IRIDEX Corporation (IRIX) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 IRIDEX Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Ms. Leigh Salvo Investor Relations. Ma'am, you may begin.

Thank you, Sayla. And thank you all for participating in today's call. Joining me are Will Moore, Chief Executive Officer; and Atabak Mokari, Chief Financial Officer. Earlier today, IRIDEX released financial results for the quarter and six months ended July 1, 2017. A copy of the press release is available on the company's website. Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical fact, including statements concerning the amount of timing of revenue and Cyclo G6 unit and disposable sales and shipments, medical retina and surgical retina projections, timing and benefits of our Cyclo G6 product initiatives, future sales and product launch activities, future operating expenses, changes in personnel, product development and intellectual property-related matters, the adoption and effect of the company products on its results, the market in which the company operates, usage and efficiency of the company's products, the company's future financial results, our clinical study plans and the company's strategic plans and objectives should be deemed to be forward-looking statements. All forward-looking statements are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a full description of the risks and uncertainties associated with our business, please see our filings with the Securities and Exchange Commission. IRIDEX disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 3, 2017. And with that, I'll turn the call over to Will.

Thank you, Leigh. Good afternoon, everyone, and thank you for joining us. Our second quarter was marked by continued execution towards our goal of making the G6 platform the global standard of care used to treat glaucoma patients across all stages of the disease. I'm encouraged by the progress we are making in the commercialization of the G6 and the mounting support we are gaining, as evidenced by a number of factors we saw in the quarter, including a growing list of prestigious institutions that we are proud to count as G6 customers; an increasing number of customers that have purchased multiple systems; higher probe utilization at selected customers; a growing base of clinical data supporting our value proposition; increasing KOL support around the world; and new MicroPulse patents issued in both the U.S. and the EU. On the financial front, we reported second quarter revenues of $10 million versus $11.9 million in the comparable quarter of last year. The year-over-year decline primarily reflects the continued impact of significant expansion and transition in our commercial infrastructure, while we managed the company's shift towards our G6 platform. We believe that this is a transformational opportunity we see for IRIDEX, and one we are confident will provide significant shareholder value. However, we believe that our growth investment activities impacted our financial results in the second quarter, and to a lesser extent will continue to impact us the rest of this year. I'd like to take the next few minutes to review the performance of each of our business segments in the second quarter, and then cover highlights relative to our commercial infrastructure and product development goals we laid out earlier this year. As a quick reminder, we have three primary business segments. First, our G6 system for glaucoma treatment. Second, our medical retina product line for the treatment of diabetic macular edema or DME. And third, our surgical retina line of products used in vitrectomy procedures such as the treatment for retinal tears and detachments. Starting with our Cyclo G6, as I have noted in prior calls, we believe that G6 business is truly transformational for us, and I remain as confident as ever in our opportunity. The scalable platform was designed to address the $5 billion spent annually on pharmaceutical and device treatments by offering a lower cost laser system and a portfolio of probes for the full continuum of care from early to late-stage glaucoma. We are pleased with our continued progress in commercializing the G6 platform on a global basis. Since our launch in March 2015, we have sold 636 G6 systems and shipped approximately 48,000 G probes. Our growth investment activity such as hiring and onboarding new reps, revisions to compensation structure and the realignment of territories to maximize reach and penetration. are vital to our long-term success. In the second quarter, we started to see some of the benefits of our growth investments on our G6 business, and I am pleased with the early traction of our new U.S. sales representatives. We are confident this momentum will accelerate into the second half of 2017, as more of our new reps come up to speed. We have previously discussed a lengthening of the sales cycle for the G6 system, as we are transitioning to larger customers and increasing adoption by companies [ph] and ophthalmologists. This broadening interest in our product is a positive development for us and has resulted in a robust pipeline. We feel confident we are building the right infrastructure and putting processes in place to realize this pipeline in 2017 and beyond. It is a similar situation regarding our G6 probe utilization. As discussed previously, we continue to believe that customer follow-up after a system sale is key to driving improved probe utilization rates. In the second quarter we made progress in improving our follow-up, and we expect this to contribute to greater probe utilization going forward. Internationally, the G6 is currently sold in more than 50 countries, and we are making progress in countries that recently received regulatory approval. In Japan, we recently hosted a successful G6 training session for several leading physicians, and expect to ramp our launch activities over the next several months in this important market. Lastly, the continued cadence of support of our G6 technology is especially encouraging. Our recent participation at the 7th World Glaucoma Congress in Helsinki was very well-received. Our hands-on wet lab using the G6 was attended by over 50 glaucoma physicians from more than 40 countries, who came to learn about our laser therapy and MicroPulse. The sold-out event highlighted the building excitement we are seeing globally. I am particularly excited about the start of a series of clinical studies that will address a variety of topics, including stage of glaucoma disease and mechanism of actions, using our G6 platform and MicroPulse technology. We have recently commenced a global multi-center study to be conducted by a distinguished group of physicians and surgeons. A leading investigator has been identified, and a group of investigators have assembled for training. I look forward to providing additional information on this important study on future calls. In closing on the G6, our goal remains the same, to make the G6 platform the global standard used to treat glaucoma patients across the full continuum of care, as the first-line therapy through refractive glaucoma. Turning to our medical retina products for the treatment of DME, we remain bullish on the value-based medicine propositions that our technology represents in an estimated $9 billion market. Revenues in the second quarter for this segment declined and came in below our expectations, primarily due to the allocation of our sales resources, rather than a lower demand. Outside of the U.S., where we sell through distributors and thus have more sales capacity to pursue multiple lines of business, our medical retina revenue grew substantially. However, in the U.S., our medical retina revenues declined materially as our new sales force has been directed to focus on the G6. We anticipate continued declines with quarter-to-quarter lumpiness in this product line through the end of 2017. Lastly, turning to our surgical retina business which delivers treatment for retinal tears and detachments, revenues declined in the second quarter at a rate consistent with our expectation. The market dynamics were consistent with the prior several quarters, with ongoing competitive pricing pressure in a mature segment. Before I turn the call over to Atabak to review the financials, I'd like to make a few additional comments regarding recent highlights related to our execution goals for 2017. As we laid out at the beginning of the year, there are 2 primary components with our current strategy. First, to expand the commercial infrastructure so that we have adequate resources to pursue the opportunity we see with our scalable G6 platform. And second, to develop new products and enhancements to the existing products, so we can continue to stay ahead of any potential competition from a product feature and cost perspective. I'd like to take the next few minutes to highlight the recent progress we've made. Starting with our commercial infrastructure, a growing market demand for our G6 platform enabled us to continue to confidently focus on the expansion of our commercial infrastructure to address this transformational opportunity that we see for our business. On the sales side, we continue to see and hire and highly qualified candidates, particularly those with experience in the ophthalmology sector. In the U.S., we have shifted our focus somewhat from hiring to training during the second quarter. We continue to target a total sales rep count of 24, and currently have 17 direct reps in the U.S. Outside of the U.S., we recently hired a new area sales manager to fill the vacancy from an internal promotion. In Germany where we made the decision to change from a distributor model to a direct sales for new products, we have onboarded our sales manager and have started the process of developing relationships with leading institutions for both our glaucoma and medical retina products. Now, these products were not previously offered by our distributors. So this is effectively a new country launch. On the marketing side, we recently hired a new marketing team, including a director of our glaucoma business, a director of our retina business, a director of marketing communication, and a product development manager. This team is better aligned with our new focus, and is already having a meaningful impact on raising our visibility in the field. On the product enhancement front, we are continuing R&D activities around advancing our product lines by repurposing existing technologies that are expected to improve the features and benefits of our products, as well as improve product quality and reliability, while reducing costs. We are making steady progress and look forward to sharing more information when appropriate. Before I turn the call over to Atabak, I want to welcome Ann Rhoads to our Board of Directors. Ann brings significant experience working with growth companies from both a financial and a strategic perspective. Her background in the health care sector, combined with her experience in creating and implementing corporate strategies, will be instrumental for our future growth. With that, I'd like to turn the call over to Atabak for more financial details.

