucoma products that are captive to a new MicroPulse laser platform, which, if successful, will position us for growth in the procedural side of our business model. By the end of 2014, we expect IRIDEX will be known for its proprietary new MicroPulse treatments providing solutions for 2 major disease states: DME and glaucoma, with growing capital and recurring revenue streams. I would like to thank our customers, our partners and all IRIDEX employees for a successful 2013 and look forward to continuing that success in 2014. With that, operator, I'd like to turn the call -- open the call for questions.

[Operator Instructions] And our first question comes from the line of Larry Haimovitch with HMTC.

Will, I know you were over -- I apologize if you went over this during your prepared remarks. I was -- I had 200 conference calls, and I couldn't catch your whole call. So if I'm covering ground that's already been covered, we can talk offline. I just want to ask you though, I know you were overseas. You were in India for a while talking to some potential customers and doctors, et cetera. Just wondering what's your sense of the opportunity, as now that you've had a very fresh look at it in some of these countries, where we all know that the possibility of monthly or as many injections per year is really a difficult financial burden and how lasers for DME -- laser treatment for DME makes so much more sense. So I'd love to hear your thoughts on that.

I did spend about 10 days in India, a number of conferences and going to different teaching hospitals and meeting with the chairmans of departments. It's pretty clear in their mind the current method of treatment, using continuous wave laser that photocoagulates the top of the spot of leakage, is not the long-term answer. They also are very clear that injections are not the long-term answer, but that's not because the outcome's not good, it's because the economic impact on society is too large. If you just think about the number of doctors versus the number of patients, the idea of coming back every 6 to 8 weeks is just not possible. And the financial burden to the individual patient and their family is enormous. So there, we will be -- hopefully, we'll be announcing a couple of studies in the near future from a couple of prestigious institutions there, looking at specifically the problem in India, to reduce the cost to society while improving the long-term durability or outcomes to the patients in and around DME, as diabetes is just a massive problem in India. So I think the opportunity is quite large.

So the clinical trials would be to show the effectiveness of a mixture of DM -- laser treatment, along with injections or maybe injections versus laser treatment. What do you think that trial might look like, if you were to start a trial in India?

I will know more in a week -- a couple of doctors are meeting this weekend. But the issue is not really -- their viewpoint is the durable outcomes from MicroPulse and the durable outcomes for injections are comparable. The issues have to do with logistics and cost. And so what they're really looking at is, if in fact that is a true statement, then it becomes [indiscernible] decision. And there's -- what their recommendations would be to society is to go to something like the MicroPulse. I don't think we're going to be doing a lot of absolute measurements for their size, the reduction of the edema. I think we're looking more from the standpoint, there's enough studies out there that show that the edema is reduced by MicroPulse and the edema is reduced by drugs. It's really what happens after 6 months, a year.

It's kind of a cost -- it's sort of a class outcome, quality of life, societal cost, kind of a thing, as opposed to a clinical trial comparing one therapy to another.

Correct. I think what we're seeing, we're seeing it in the U.S. as well, when we use this term value-based, it's really, there's not enough financial or human capital to treat some of these large diseases that are out there. What's the best way to do it? And their interest is clear, that their viewpoint is drugs do work, but they're just way too expensive, and the logistics are impossible to deal with in India.

Our next question comes from the line of Sam Bergman with Bayberry Asset Management.

I got a couple questions for you on the TxCell scanning system. You, I assume, saw some acceleration in the MicroPulse sales from that digital product in the fourth quarter. Are you seeing the same in the first quarter with that? And what's your expectations for '14 with the MicroPulse product, with this new addition?

