IRIDEX Corporation (IRIX) Q3 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the IRIDEX Corporation Third Quarter Second Quarter 2016 Earnings Call. [Operator Instructions]. As a reminder this conference is being recorded. It is now my pleasure to introduce your host Mr. Will Moore. Thank you. You may begin.

Thank you, Operator. Good afternoon and thank you for joining us as we discuss the results of the third quarter of 2016. My name is Will Moore, and I am the CEO of IRIDEX. I'm joined on today's call with Atabak Mokari, our CFO. 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 IRIDEX's business, economic and market outlook, business strategy, future financial condition and operating results, product plans, safety, efficacy, regulatory and clinical matters and overall future prospects. Forward-looking statements include our guidance concerning the company's growth rate as revenue guidance in the fourth quarter of 2016 and for fiscal 2016, statements concerning backorders with respect to certain net products and related corrective measures and availability of funds under the company's loan facility. 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. These factors include the effectiveness of the remediation natures taken by the company in response to the supply chain and sales force training issues in the third quarter of 2016. Risks associated with international sales, economic and political changes development and adoption of due products and other organizational and operational risk that may affect the company's business and it's stockholders. Please see a detailed description of these and other risk contained in our annual report on Form 10K for the fiscal year ended January 2, 2016 and our quarterly reports on Form 10-Q for subsequent fiscal quarters each 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 will now turn it back over to Will.