Thank you, Will. I will begin with an update on our G6 business, and then review the financials. In the second quarter of 2017, we sold 69 G6 systems. Turning to probes, we shipped approximately 7,100 G6 probes in the second quarter. Both G6 system and probe results came in below our expectations due to the near-term disruption caused by our growth investments that Will reviewed previously. Revenues for the second quarter of 2017 were $10 million compared to $11.9 million in the prior-year period, representing a decrease of 16%. Revenues in all three of our business segments declined in the quarter. Notably, we experienced a year-over-year decline in our G6 revenues due to a tough comparable in the prior-year period. Recall that in the second quarter of last year we sold a record 124 G6 package systems, which coincided with our launch outside of the U.S. In the second quarter of 2017, domestic system sales decreased 38% to $1.8 million from $3.0 million in the second quarter of 2016, while our international systems sales decreased 15% to $2.5 million from $2.9 million in the comparable quarter. Our business generates recurring revenues through sales of consumable products, predominantly single-use laser probe devices and other instrumentation, as well as repair, servicing and extended service contracts for our laser systems. Recurring revenues in the second quarter of 2017 decreased 5% to $5.7 million from $6.0 million in the prior-year period. The decrease was realized across all of our probe lines. Notably, we experienced a year-over-year decline in our G6 probes, given the tough comparable in the second quarter of 2016 that I mentioned earlier. As a reminder, a G6 package includes 30 probes per system sold. Gross margin in the second quarter of 2017 was 44.9% compared to 48.2% in the second quarter of 2016. Gross margin was primarily impacted by less efficient overhead absorption due to the decrease in revenues, which was partially offset by an increase in contribution margins, due to favorable shift in product and geographic mix. Operating expenses for Q2 2017 were $7.2 million, up from $6.1 million in Q2 2016. The level of our operating expenses reflect our growth investments to support our expanding commercial infrastructure, including increased sales and marketing expenses. Consequently, our operating loss for the second quarter of 2017 was $2.7 million, compared with an operating loss of $0.4 million in the prior-year second quarter. In terms of our 2017 financial expectations, we continue to anticipate revenue growth to be more heavily weighted towards the second half of the year, as we start to see the full benefits of our growth initiatives. However, in light of the weaker-than-expected second quarter and continued transition in our commercial infrastructure, we are lowering our full-year 2017 revenue guidance to a range of $43 million to $46 million, from $46 million to $49 million provided on May 3, 2017. We are also reducing the number of anticipated G6 system sales to a range of 350 to 400 from prior guidance of 400 to 450, and G6 probe shipments to a range of 30,000 to 35,000 from prior guidance of 35,000 to 40,000 for the full-year 2017. Regarding our retina businesses, we anticipate that our medical retina and surgical retina businesses will decline in the mid-to-high single digits. Lastly, as previously discussed, we expect to incur operating losses in 2017. With that, I'll turn the call back over to Will.

