IRIDEX Corporation (IRIX) Q1 2016 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen, and welcome to the IRIDEX Corporation’s First Quarter 2016 Earnings Conference. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host Mr. Will Moore. Thank you, sir. You may begin.

Thank you, operator. Good afternoon and thank you for joining us as we discuss the results of the fourth quarter of 2016. My name is William Moore, and I'm the CEO of IRIDEX and I'm joined by Romeo Dizon, our Vice President and Controller. I will be delivering some prepared remarks and then we'll open up the floor for questions. Before we get started, Susan Bruce will read the required Safe Harbor statement. Susan?

This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended, relating to the effect of currency exchange rates and other global and domestic market conditions on the company’s business, the product mix composing sales in future periods, demand for the company’s products and market acceptance of the company’s new products, sale levels, continued developments, pricing model and contribution to earnings in future periods of the company’s Cyclo G6 product platform, the impact of these and other new products on the company’s business, trends in the global healthcare marketplace with respect to the treatment of eye diseases, such as diabetic macular edema and glaucoma, the company’s growth strategy and growth opportunities, including acquisitions, technology investments, and strategic relationships, pricing of the company’s products, the company’s operating expense controls and cost reduction programs, and the impact of these controls and programs on the company’s financial results, the company’s clinical and other marketing initiatives, the availability or results of future clinical studies relating to the company’s products, the company’s changes in personnel, the company’s share repurchase program, the company’s financial outlook and performance in the second quarter of 2016, fiscal year 2016, and other future periods, including future revenues, sales, gross margin, operating expense and pricing levels, the company’s business and sales model, regulatory developments and approval for company’s products, the impact of sales cycles, tax rates and cash requirements related to tax obligations in future periods, any health risks associated with the use of the company’s products, and other industry-wide factors affecting the company’s business. These statements are not guarantees of future performance and actual results may differ materially from those described in these forward-looking statements as a result of a number of factors. Please see a detailed description of these and other risks contained in our annual report on Form 10-K for the fiscal year ended January 2, 2016, filed with the Securities and Exchange Commission. Forward-looking statements contained in this conference call are made as of this date and will not be updated. I'll now turn the call back over to Will. Will?