Thank you, Susan. This a very exciting time in Iridex, as our opportunity in glaucoma is one of the largest addressable markets I've been involved in my entire career and it's rapidly transforming our business. I look forward to providing you with an update on our progress but before we discuss the quarter I want to provide you an update on the business dynamics of our three product categories. First is the G6 platform for glaucoma. This business is powered by our proprietary MicroPulse Laser and is experiencing rapid adoption. We have the right business model in this segment with significant recurring revenues and we are experiencing success in both system placements and proprietary disposal probes utilization. This business now represents about one quarter of our revenue, recall that we only launched the product in March of last year and it has tremendous upside to continue to transform our business. Second is our medical retina business for the treatment of DME, this business is also powered by our powered by our proprietary MicroPulse Laser technology has been a good driver of growth for us over the past several years and continues to have nice growth prospects. However this business has inherent lumpiness given the capital equipment nature of the business model and has been impacted by the success of the G6 resulting in capacity constraints for our sales team. This business also is up about one quarter of our revenues. There is our surgical retina business for the treatment of retinal tears and detachments which makes up the balance of our revenues. This business is powered by our legacy laser technology and is a mature segment with flat to declining revenues. It does however generate nice contribution margins. Now into the third quarter revenue for the third quarter was $9.8 million which is flat to the comparable quarter last year and below our initial guidance range as we've previously pronounced. The good news is that that our G6 platform for glaucoma continues to exceed our expectations and we're really excited about this opportunity. However the medical retina side did experience a short term issue that impacted our rate of shipments in the third quarter which we resolved and we're now working through our back orders. Now let's get on into both of these dynamics in more detail. Let's start with glaucoma. We're seeing rapid market adoption with our G6 platform revenues increasing 442% in the third quarter relative to the comparative period in the prior year. The success is based on the following four key attributes of our G6 six platform, one, strong safety profile it's easy to perform. It's not incisional and it does not limit future treatment alternatives. This profile has been further strengthened in the physician community as there are no reports of major safety issues today, but we have shipped over 27,000 probes since launch. Two, proven and durable efficacy profile we have data from numerous sources across the globe that illustrates a consistent clinical efficacy and results. Also at the recent European Glaucoma Society meeting data was presented to illustrate the durability of outcomes upto to 6.5 five years. We will get into this in more detail shortly. Three, our procedures repeatable and [indiscernible] tradeable which is an important attribute in the area of personalized medicine and also enables us to address the full continuum of care for the treatment of a glaucoma. Lastly we believe that our technology can not only yield better clinical outcomes but it can reduce costs thus supporting the importance of value based medicine. The establishment of reimbursement code provide significant economics to the physician for medical facilities to support the adoption of our technology. These attributes enable us to outperform our expectations in the third quarter for both system sold and probe utilization. We sold 90 G6 systems in the third quarter which brings our total system sold [indiscernible] 401 since our launch in March of 2015. We shipped approximately 7000 G6 probes in the third quarter which brings our year-to-date 2016 total of approximately 19,500. Note that this compares favorably to a very successful recent launch in the glaucoma market specifically the leading player in the mix sector at a similar point in their launch. We remain very bullish over the prospects of our positioning in the glaucoma market, the global glaucoma market is one of the largest healthcare with more than $5 billion spent annually on pharmaceuticals and device treatments. The significant market growth driven by the aging population, improved treatment alternatives, enhanced diagnostic technologies have increased patient awareness. We believe that we can capture a significant portion of this market given one that our business model which includes a captive single patient used disposal enables us to participate in approximately the value created by the technology and two that over time we are optimistic that the G6 platform can become the standard used to treat patients across the full continuum of our glaucoma care as a first line therapy through refractory glaucoma. Initially the G6 was primarily used by our physician customers to treat mid to late stage glaucoma, as physicians have become more comfortable with our technology in particular with the safety profile and accuracy profile relative to other treatment alternatives many physicians are migrating to treating patients earlier in the treatment continuous with success. A big driver of this evolution towards treatment earlier in the continuum of care is the volume of data that we have amassed today and continues to be generated. As a reminder our landmark study was conducted by Dr. Paul Chew, NUHS [ph] which is National University Hospital Systems in Singapore illustrating a 33% drop in IOP in 18 months. A few months ago Dr. Chew presented data on the subset of those patients that he was able to file for 78 months at 6.5 years we still are certain to drop of 43% in IOP. With this thing is that on average each of those patients were treated 3.6 times During that timeframe, this is really exciting data, unusual for a medical technology company to have less than two years into a launch but has served to support the safety, durability and repeatability attributes of our technology. Furthermore, there are numerous leading positions in the US and across the globe that have studied the use of our technology with consistent results, this includes studies completed in presentations by Dr. Noecker from Yale, Dr. [indiscernible] from Wills Eye, Dr. Lin at UCSF and several other leading physicians. Know that all of these studies were completed without any funding by Iridex. A few other highlights on glaucoma, one we have recently seemed FDA authorization for our third probe in the G6 platform because of the six in the G6 refers to the number of probes that we are developing for this platform. The latest probe is the first eliminated probe for the treatment of late stage glaucoma which will be a nice addition to our portfolio treatment alternative across the continuum of care and two, we recently received authorization to begin marketing the G6 in Singapore. Well we have sold G6s in over 40 countries today we are still actively working and getting [ph] approvals in several key markets such as China and Japan. I hope that our excitement in our G6 platform for glaucoma is coming across loud and clear. We have high aspirations for this business and are focusing our company's resourcing on executing on this mission. Now let's turn our attention to the medical retina business, we continue to be optimistic about the growth prospects for this business as the demand continues to be strong for our products. For example at our recent AOO Meeting numerous presentations were made by physicians on the advantages of our technology and customer interest from inside. We did have a temporary issue in the third quarter which resulted in record high back orders. Towards the end of the quarter we experienced some error alarms upon escalation of one of our medical retina products. We reacted swiftly to this issue with the goal of delivering a positive experience of physician customers. Our analysis indicated potential supply chain and sales force training issues. We recently concluded our analysis and implemented a plan to resolve these issues. I'm happy to say that we’re now working through our backorders. It is big credit to our team for the rapid rate of response in identifying and analyzing and resolving the issue. The long term growth prospects for this business are clear. For example we recently initiated a National Institute of Research Study and a National Institute of Health And Care Excellence, NICE funded study in the UK at [indiscernible] to evaluate the clinical and economic benefits of our MicroPulse technology for DME. Past studies like this are published, we feel our business will be well-positioned to achieve sustained long term growth. Over the near term we do expect some lumpiness in the business given the capital equipment nature of these products and our sales forced focused on G6. The latter front will be addressed as we expand our sales force which we will get to shortly. Shifting gears for a moment to our third segment, our surgical revenue business in the third quarter this business performed as planned as market dynamics were consistent with the prior several quarters in that we continue to experience competition in mature segments and realize declining revenues. We continue to expect flat to declining revenues for this segment. Lastly before I hand the call over to Atabak to review our financials I want to provide an update on our previously discussed plans to expand our sales infrastructure. As a reminder given the success of the G6 platform our sales force has been capacity constrained and has been a challenge to retain optimal focus on all our products given the broad geographic that each of our representatives covers. In the US we recently hired a new Director of Sales we think this is an important addition to our sales team to help plan and implement the expansion of our sales force upto 24 representatives in the next several quarters. We also hired a new sales professional at the end of the third quarter so we are upto 13 direct reps in the US this time. Outside the US we recently promoted one of our four area managers to position of Director of International Sales, this will be an important given the following issues that we have underway. One, expanding our team to improve our ability to actually manage their growing book of business by international figures and two, establishing direct sales capacity in selected countries. For example we recently established Iridex's GMVs that we may directly market to G6 in Germany and in the nearby country where we do not have currently distributed relationships. Now I will turn the call over to Atabak for more financial details. Atabak?