Well, I'm going to answer part of that question. The TxCell system, in combination with MicroPulse, makes the entire procedure that much better. The -- if you think about what we do with MicroPulse, it presents itself on the eye and leaves no damage. There's no visible evidence that it's even been there. When you have the TxCell, you look at the eye and you put these confluence spots, you basically paint it, lay the blanket over, whatever term you want, over the entire area, and now you know what you've been treating. So the 2 of them together really promote the ability to do MicroPulse faster, easier. And as Jim said in his comments, it raises the price for the MicroPulse in the total sales system, and it also increases the value of the laser system itself. Now to answer your other question, I'm not -- I'm just going to say that we believe we got good momentum going forward, but I'm not going to put out a numbers as to how many TxCells we're going to sell. But I think we're comfortable in saying that the number we sold in the last part of the year with -- and with the new one, the new reduced cost and more -- and faster, we'll do just fine.

And the other question I wanted to ask is in regard to the glaucoma product, are there any FDA approvals needed for any of these products in 2014?

Well, there's FDA approvals on all products that we manufacture. I think on earlier calls, we talked about these are not scientific projects. So you've heard me talk in the past, and Jim talk in the past, about all the little nuggets that Ted and his research group left in the war chest. These are straightforward engineering projects. They'll be 510(k)s, and they'll be approved, the projects at this point in time. We've got product. We've got a few more products, and Paul will be filing with the FDA in appropriate time. That's about a 90-day window that it takes for a 510(k).

Do have the timeline for these products so that you can share with us?

We said we'll be out by the AAO.

Our next question comes from the line of Jason Stankowski with Clayton.

The question, I guess I've asked at each call is sort of trying to get a sense of a little bit of the inflection point. I know it's not all going to come in one quarter, but is there anything anecdotal to how many -- I know we shut off shipping lasers with MicroPulse activated and have started to charge, over the last year or so, charge for that additional benefit in the lasers. And I'm just curious if you're seeing in the numbers an acceleration of people buying lasers and/or people coming over the transom or through the Internet, that are asking for the MicroPulse feature, sort of independent of us out there trying to sell it. Is the buzz starting to percolate a little bit? And if so, what gives you confidence that, that's happening?

Okay, so that was a fairly long question, with multiple components. I'm going to try to answer correctly. The short answer is we're getting calls from doctors, and our salespeople are going in and selling products to some that they haven't talked to before on a regular basis. Those are coming from Internet. They're coming from trade shows. They're coming from -- we sold one to Tufts University not long ago. And pretty soon, you get alumni from Tuft that are elsewhere, that are calling and saying, "I want to do what Elias Reichel is doing." So we get that. I think the -- we use the term -- we've used the term tipping point. And to me, what we're doing -- what we're seeing now is an acceleration of our product acceptance. As Jim defined, it's running 10% to 15%. To me, that's not the tipping point yet. I think you'll see it accelerate even greater than that when we reach that point. And when I look for a few anecdotal-type things that you mentioned, if I look on the Internet and I type in DME, the day I see MicroPulse, that's a good signal the tipping point's there. So it's still not to that point where it's widely accepted, other than the fact I can say it is widely talked about. Wherever I go, I mean, on the trip to India, people were talking about it. I was in Germany before I went there. They were talking about it. They're not buying it yet, with purchase orders, but they are discussing it amongst themselves. And I think what we've said and the way we are positioning it is the right way to go. We do no harm. We provide a mechanism that allows the patient's own body mechanisms to treat itself. And the durability of that treatment is so much better than anything else in the market. That's the message. And I think it's resonating, and I think it will continue to resonate in 2014 and beyond.

Okay. And just, I guess, one other thing. We were, I assume, at Hawaiian Eye here in, was that in January?

Yes.

And just curious, if anything came out of that, is that more the comprehensive docs, and I know we're looking for some signs that they're entering kind of our purchasing universe as well. I'm just curious if you'd -- you had mentioned from a couple of the European shows last year that you really thought the conversation was getting elevated. I'm curious if there's any feedback from that show that you can share with us, positive or otherwise.