Thank you, Susan. Those of you who have been following us closely know how excited we are about our business. It’s a very compelling time at IRIDEX. Our commercial outlook today is probably the most promising it has been in a more than a decade and definitely the most promising it has been since I became CEO three years ago. Total revenue for the first quarter was $11.9 million, compared to $10.8 million a year ago. We closed out 2015 very strong and I’m glad to report that the first quarter of 2016 saw the continuation of that momentum. The revenue number was good, the highest ever for our first quarter. But that does not begin to show why we are so excited. As compelling as our story is, our real commercial progress and growth isn’t really reflected in the top line revenues, not just yet. To explain, our business today has principal elements, the largest bringing in the majority of our revenues is our legacy laser consoles and our disposable EndoProbe business. While we still sell into a steady replacement cycle in US and receive and win tenders across the globe, we anticipate this hardware and EndoProbe business will remain a stable to slow growth business in the coming periods. The other elements of our business are and will continue to solid growth engines built upon our core MicroPulse technology. The first is MicroPulse for retina conditions like, diabetic macular edema. This is a stable, growing global business that continues to gain penetration and acceptance and is delivering growth through market share gains. We currently have more than 650 MicroPulse lasers installed and have treated an estimated one million patients in 61 countries. We are investing in this space and expect to continue to do so. It is the third and newest component of our business, our MicroPulse glaucoma platform that has us so excited. The glaucoma market is very large, including $5.5 billion annually in eye-drop medicines alone. This is one of the areas where we see great opportunity and since poor patient compliance with their eye drops regimen is one of the factors leading to ongoing high levels of intraocular pressure or IOP. Our Cyclo G6 laser provides doctors and patients with a new treatment option that often reduces the need for meds. We are seeing the Cyclo G6 quickly gaining acceptance and creating a real potential for G6 to be a breakthrough new business for IRIDEX. We sold a 117 G6 lasers in the first nine months of 2015, including 72 in the fourth quarter and then we sold 84 in the first quarter of 2016. As you know, the real potential for the G6 placements is the razor, razorblade model with doctors using the laser system requiring a new MP3 probe for each treatment. We sold 7000 MP3 probes in the first nine months and then 5000 more in the first quarter. Clearly, the adoption of the technology is going well, admittedly fast than we had predicted and at times, even challenging our ability to produce the laser console and the probe to satisfy orders we are receiving. What has us most encouraged about the G6 sales is not the near term top line growth. In fact, we priced the laser console to make sure the price for admission [ph] was not a barrier for physicians. What we are aiming for is to create a large and growing installed base of G6 lasers which should provide IRIDEX a new recurring revenue stream from the MicroPulse probe with strong gross margins. Further, we expect that the low entry price for physicians will pay out again when we begin introducing additional G6 laser specialty probes to be used with the console later this year. This will IRIDEX even more mind share and recurring revenue potential with the recurring revenue and joint [ph] gross margins we expect to be in excess of 60%. The margin may improve as the volume increases, as we anticipate moving from cast aluminum to high-quality injection molded plastic probe sometime in 2017. To give you an idea that power the model, we plan to sell approximately 30,000 MP3 probes in 2016. With those numbers increasing in future years due to rising console placement levels and new probe designs to allow different glaucoma related procedures. In terms of overall revenue growth this year, two points, the price of the G6 laser by design is about one-fourth the price of our legacy lasers. And while we are selling them at rates above our expectation, it will still take some time for the recurring revenue model to kick into high gear. To illustrate and the power of this model, at this point, sales from our glaucoma platform represent about 8% of our revenue. By mid-2018, we expect glaucoma product sales to be approximately 50% of our total revenue, while driving higher gross margins than we have today. I mentioned that the G6 offers key competitive advantages, unlike our competitors who tend to specialize in products that treat a particular stage of the disease. Our G6 platform was designed to support additional disposable probe solutions for several distinct stages of glaucoma treatment. On top of that, the economics and logistics for the ophthalmologists are superior to past solutions, as we only take about five minutes to perform an MP3 procedure. In MicroPulse glaucoma treatment, it’s safe, minimally invasive, non-incisional and can be repeated at intervals [ph] over many years as it causes limited-to-no damage healthy tissue. It is also titratable to a patient’s condition which is an important attribute in the area of personalized medicine. Also, thanks to a select few pioneers and now a growing population of MicroPulse doctors, there is growing clinical evidence that the MP3 could and should migrate towards earlier stages of the glaucoma treatment and finally, the reimbursement is good for both the physician and the healthcare facility. We believe these tangible reasons are driving excitement in the glaucoma community for the G6 and openly are behind the remarkable sales growth. We have now sold over 200 G6 lasers and treated approximately 14,000 patients without published peer review clinical data or marketing muscle. Our clinical marketing initiatives are just now getting underway and their clinical presentations are beginning to emerge at major meetings. There was a podium presentation at the American Glaucoma Society Meeting in March, incidentally, not sponsored by IRIDEX, but sponsored by the Society. There are another two presentations at ARVO the first week of May and then there will be two more at ASCRS in New Orleans this weekend. These presentations will be followed by published papers in the coming months that we believe will continue to fuel accelerated interest in sales. Another important differentiator that can’t be overemphasized compared to other therapies in the market, whether it be drugs or devices, our products deliver real value to the healthcare system and provide benefits to both physicians and patients. With the cost of glaucoma therapies increasingly straining the resources of healthcare in the US and around the world, our effective durable products deliver the best medicine at the lowest price, helping us to become the go-to choice. We are currently just starting to introduce the G6 on a limited basis internationally in Europe, the Middle East, and Australia, but our sights are also set on large developing markets like India and China. Our first Asian study was published late last year and doctor is now working on a follow-up that will provide additional data covering over two years on the patients he treated in the initial study. Needless to say, we believe we are entering a new era at IRIDEX where the steady, modest growth of the past is being overcome by a real growth dynamic and with considerably more upside on the way. With that, I’ll turn the call over to Romeo for more detail on the financial results. Romeo?