Thank you, Will. Our revenues for the 2016 third quarter were $9.8 million compared to $9.8 million in the prior year period. Revenue growth in our G6 platform for glaucoma which increased 442% compared to the third quarter of 2016 was offset by a lower revenues and certain revenue products due to the issues that Will just discussed. Our domestic system sales decreased 5% from $2.3 million to $2.2 million while our international system sales decreased 14% from $2.5 million to $2.1 million. On a global basis increased revenues from our G6 laser system were more than offset by lower revenues from our retina laser systems. Internationally we experienced some additional weakness in our retina businesses due to the strengthening dollar which effectively increases our price to our customers and heighten the competition. Our recurring revenues which include sales of our consumable products, service and royalties increased 9% to $5.4 million from $5.0 million in the prior year period. The increase is mainly attributable to an increase in the sales of our proprietary G6 MP3 probes which offset the decline and the sales of our legacy EndoProbe's. Gross margin of 2016 third quarter came in at 43.4% compared to 49.3% for Q3 2015. Gross margin was impacted in the third quarter by an increase in manufacturing overhead spending and an increasing manufacturing variances. This was primarily due to lower than expected revenues given the issues we discussed at [indiscernible] last weeks of the quarter and due to additional expenses as we work to rapidly response to the issues. Our operating expenses for Q3 2016 were $5.5 million up from $4.7 million in Q3 2016. The level of our operating expenses met our expectations as we have made investments to support our commercial infrastructure. Consequently our operating loss in the third quarter 2016 was $1.2 million compared with the operating income of 0.1 million in the prior year's third quarter. The net loss for this year's third quarter was 0.7 million or $0.07 loss per share compared to net income of $0.4 million or $0.04 income per share for the prior year period. In terms of guidance we’re maintaining our guidance for the full year 2016 of low double digit revenue growth. For Q4, 2016 we anticipate revenues of $12.4 million to $12.9 million which is primarily driven by growth in our G6 platform. Lastly today we announced that we obtained a $15 million revolving credit facility with Silicon Valley Bank. The facility which is currently undrawn provides availability based on an accounts receivable borrowing base formula. It's a three year facility at a rate of prime plus 1.5 and does not include any financial covenants. We believe that the facility provides us with an extra layer of liquid to-date as we embark on our growth initiatives. With that I will turn the call back over to Will.

Thank you, Atabak. In my closing remarks I want to reiterate our excitement for the G6 platform and it's potential to transform our business in the treatment of glaucoma. We are fortunate to pursue this opportunity with an established base of revenues in our medical retina and surgical retina business while we expect some [indiscernible] as we transform our business I'm confident that we have the right technologies and the right people to execute on our strategy that will deliver long term sustainable and profitable growth. I want to personally say thank you to all of our employees for job well-done. With that I would like to turn the call over to the Operator for questions. Operator?

[Operator Instructions]. Our first question comes from the line of Lisa Springer from Singular Research. Please go ahead.

Hi, Will.

Hi Lisa.

A question regarding the retina product flow problem with that -- was that with products that had already shipped to customers or was that done before they shipped and if it was shipment to customers how many customers were affected?

