IRIDEX Corporation (IRIX) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the IRIDEX Q2 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call may be 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, and thank you all for participating in today's call. Joining me are David Bruce, Chief Executive officer; and Romeo Dizon, Vice President of Finance. Earlier today, IRIDEX released financial results for the quarter ended June 29, 2019. A copy of the press release is available on the company's website. Before we begin, I would like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements made during this call that are not statements of historical fact, including but not limited to statements concerning our strategic goals and priorities, product development matters, sales trends, the market in which we operate, our guidance for 2019 and our plans to provide public updates on any of these matters. 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 discussion of the risks and uncertainties associated with our business, please see our most recent Form 10-K and Form 10-Q filings with the SEC. 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 6, 2019. And with that, I'll turn the call over to Dave.

Thank you, Leigh. Good afternoon and thank you all for joining us. I'm pleased to be participating in my first call as CEO of IRIDEX. As many of you know, I served on the IRIDEX Board for a year before taking the role of CEO 2 months ago. I was initially attracted to IRIDEX because I was impressed with the company's long history as a leader and innovator in ophthalmology. Strong reputation in the industry and unique technology offerings around MicroPulse treatments for both retina and glaucoma therapy. In the past year, I've been gaining confidence in the company's significant value potential, particularly as we continue to expand in the glaucoma space. When the Board began to consider CEO succession, I raised my hand as to be considered for the role. I believe my background managing medical device companies in early market penetration and adoption was directly applicable to the company's situation, and I was confident in my ability to provide the leadership needed for IRIDEX to realize its potential. Since joining the executive team, I focused the company on areas I believe are the keys to our future success. These include: First, shifting our sales team activities to drive deeper physician adoption of our MicroPulse glaucoma therapy, transitioning the procedure to a mainline tool for managing long-term outcomes in glaucoma patients and thereby driving recurring revenue from disposable probe sales. Second, execution on product strategies to stabilize our retina business. And third, reducing our cash burn. The higher value potential of the company is clear and compelling. However, these are necessary adjustments we're making to set us on the path to achieving that value. The company's biggest opportunity is in glaucoma, with our MicroPulse transscleral laser therapy, it's been repeatedly and consistently demonstrated to provide a significant reduction in intraocular pressures. Today, we have a meaningful opportunity to transition this therapy from early-stage adoption to a more mainstream tool to glaucoma specialists and comprehensive ophthalmologists. To date, more than 50 studies have been presented at industry society meetings, including 16 peer-reviewed publications that have attested to the procedures strong efficacy, durability and safety. Cumulatively, we've shipped over 120,000 probes to nearly 1,500 user sites; about 50,000 of those probes were shipped in the last 12 months with a 50-50 split between the U.S. and the rest of the world. This initial penetration success gives us confidence that we can build this growth opportunity in a market that is estimated to include 16 million diagnosed glaucoma patients in developed countries, of which 4.4 million are in the U.S. Though the largest segment of glaucoma patients are early stage and being treated with eye drop therapy, more than 0.5 million U.S. patients and a multiple of that worldwide have more advanced disease that warrants moving to direct therapies and surgeries. Our transscleral laser therapy directly addresses this large segment of the market, offering a significantly attractive alternative. Our goal is to increase adoption for mid-stage and later glaucoma patients where eye drops are no longer adequate IOP control. In order to capture a broader share of this segment, we must shift focus to achieve greater physician adoption via clinical education and direct support. We believe we will accomplish this as we support physicians gaining first-hand experience and confidence in the ease of use, durable IOP reduction, benign safety profile and the retreatment potential of our therapy, leading them to select us ahead of choices they are making now. All glaucoma therapies and surgeries eventually fail, leading to additional action needed to control intraocular pressure. We believe the noninvasive and repeatable aspects we offer make us an appealing choice. For example, 1 study has shown MicroPulse transscleral laser therapy used to safely manage patient's IOP over a 6-year period using repeat procedures. Last week, we held a U.S. sales team meeting, where we implemented a new process that supports our customers in moving through the phases of understanding and embracing the benefits of MicroPulse therapy, validating treatment outcomes in their hands on their patients, which we believe will lead to use of MP3 probes in a broader range of appropriate patients. This focused attention requires that our sales and clinical teams spend more time with the right target customers to work through common treatment learning curves and truly validate the techniques and outcomes in the hands of each physician. We believe that combining all the studies demonstrating that MicroPulse laser therapy is effective, durable and safe, with hands-on validation and real-world experience, we'll lead to broader adoption and higher customer usage rates. IRIDEX has done a great job building a worldwide installed base and market awareness. As we concentrate our sales and clinical efforts on more time spent with customers to increase the adoption and use, in the near term, we expect to see a lower rate of new systems placements in the U.S. Many of our U.S. system placements were sold under a program we call the LAP program, an attractively priced package with a Cyclo G6 system bundled with 30 probes. We discontinued the LAP program in the second quarter, and