Thank you, Will. As we noted in our press release and in Will’s comments, our revenues for Q1, 2016 were $11.9 million compared to $10.8 million in Q1 2015, an increase of 11%. The increase is due mainly to the increase in our international system sales which increased $1.0 million or 30% from $3.5 million to $4.5 million. This was primarily a result of an increased sales to the Asia region. Our domestic sales increased $0.1 million or 6.3% from $2.1 million to $2.2 million. The increase in our domestic system sales was fueled mainly by the sales of our Cyclo G6 laser systems which more than offset the decrease in the sales of our legacy products. Recurring revenues, which include sales of our consumable products, service and royalties were flat overall at $5.2 million. Sales of our proprietary Cyclo G6 MP3 probes and G-Probes increased in the quarter from the prior year, but were offset by decline in royalties and sales of our legacy EndoProbes. The growth in part was due to launching of the Cyclo G6 system which we introduced as a starter package consisting of the laser console and MP3 probes for a number of procedures. As Will had indicated, we sold 5000 MP3 probes in Q1 2016, over and above the bundle [ph] probes included in initial purchase. Gross margin in the 2016 first quarter came in at 44.4% compared to 50.1% for Q1 2015. The decrease in gross margin was attributable primarily to the special introductory prices for the Cyclo G6 glaucoma system, to sales mix both in terms of product and geography and to the impact of the foreign currency exchange rates in our international sales. For the remainder of 2016, we see opportunities for margin improvement through volume efficiencies with anticipated revenue increases and anticipated increased consumable sales associated with our Cyclo G6 system. However, as we continue to grow the Cycle G6 system business under special pricing to drive share expansion and to continue to see the impact of the currency movement, we will likely see a temporary compression of gross margin in the coming few quarters. Relating to the launch of the Cyclo G6 platform, we have introduced a business model that is new to IRIDEX and that we expect will be a plus going forward. Till this point, we have worked either under a capital equipment model or a consumable model, but have not combined the two in a razor, razorblade model. The Cyclo G6 platform provides us the advantages of both revenue streams and associated benefits of a growing installed base, providing a regular, predictable, consumable revenue stream. We are seeing that come to fruition and the impact is just beginning. As the market develops, we look forward to updating you more on the success of that model within our overall business. Our operating expenses for Q1 2016 were at $5.1 million, up slightly from $5.0 million in Q1 2015. The increase in operating expenses was attributable primarily to an increase in the general, selling, and marketing expenses, partially offset by decreases in legal expenses, bonus, and salary related costs. Consequently, operating income in 2016 first quarter was $0.2 million, compared with operating income of $0.4 million in the prior year’s first quarter. Net income for this year’s first quarter was $0.1 million, or $0.01 per diluted share, compared to $0.2 million or $0.02 per diluted share for the prior year period. In terms of guidance, for Q2, 2016, we anticipate revenues of $11.6 million to $11.9 million and operating expenses of between $5.3 million to $5.6 million. Lastly, during the quarter, under share repurchase program, approximately 7000 shares repurchase at an average price of $9 per share. Approximately, $1.0 million remains available under the program which expires in August 2016. And with that, I’ll turn the call back over to Will.

Thank you, Romeo. In conclusion, as I stated earlier, this is an incredibly compelling time at IRIDEX. While we have a steady, stable legacy laser and disposable EndoProbe business, a strong MicroPulse retinal [ph] business which we will continue to invest in, what has us all excited is the interest in our huge global glaucoma market. Glaucoma is a chronic, global and rapidly expanding disease that’s meant [ph] to affect more than four million people in the US and approximately 60 million people worldwide. An estimated 9.4 million glaucoma patients are currently on medications and compliance with these medicines is extremely low compared to other areas of healthcare. We believe all these people are potential customers, all looking for a better option, an option like our Cyclo G6 laser featuring MicroPulse, it’s safe, effective, minimally invasive, and virtually, limited-to-no side effects. Sales of G6 platform have already ramped beyond our internal expectations. The disposable probe has created for us a new razor, razorblade model that will compound in the coming months and years, providing both revenue and margin growth. Based on the marketplace dynamics, we are investing in that growth adding to our domestic sales force at measured pace, signing additional international distributors and preparing operationally for the exciting runway ahead. As I said, our prospects for growth at IRIDEX have never been better and we look forward what we believe may be our best period of growth and performance yet. With that, I’ll turn the call over to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from Lisa Springer with Singular Research. Please proceed with your question.