There customers that were affected and that we talked about which is really on the air of our [indiscernible] the device work that was prescribed but they were not -- I said the customer was not in service appropriately to be able to understand that but given what happened to us last year we were very conservative and so we sought to verify that it was -- that was the only thing to do.

Could you also comment on international sales with the G6 during the quarter?

Can you be a little more specific?

Were there international sales?

Yes.

And could you tell me how many units?

Lisa, this is Atabak I know historically we’ve provided some breakout but the G6 units by geography but for competitive reasons we’re no longer going to provide that but I think as Will said we want to make clear that we had nice system sold in both the U.S. and internationally.

Okay and one more question for you, I get a lot of questions from investors when new glaucoma drugs come out. Could you briefly comment on the economics of the G6 versus glaucoma treatment with drugs?

So the economics from the patients standpoint, the drugs are generally about a $100 a month per med, so depending on how many the patients on, it's roughly a $100 to $200 per month and with our treatment it's onetime maybe 12 to 18 months and I don’t really know exactly what the doctor charges but the economics for the doctor is approximately $399 for his services or her services and another $800 for the facility fee.

Okay. Thank you.

Thank you. Our next question comes from the line of Larry Haimovitch from HMTC. Please go ahead.

Hey, Will. Hi Atabak.

Hi, Larry.

Hi, Larry.

So what's the increasing impact of the glaucoma business, do you guys have a sense about where your gross margins can be over the next couple of years. Obviously they are going to be higher, we have been able to model it out in some way that gives you a sense of where you’re growing with gross margins?

Well you’re right Larry, and that we do expect to see some nice margin expansion given the relatively high margin profile of the G6 probes. So we haven't gotten into detail where we think we can -- how that’s going to play out over the next few years but as you can imagine the model is pretty powerful as those -- as that becomes an increasing part of our revenues.

Okay. Then second question I know you wouldn’t in the quarter with some kind of a backlog, at least that’s what I understand because you didn’t shift near the end of the quarter. Are you able to provide any magnitude of how much that was and how much that will fall into Q4?

That’s not something we have that we finally disclose and -- but the one thing we want to make sure to communicate is that we have resolved the issues that rose at the end of the third quarter and should be in a position to work through those that quarter to this quarter.

Okay. Then internationally on glaucoma, I know you had some shipments, you’ve got some big markets out there like China and Japan and others that have yet to be penetrated, can you give us an update there?

Well the registrations, are you talking about the timing of the registration? Are you talking about the market we penetrated?

I know, I want to know the exact dates of approval.

Okay. So I will come back, the Chinese, they usually take somewhere between 18 months to two year we have been in it for just about a year, so we’re expecting some time during next year late at the end of the year, we see China come on board. I have shown it generally takes about 18 months that’s in-line as well that one -- I don’t know the exact date that regulatory filed, I do know that we have two people in the country that have devices that they are using under the protocols of working with IRVs in their universities. I would say end of '17 early '18.

Okay. Thanks guys.

Thank you. Our next question comes from the line of Stan Manne, a Private Investor. Please go ahead.

Stan Mann, excuse me. I guess my question frustration at us not attacking this opportunity in a stronger way. We have not used our capital. We still have close to $10 million in cash which earns us nothing and I would like to kind of get a feel for how we’re going to get the first step is a $100 million and it looks like we’re just -- I don’t even want to say strolling [ph], I would say slow walking, so can kind of talk about our ramp up and when we’re going to get into a significant move up and utilizing some of the capital to build an organization. It seems to me we can't get there without a build in spending some of the money properly. Can you speak to that? A ramp up and your vision and timing?

Sure. I think in the prepared remarks I said we were going to upto 24 reps within the next several quarters. We hired a Director of US Sales who comes to us from like as -- and certainly the other type of work. So we hired him. He is already hired as first person and we’re start marching through that process. We have elevated a gentlemen that’s Biomedical Engineer, has been with us for four years before that is a [indiscernible] to become the Director of O-US sales and he is already looking at a couple of country managers as well. I will come back to what I’ve always said. Sometimes in these products you can get out and run really fast and end up having adverse event that derails the product. I will stand-by my decision, I said I'm going to be very conservative and make sure nothing happens and at this point in time now that we have roughly 30,000 in probes used and roughly 400 customers. We’re not going to get derailed by a single one or two type of adverse events if they come about. But to do it beforehand and run in to a point where you’ve got doctors or not well-trained and end up with a possible adverse events, I will be shitting myself in the foot. So I think you and I just have a difference of agreement whether we are [indiscernible] or running.