as a result, are seeing a reduction in G6 system sales and the associated volume of initial probe shipments recognized with those systems. This shift will contribute to improve ASP and gross margins per system sold, somewhat mitigating the financial impact from decline in placements. And over time, we will realize the probe revenues through reorders rather than initial package units. However, I'm confident over time, we'll continue to place significant number of new systems and those systems will be placed with higher potential volume users. Turning to our second quarter results in glaucoma. We achieved record probe shipments of approximately 14,200 probes, 23% year-over-year increase, this despite the elimination of the LAP program. This improvement in the quarter was broad-based with a balanced number of shipments in the U.S. and international. Importantly, in Q2, we saw the highest number of probe reorders in both the U.S. and international markets. This is the trend we will be focused on extending and increasing going forward. Due to the discontinuation of the LAP program and our shift towards focus on adoption and probe reorders, we shipped 85 Cyclo G6 systems in the quarter, a reduction from 125 in Q2 last year. Given this shift, we are reducing our 2019 guidance for Cyclo G6 system shipments to a range of 375 to 425 from 475 to 525. As a part of our focus on driving adoption, we're investing in activities that specifically support the clinical value proposition of our therapy. In April, we did our first glaucoma webinar that was observed by nearly 100 participants. Our second one in July was also well attended, where one of the first Cycle G6 users shared clinical cases and talked about his research and experiences treating glaucoma with our technology. We'll be expanding these types of activities to encourage regional peer-to-peer endorsement and education as well. Finally, we had multiple successful booth exhibitions, symposiums and seminars around the world at ophthalmic society meetings. Highlights include our first-ever symposium in Germany with 5 speakers and 40 attendees, and our busiest-ever event in Latin America, the symposium at the Pan-American Ophthalmology Association in Cancún Mexico, with 5 speakers, 200 attendees and a line out the door. The last item on glaucoma is the news that we completed development of our enhanced MicroPulse P3 probe and have begun clinical cases to gain experience, starting with a limited user base. The updated probe is more ergonomic and intuitive, simplifying the technique with the objective allowing greater consistency of use. We'll start broader shipments later in Q3 and begin commercialized rollout in Q4. Early indications are that this probe is being very well received and should promote increased confidence in performing high-quality procedures. Turning to our retina business. In the second quarter of 2019, revenues from our retina products were $5.2 million, about 50% of total revenue, representing a decrease of approximately 6% year-over-year for that segment. As a reminder, we have 2 retina product lines, a medical retina line for the treatment of diabetic macular edema and other retinal diseases, and a surgical line of lasers and disposable EndoProbes used for retinal detachment surgery and interoperative photocoagulation for advanced diabetic retinopathy. Our retina business is split about equal between medical and surgical. IRIDEX has a strong historical reputation of retina laser therapy developed over its 30-year history. With a larger installed base, customers know the brand and trust the company. Yet while our surgical retina business has been fairly stable with a mix of laser systems and disposable probes, we continue to experience challenges in medical retina. We are looking at ways to better position our products that address the realities of the market in order to contribute to revenue stability and gross margin improvement. As has been discussed previously, our long-term plan involves the introduction of updated laser systems with reduced cost to manufacture that will better position us to compete in a more mature and price-sensitive market. First in line is the introduction of a new 810-nanometer system that will be applicable in both retina and glaucoma treatments. These new lower-cost systems are important because they allow us to raise margins, reduce our cash burn, and help us reach cash flow breakeven sooner. We're evaluating milestones in our development programs, and I'm working to firm up our schedule and planned market launch dates. Lastly, turning to guidance for full year 2019, our growth of MP3 glaucoma therapy probes has been solid, and we reaffirm our expectation of 58,000 to 63,000 probe shipments. However, as we shift our sales focus to further drive procedure adoption and higher probe uses rates, we are reducing our guidance for Cyclo G6 system shipments to a range of 375 to 425 from 475 to 525. We do expect our systems ASPs to improve in the second half of 2019, mitigating the impact of fewer total units. We are also revising our revenue guidance to a range of $41 million to $44 million from $43 million to $46 million. This is largely attributable to changes in 3 factors that were expected to contribute to 2019 revenue. First, we are not seeing the forecasted increase in our medical retina business, following the reintroduction of our LIO delivery device after last year's voluntary recall. That business has instead stayed on trend. Second, as a result of the shift in focus I described to drive glaucoma probe utilization, we expect somewhat lower revenue contribution from Cyclo G6 system sales. And third, the anticipated China regulatory approval of our G6 platform is pushed back several quarters and thus, will not contribute to our 2019 revenue. Our partner distributor in China carries several lines of ophthalmic products from U.S. manufacturers and has observed a slowdown in China FDA approvals across the board, likely due to U.S.-China trade tensions. In summary, the value opportunity of IRIDEX that I was attracted to is unchanged and highly motivating for me despite some headwinds impacting our near-term growth. As I continue to work with our leadership team and Board to refine strategies, my focus is to improve our execution on programs and innovations that support customers and drive adoption while maintaining focus on reducing our cash burn through operational efficiencies. Now I'd like to turn the call over to Romeo to discuss our second quarter 2019 financial results in more detail. Romeo?