Thank you, Atabak. In closing, I believe the G6 represents one of the most powerful tools available for the treatment of glaucoma, a very large and growing market. Today there are 5 million people worldwide that are on multiple medications for glaucoma. Given the high cost and poor compliance of that clinical pathway, I believe we have a strong core target patient population. Physicians and surgeons around the world are recognizing the value of our G6 platform, and we are committed to making our product not only available, but the standard of care in the treatment of glaucoma. We remain steadfast in our enthusiasm for the G6 platform to transform our business. Moreover, we are confident we have the right products and are expanding our organization with the right people to execute on a strategy that will deliver long-term sustainable and profitable revenue growth. Thank you to all of our employees for all the hard work during this time of transformation. With that, I'd like to turn the call over to the operator for questions. Operator?

[Operator Instructions] And our first question comes from Chris Lewis with ROTH Capital. Your line is now open.

Hey, guys, good afternoon. Thanks for taking the questions.

Hey, Chris.

Hi, Chris.

I wanted to start on the G6 probe utilization. I appreciate the color in the prepared remarks. But Will, I was just hoping you could elaborate on kind of what you're seeing at this point, given some of those new sales strategies and how they're starting to impact the probe utilization as those reps have started to go back into some of those accounts that hadn't reordered since the initial system purchase.

Okay, so for example I'll use a representative we have in Atlanta. We asked him to focus on accounts that had purchased probes. And we used a different versus (inaudible) of reordering. We're looking at it saying, they were ordering at a rate that's below what we thought was standard. So we had them go back in and talk to the doctors, to discover that we had trained 1 doctor or maybe two out of a group of, say, 10. And they spent time going in and training the other 8, and from that point we started seeing additional orders. And he's done that a number of times in his territory. And that gives us -- there's a variety of other accounts as well in our other territories -- that give us the same kind of confidence on the probe utilization. I mean it's along what we said at the beginning, Chris, which was without that expansion of the territories and having more people, we just didn't get deep enough in each account.

Right, okay. And then in terms of targeting, the customer targeting you've talked about, going after higher volume, larger accounts typically. Sometimes that requires more work in the front end, and it lengthens the sales cycle a little bit. Can you just talk about the customer pipeline and have you started to see any of those wins from those larger potential customers?

Yes. Chris, it's Atabak. So I'll start with that. So yes, we are starting to make some nice progress on that front. And as we talked about before, while these are large customers that represent a lot of opportunity over time, they tend to not come in sort of large batches, but come in over a period of time. And so the lengthening time is to get that initial -- to get through their initial ordering phase. So we've been able to successfully do that on a number of occasions now. And some of them coming in with multiple orders, but our expectation is that over time that we're going to start seeing a continued cadence of activity from those customers. So as we talked about, we have a pipeline that we're pretty excited about that we're working hard to execute to close.

And then as I look over the remainder of this year into 2018, in order to get to the low end of your guidance implies a pretty healthy acceleration in the second half versus what you've done in the first half. So I guess, what gives you confidence in that outlook? And just in terms of cadence over the third and fourth quarter, any commentary or directional color you can provide about how we should think about the quarters from a sequential revenue growth perspective? Thanks.