Yes, this is Jim. I'll just pass on some comments that Tim mentioned, who was there. He's our VP of Marketing and U.S. Sales. So yes, continue to be good traction from the comprehensive guys. And I think probably, Jason, something you should note on your calendar is actually coming forward in -- I think it's April for this year. We're going to be doing -- hosting a large luncheon at the cataract -- Annual Society of Cataract and Refractive Surgeons, which is predominately a meeting that a lot of comprehensives attend. So in April, we'll actually be hosting one of those large luncheons, where we're looking to get maybe north of 300 to 400 docs in the audience, who will predominately, again, be comprehensive in nature. And we will be looking to really message, as Will has indicated, some of the crossover ability of the IQ 532 to treat glaucoma, as well as retinal conditions, to that market. So I think we continue to focus on it. We like the early signs, and we're starting to put some aggressive marketing to penetrate further.

And our next question comes from the line of Joe Munda with Sidoti & Company. Joseph P. Munda - Sidoti & Company, LLC: In your prepared remarks, you emphasized the cost benefit of the lasers versus the drugs in particularly the BRIC nations. I was wondering, can you give us some sense of what the cost differential would be? I know you've highlighted some of those points in your slides, but I was wondering if you could give us a little bit more detail.

There's a -- and I'm pulling this from memory, but just to try and help to give you a crystal sort of response. There's a metric out there of the cost of life investment. And the numbers that we have heard referenced for the drugs can be as much as $30,000 on an annual basis per patient, and the equivalent can be $3,000 for the patient on an annual basis using a laser. Joseph P. Munda - Sidoti & Company, LLC: Okay, that's very helpful. And then as far as a follow-up question is concerned, what is -- I'm a little confused, the second iteration or -- of TxCell, what is so different from the first version, as well as why is it so much cheaper on the cost side?

Well, so the first version of TxCell, these are delivery devices that hook on to a slit lamp that the ophthalmologist owns. So the first version was one flavor, which would be a Zeiss flavor. And typically, our rough back-of-the-envelope says that's about 40% of the market. So we knew that, we wanted to get selling into the market. And because we wanted to get selling into the market relatively quickly, we did first-round engineering efforts, if you like, to get the product out, fully knowing that we have to come out with a second version. The second version is Haag-Streit and Zeiss compatible. So it allows us to sell one product into both. So now we've got the additional 60% market opportunity, which is the Haag-Streit slit lamp. So now you've got one product that effectively sells to both, most common styles of slit lamps. And we took the opportunity to take early customer feedback on a couple of the features, most notably speed. We did improve the speed of scanning, and we also took the opportunity to cost engineer out, some of the [indiscernible] materials. So that was the purpose of TxCell 2. Joseph P. Munda - Sidoti & Company, LLC: Okay. Got you. And then I guess one other, you touched on glaucoma opportunity. But specifically for what you guys are targeting, what is that market opportunity, specifically, to your products?

Well, Joe, I think the way we'll talk about the opportunity at this point in time is, Jim and I look at markets, overall markets that we can address. And the first one was the diabetic market, and it's estimated now that we're talking 450 million people within another 10 years or so with the disease. So the magnitude of the problem is pretty big. The next major area in our space has to do with the macro trends of the aging population and full 65 is the fastest growing demographics in that thing -- in that area. And those people coming down -- are the ones that come down with glaucoma. The glaucoma piece has multiple facets for us. And from early stage to late stage, and it's not curable, all you can do is slow it down. We started out by doing the late stage, with the G-Probe. And we're just -- and we're migrating up to earlier and earlier stages. And we will -- as we get closer and closer to the release, we'll provide more information as to what we think the exact market opportunity is for us. But I think you can look at it from -- right now, just look at it in the macro trends. We're attacking a population that is aging, that has glaucoma, that there's no solution, so it's a pretty serious issue. And the only treatments are drops, which help, but it gets difficult when you're having to take 2 or 3 drops, and you're 70 years or 80 years of age. Surgical intervention, SLT lasers, ALT lasers, shots, there's just a variety of treatment modalities. And we'll be moving into that with a system that has a laser that produces a treatment for 4 or 5 differing areas of glaucoma, and that's about as much as I'll say.

And there are no further questions at this time. I'd like to turn the call back to management for any closing remarks.

I'd like to say thank you to everyone for attending today's conference, and we look forward to having another positive call next quarter. And thank you.