No I don’t think that that’s true. I think you’re not running. I think my question is do we have a probe, do you feel confident that we have a product design that we can ramp up and get a training force and a manufacturing operation and build an inventory. Are we at that point yet?

Yes.

We are?

Yes.

So we can expect that we are going to see a building of an organization, of an inventory and the use of cash properly to accelerate and move the program forward properly and call it conservatively how you want but that we’re going to see a ramp up before some other laser company comes in or many and feels the market based on price and give-aways.

When you use terms like properly I will probably take off sense of it and that’s your opinion and my opinion is slightly different. I think we have done a good job. I think we are continuing to do a good job. I think we have got a -- we have put together the plan and we said you’ve 6.5 year data with the product that’s less than two years old. This is all strategically put together that come out and if anybody comes in the market today has to justify that they have got that kind of long term data and safety profiles that we do. So I think it's going to tough for them. Ophthalmology is a very conservative market and people just don’t take and use the product because they say it's as good as somebody else's. So I think we’re in pretty good shape. You can have an opinion and I will respect it but I think the pace that we’re going is fine, I would have not let -- I didn’t like what happened this quarter but you know I was conservative in my nature that I'm going to call it quick voluntary hold because I don’t want to get into some kind of other issues and therefore the revenues slowdown I think the discussion would have been different if we hadn't had it but that’s what happens. I'm perfectly happy with where we are and what we’re doing, the teams come together. The sales force is coming together, we have added 20 some odd people in the organization inside here trying to be with -- deal with us. So it's just something that you don’t see or I don’t talk about but I think we’re doing a good job.

Okay. No one said you didn’t do -- you are not doing a good job. Are we going to see a build in inventory near term?

Define what you mean by that? What do you mean by it build-in inventory?

Build of inventory so we can ship--

I understand, Stan. I'm doing what I can do and we have inventory we’re not having a situation, we’re backordering people because we don’t have products. All right, so I don’t know where you want me to go with this.

I can see it. Thank you.

[Operator Instructions]. Our next question comes from the line of Joel Westerstrom from RedEye. Please go ahead.

Hello, Will. Hello, Atabak and Joel calling from Stockholm.

How are you?

I'm good. Thank you. Congratulations on the great growth in cycle G6 and sorry to hear about the other issues but I guess [indiscernible] sometime. I had some question regarding the gross margins. The longer term gross margin, where do you think you could end up when you transition to the new business model? I mean can you give us a ballpark figure?

Sure. Historically we have been operating and call it sort of 50% gross margins level and with the G6 launch the probes in particular kind of a significant higher margin that I think we have previously guided to around 80% gross margins there. So that was my comment earlier and then that becomes an increasing part of our revenues you can see a pretty meaningful increase in our gross margin.

Just a follow-up in that front, you’ve previously had some impact from starter kits and so on when you shipped new systems and it seems like you shift more systems now than in Q2, so is that part of the reason you still ship those starter kits where you sort of discount the system and give away some probes for cheap?

I wouldn’t say that we give that starter packages are not necessarily a price break, they are of that we want to bundle them together so that the customer gets a system with some probes on the shelf to encourage them to utilize the product. So that is -- I think we had early in our launch is what I think you’re referring to in that our introductory launch prices were lower than where they are now so it has impacted our margins but that’s not something that has impacted us over the last several quarters.

Okay. So that’s really good to see that you’re still [indiscernible] quite a lot despite not discounting them so much. Another question, what's your ability to push forward cost increases or FX effects etcetera to other markets?

It depends on which one of our product lines you’re talking about?

I guess the competition is tough on the legacy business so I'm more thinking of growth.

On the G6, given where we are in the launch there and like our competition you know we have been able to have a decent amount of pricing power. We have been I think there is some additional upside there that we could realize. We have been careful on sort of rolling out and managing that just in terms of making sure that we get -- that we encourage systems placement as well as utilization at this early phase that we’re trying to well become part of the standard of care.

Thanks a lot. May I go on with a few more questions?