Sure. So as we have stated now for a couple quarters in a row now, we've talked about our growth investments just needing some time to mature and start contributing. And so that's what -- so we're starting to see some of that benefit here in the second quarter. But so far this year, we've actually probably seen more of the downsides to going through an expansion than the upsides. And we're confident, as based on the signs that we're seeing, that the second half is coming together in terms of the infrastructure coming in place. In terms of your question regarding between Q3 and Q4, as you know, the third quarter tends to be our weakest quarter and Q4 tends to be our strongest. So that's a sort of natural trend just based on some seasonality in our business, particularly outside the U.S. So we expect that to continue. But we do expect that new infrastructure that we have in place to start contributing nicely in Q3 as well.

Okay, and just one more from me, on the medial retina business, it sounds like that's continuing to decline maybe a little bit faster than you had expected this year. Can you elaborate on just what you're seeing there? Is it strictly really just a sales resource capacity issue? And as we think about '18, I know you're not giving guidance, but at least for that segment, as you work through the sales transition do you expect the medical retina business to return to growth next year? Thanks.

Sure. So in terms of -- as Will mentioned in his prepared remarks that we don't think this is a demand issue. And the evidence behind that is, is that we're seeing some nice growth outside of the U.S. where we sell through distributors and we don't have the sort of sales capacity constraint. Whereas in the U.S., that's where the bulk of the miss came from. And so which is really driven by our decision to focus the new hires on the G6 in place of the medical retina. So as the reps start coming up to speed and can have the capacity to sort of take on multiple lines of business, which we think they're capable of, we do expect it to rebound in the U.S. as well. So that's part of this transition that we're going through over the next couple quarters as the reps get fully up to speed, and we further expand our sales force, we expect that to start contributing and getting that business certainly stabilized and hopeful that it gets back up to growth as we head into next year.

Our next question is from Larry Haimovitch with HMTC. Your line is now open.

Hey, Will, hey Atabak. Your guidance for 2017, does that include any contribution from China?

No, well, not G6 China if that's what you mean. But obviously other business, yes, but not G6.

G6 China, yes. And you are still expecting that to come? Obviously it's hard to predict. It's a regulatory body. We can never predict those things. But I think the last time we talked about it, you were hopeful that you could have this approved by before the end of this year.

That's still our hope that we can get it approved by the end of the year. I think the issue is the timing when you start talking about contribution. If it's late in the year, late in Q4, when do we get started? You've got Chinese New Year's coming up after that. I don't expect any substantial revenues from that until mid-to-late part of Q1.

When you get the approval and have had a chance to work through whatever holidays there are or whatever other issues there are, how important can China be to the overall G6 business?

We think similar to as we've talked about on Japan being a really important market for us. I think China falls in the same category of being a pretty big opportunity for us that we're actively working on already to plant the seeds to be able to go after that market.

Any update on Japan, Atabak?

So on Japan, as Will talked about, we're going through our KOL-driven launch strategy. So it's similar to what we did in the U.S. So we've trained a number of centers already. And we are actively working on getting other folks up to speed and doing more of a full-scale launch there over the next several months.

Were there any shipments in Q2 to Japan?

I don't want to get into country-specific detail.

Were there international shipments at all in Q2?

Yes, there were shipments. I'll come back to your China question. I think it's very important to us. And what we've done to, I'll say, pre-condition the market, we had the ability to sell in Hong Kong. We did our KOL piece, and then we got a tender from the government to take care of all of the government hospitals in Hong Kong. We're doing something similar to that in Taiwan now. And we'll have a presence forthcoming in the Chinese Ophthalmology Congress in several weeks, a couple weeks from now yeah.

I have a couple more questions, but I don't want to hog the limelight here if there's other questions, I can come back in the queue. It's up to you guys.

Just ask the question. It's fine.

Okay, so the probes, I don't know if caught this right. But I thought I heard you or Atabak say probe sales were down in Q2 versus Q2 last year?

Yes. That's the case. And that's primarily because of the probes that are included in the package system. So since we had such a large number of package systems that were sold in Q2 of last year, that it's directly tied to the number of systems that we sold this year versus last year. That impacts that number.

That's what I wanted to verify, whether the probe sales included the initial 30 in the box. But if you take those out, what about the existing customers in Q2 of last year versus the existing customers of the Q2 this year that weren't new customers and weren't getting 30 probes in their shipment? Can you give us an idea about how those customers who are not working off inventory that came with the box are doing?

So that increased on a year-over-year basis.

Increased? Any more color than that?

I think it's math that you can do basically to back out. We've disclosed probes, total probes. And you can kind of back out the number of package systems from that and come up with that.

Well, I'm not that smart. Maybe you can help me do it.

We can do it offline, okay.

Okay, fair enough. Thank you.

And at this time I'm showing no further questions. I would like to turn the call back over to Mr. Will Moore, CEO, for closing remarks.

Thank you once again for joining the call today. We appreciate your interest in IRIDEX and look forward to our next progress update. Have a good evening. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.