Good afternoon. Will, I believe you’ve said in the past that there are something along the lines of 300 high volume glaucoma accounts in the US. How many of those accounts do you feel that you penetrated at this point?

That’s correct. There is approximately 300 that account for 50% of the business. At the end of Q1, we were over 40 of those.

Okay, great. And did you have any sales upside the US, of the G6 system?

We did, in the Q1, just a few, I think they went to Australia, the UK and Switzerland, I believe.

Okay. And in terms of the sales mix for G6, was it mostly new customers, or did you see a lot of customers coming back to buy an additional unit?

So, obviously, outside the US, they were all new. In the US –

Great. Yes.

We are seeing repeat orders from approximately 40% of the accounts that have purchased product. The issue we run into in there is to analyze – some of those had a starter pack of 60 and some of them had a starter pack of 30. I think that the number is a little difficult to give to you at this point, but I believe we were well over 40% of the customers that have had it for six months, are buying product again. The issue that we have with that is, Lisa, we think – in the initial packages, they had 60 probes, we said [ph] if they did 10, we look at them at 10 per month, we’d look at them at the six month model. What we began to discover was the product that once it was shipped out the door, many times, it wasn’t used for a week or two until that was in service. There’s a little bit of variance in that. But we are satisfied with that rate moving towards a 50% level already.

Okay, great. And the increase in sales and marketing expense year over year, was that mostly related to the G6 and what does your sales force look like now as compared to at the end of last year?

It’s not related to the G6, it’s just related to growing our sales department, we’ve added a territory or two, we’ve elevated a person to become a Field Manager, so we have two of those now. That’s really the expense.

Okay. Thank you, Will.

All right, thank you.

Thank you. Our next question comes from the Larry Haimovitch with HMTC. Please proceed with your question.

Hi, good afternoon. Well, congrats on the progress.

Thank you, Larry.

So I think you said you shipped 84 Cyclo G6s in Q1, did I catch that right?

You did.

Okay. Were constrained from a manufacturing standpoint? Would you or could you have shipped more if you had split [ph] more manufacturing supply?

We could have shipped more. I am not going to say it’s a manufacturing, supply, all these things depend upon when the order comes in in the cycle. And in this type of business, 60% of our quarterly revenue comes in the last month of the quarter, about 60% of that comes in the last two weeks.

Right.

Sometimes [ph] we just can’t get them out the door, and I would say there were a few that didn’t get out the door.

So based on Q1, would you say that if we multiplied at least by four or more that that could be what you could do for this year? Should we think of your run rate at 80%-plus per quarter as a reasonable run rate?

Well, I think that’s a reasonable way to think about it. We haven’t given out a number which we’ll do for the year. But I think that the idea is by the end of the year, we should be doing at least four times the first quarter.

Okay. And then I think you mentioned international or maybe Romeo mentioned international was up $1 million, is that sort of one-time tender offer or is that indicative of greater strength in international that you’ve had in past years?

I think it is not a one-time order. It’s greater strength on international standpoint, but predominantly, we had a couple of large orders from China and Japan. And the China was predominantly around what we talk about before which was a Beijing remote project which they were trying to treat people in the rural areas, they are looking at other parts of the country now and we’ve seen those. And then on the Japanese side, we started a couple of studies around MicroPulse in Japan that have begun to pay some dividends and the sales into Japan were all on the MicroPulse retina side.

Okay. And one more question and then I’ll jump back in queue, and that’s on the gross margin. Reading between the lines, my interpretation of the decline in gross margin was perhaps a little bit of was discretionary in that you had an opportunity to get some more business and you were able to do it or willing to do it at bidder [ph] lower price to getting it installed – install the larger install base, did I read that right, or did I misunderstand?

I am going to try to clarify, because as Romeo said, there was a geographical mix issue which we had a large amount of business coming from international.

I see.

And it’s predominantly hardware which is if you look at multiple – our components, the hardware sales has lowest margin whether it’s in the US, international and disposable, a little [ph] higher, but international sales in general are lower. So, we had a couple of large orders out of our distributors overseas which pulled it down – and that is not from a situation of reducing the cost. Those were just as a factor of the size of the business. And then we –

So, it’s mainly mix, it’s mainly mix, the mix was larger internationally and that’s a lower gross margin business.