One more.

So I had some questions regarding the demand and a bit like Stan talked about you know what you see as your biggest challenge and how you see can expand production of probes because my impression from being over here in Sweden is that you can't really meet demand at the price now and connected to that I'm trying to take all my questions in one basically. Connected to that it seems like so I really want to avoid CapEx over here in Europe since it's mostly publically funded. So are you looking at sort of also changing the business model to basically give away the systems and selling them the consumables or the probes?

Sure. So to answer your question it's I don’t think we have a dynamics that we have exceptionally constraints on probe manufacturing, so just to make that clear. Clearly as that business grows for us we will need to make some investments to whether that’s internally or through outsource manufactures to what build or meet the demand there but currently we have our quick capacity to meet our customers demand and then the latter part of your question in terms of CapEx needs, I mean this isn't a major CapEx requirement because like I said a lot of this even if we do some of this in-house this is largely an assembly operation. So even if we do it in-house or do it with an outsource manufacturer we are not looking at a lot of capital outlay.

Sorry I mean for the healthcare institutions over here. They usually want to avoid CapEx and instead have higher OpEx so I know your probe saved a lot of money compared to other kinds of surgery. So it might be an idea to sort of price down the systems and then just take more towards higher for the flow [ph].

So Joel I understand where you’re coming from. In the areas where we go through the distributors we work with them and they all have their own specific plans and how they market it in their markets and our distributors that we work with to take and provide contracts if you will through the hospitals and so they move it to a cash flow business versus a capital equipment business and that our distributors handle. We have not had that request in the US that most of the time here in the US, the doctors and the hospitals they understand it you can upcharge the probe, you’re going to pay more in the long run and because it's only $20,000 for whole system they tend to buy them. But we see and especially in Europe and I'm sure the business will continue, they have varying pricing and varying strategies in varying countries.

That’s great to hear and you don’t have to put it in your balance sheet, if I'm understanding it correctly you’re a distributor and can do that. Okay. Great.

That’s a lot.

Congratulations once again, I think it was really good progress.

Thank you.

Thank you, Joel.

[Operator Instructions]. Our next question comes from the line of Paul Svetz, Private Investor. Please go ahead.

Yes. Good progress.

Thank you.

With the build-out of the sales force in front of us and support people and training in both the sales force and customers outside the U.S. is a big challenge and I'm sure a big use of cash. So you’ve put a credit line in place for inventories, I assume it rivals the ramp up depending on how you allocate all this stuff but I'm wondering if I normalize this, if we look at today before this build-out occurs, so take out that extra [indiscernible] items. Do you’ve any idea what it cost in terms of working capital for an incremental dollar of sales? So we have a starting point to try to assess this stuff.

I'm not sure I fully that -- the question but let me attend to give you a framework to think through our cash requirement. So if you look at our business we have a large portion of our business from our legacy product lines, it's substantial contribution margins for us and give us a base of business to fund our operations and so we are fortunate in a sense that we’re going after high growth opportunity but have internal cash flows to support a lot of that growth. So, as we look out to our income from operations over the next several years we have that as a next starting point and depending on the pace that we make investments we can have a range of outcomes there. Then in terms as you rightly point out, if you grow rapidly there is a need for growing, for building out and making some investments in working capital and we’re doing something's on that side to realizing that we’re going after such a high growth opportunity that we need to make some investments and put different processes in place so that we become more efficiency in managing our working capital so that we -- so that doesn’t become as much of a use of cash for us going forward. So I think coming back to the point of what I said earlier. I mean somebody said we have $10 million of cash, we have been profitable and so we should have a fair amount of cushion in terms of going after our growth initiatives, but we have put on this credit facility to add another layer of liquidity as necessary.

Well the question if I look backwards in time not forward, not with the special requirements for ramping the sales force and training all that, what does it cost you in terms of working capital to generate an incremental dollar sales?

I don’t really follow the question, so we can maybe take it offline.

That’s fine. Thank you.

Thank you. Ladies and gentlemen we have no further questions in queue at this time. I would like to turn the floor back over to Will Moore for closing comments.

Thank you, Operator. Thank you all for attending and listening to the call today and look forward to speaking to you at the end of Q4 results.