Correct. And the mix is both in regional and product. And what Romeo said in his call is appropriate that the bundled price for the initial thing on the G6 is a temporary piece where it’s lower now and they will be replaced by higher margin disposables as we move forward.

Right. Got that. Okay. Thank you very much, Will.

All right, thanks.

Thank you. Our next question comes from the line of George Monk a Private Investor. Please proceed with your question.

Hi, Will.

Hi, George.

Hi. The last conference call, you said in your experience, if a doc has a bad experience the first time they use a machine, then they don’t come back a second time, and you said was the reason you are doing a measured roll-out for the G6, do you have any statistics on how successful you are in teaching – in performing [ph] doctors, how many of them have [ph] come back for the second time?

Your call is very static. [ph] I am going to repeat the question. You can tell me whether I got it right or not, but I think your question has to do with, the mention of it [ph], if we don’t train doctors correctly, then their ability to get patients possibly positive results, they may not come back a second time and do a second treatment, is that where you are going?

That’s correct. And what statistics do you have on how [ph] successful you are? [indiscernible]

Okay. So, here is how I look at that. We are very successful, people are reordering, people are reordering not only probes, but additional boxes. Now, let’s put that into a qualification with statistics. The studies that we have both in the Asian market, Canadian and US markets that are being published and coming out in presentations, support a position of 72% to 84% of the patients they treat, they are successful. The other 20% some odd, we are not saying they are failures, that we are saying they are outside of the realm of patients that should be or could be treated with our device. So, we have to be doing a little, I’ll say a little better at identifying that population and our new product that’s understandable. And if a physician was trained correctly and did those patients, the outliers [ph] that were not deemed to be in that success rate, they probably wouldn’t have a good experience or opinion of our product. So, it’s up to us to make sure they understand how to use and what patients to treat.

Interesting. Thank you.

All right.

Thank you. [Operator Instructions] Our next question comes from the line of Paul Seth who is a Private Investor. Please proceed with your question.

Hi, thank you. And Will, thanks for the good progress. Previously, you stressed the importance of training and the introduction of the new products in the US, and looking forward, international lies ahead and I am – I was also looking at that gross margin change. The expense burden per dollar on incremental revenue must be higher in the international markets, and can you entrust your distributors to do that training, is the burden on you to expand, how do model this expense ratio out there?

Well, the sales price of our products to our distributors is obviously lower than we sell it one a direct basis. But then we have a smaller sales cost associated with that. The distributors we have – there’s a couple of things we are doing to try to mitigate what you are asking. No distributor can get our product, the G6 product, until they’ve gone through and they have agreed to hire, or promote or create a product specialist in their region. The next part is they cannot just by one. So, the distributor has to commit to us that they are going to have somebody we can personally train and certify who is response [ph] for the G6 in their territory and then they must buy an equivalent amount of G6s which we think is an appropriate investment to make sure they are doing it correctly. The next part of that is we have our own people located, for example, in Europe and when we say we release to Europe, he can only release to a few countries at a time to make sure that our manager, along with that product specialist are working with the hospitals on a one-by-one basis until we have that community put together in that country. Once we are comfortable that country has got the basis there, that if somebody has a problem – for example, we’ll talk about the UK, we picked the top two hospitals in England, Moorfields and I am trying to remember what the other one was, and said those two are – they are starters. They had to buy a product before we put anything else in, because – why because they do a large volume of patients. Two, they have the prestige and other hospitals and doctors will call on them for answers. Those two hospitals are trained and up and running and buying product. We did the same thing in Switzerland and then we were doing the same thing in the other countries. So, it’s not – I wanted to be cautious that it’s not a free for all [ph]. We are not releasing this product on a open across the world at this time. So, the growth rate has its own set of governor on there, if you will, to make sure that the users are well trained, well documented and they are willing to work on a community basis of helping other people and that’s what we are doing at this time.

And the expenses associated with that process then, would you say they were a greater burden than what you’ve experienced so far in the US?

No, no.

Thank you.

Okay.

Thank you. Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back to Mr. Will Moore for closing comments.

Okay, thank you, operator. And thank you all that have listened today and I appreciate your time and look forward to speaking with you again at the end of Q2 conference call.

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.