Thank you, Dave, and good afternoon, everyone. Total revenues for the second quarter of 2019 were $10.4 million compared to $10.3 million for the comparable period of the prior year. Revenue growth continues to be driven by our Cyclo G6 products. In the second quarter of 2019, Cyclo G6 product revenue was $3.4 million, an increase of approximately 11% compared to the second quarter of 2018. As Dave noted, during the quarter, we shipped a record high of 14,200 probes and placed 85 systems, reflecting our strategic shift towards probe adoption. Revenues for the retina business were $5.2 million, a decrease of approximately 6% compared to the second quarter of the prior year, reflecting the continuous pressure in our medical retina business. Looking more specifically at our second quarter 2019 revenues geographically, approximately 58% of our Cyclo G6 revenue was in the U.S., 42% outside the U.S. This compares approximately 60% of our Cyclo G6 product revenue in the U.S. and 40% outside the U.S. in the second quarter of 2018. In our retina business, approximately 48% was in the U.S., 52% outside the U.S. in Q2 compared to approximately 44% in the U.S. and 56% outside the U.S. in the prior year quarter, Q2. Other revenues, which include royalties, services and other legacy products, were $1.8 million in the second quarter of 2019, an increase of approximately 7% as compared to the same quarter of the prior year. Gross margin in the second quarter was 43.6%, improved from 41.4% over the second quarter of 2018. The higher gross margin was primarily attributable to a decrease in manufacturing overhead spending, partially offset by the increase in manufacturing overhead variances that included an adjustment to warranty expense. Operational expenses for Q2 2019 declined to $7.0 million from $7.6 million in Q2 2018. Operating expenses in the quarter reflect a reduction in cost associated with lower headcount and efficiencies gained in adjustment to our sales and marketing programs, partially offset by an increase in severance costs. Our operating loss for the second quarter of 2019 was $2.5 million compared to an operating loss of $3.3 million for the second quarter of 2018. This improvement is a direct result of our focused attention on productivity and our efforts to reduce spending, allowing us to reduce cash burn to $1.6 million in the quarter. Turning to the balance sheet, as of June 29, 2019, we had cash and cash equivalents of $15.6 million and no debt. Turning to our guidance for 2019. As Dave notes, we are reducing our revenue guidance for the full year 2019 to a range of $41 million to $44 million, down from $43 million to $46 million. We are maintaining our Cyclo G6 probe shipments guidance of 58,000 to 63,000, but we are revising our expectations for Cyclo G6 system shipments to 375 to 425, down from 475 to 525, reflecting our shifting sales focus towards increased physicians' utilization. With that, Dave and I would like to open the call for your questions. Operator?

[Operator Instructions] And our first question comes from Jon Block with Stifel. Your line is now open.

Hi. This is Trevor on for Jon. How do you balance preserving the balance sheet as opposed to attacking the market a little bit more aggressively in order to drive sales products for G6? And then I have a follow-up.

We're trying to balance that by making the push in the sales and clinical teams and not backing off from that but controlling expenses in other areas. We've done outsourcing. We're looking at our staffing levels and programs in marketing, for example, to make sure that all these spend are cost-effective. So we keep that burn down under control while we're building up the user base and the average usage of customers.

Okay. Great. I think you mentioned earlier that you expect the P3 to roll out in Q4, how do you expect this product to impact cogs once it's on the market?

It'll be a little bit cheaper to manufacture than the existing probe, few percentage points we believe, possibly better than that. But the real driver is if it delivers more consistent outcomes and less dependency on the specific technique of the physicians, higher outcomes, better durability, safety profile is going to increase the confidence, so people will feel they can use and drive a broader set of patients. So we think it's as much a confidence builder as it is a cost reduction.

And our next question comes from Scott Henry with Roth Capital. Your line is now open.

Thank you and good afternoon. A couple of questions. I guess starting on the G6. 11% growth, it's not bad, but certainly not where I think you want to get to turn profitable. When do you think we might see an inflection point? I imagine that would be twofold, 1 growing units but then also higher utilization. Just trying to get a sense of where you think that inflection point will be? And what kind of growth you aspire to for that division?

Yes. So put in perspective, historically, I think the focus was on placing a large footprint of systems with customers as quickly as possible and believing that the clinical evidence and the initial results that users got would drive usage. And our actual experience showed that it takes more clinical support and technique and learning curve for physicians to consistently achieve those results and get confidence to use it on a broader set of patients. So that's really what we think is the shift that will drive better utilization. It's a combination of more physicians getting confidence and using it on patients, but also our users broadening to earlier stage. The initial product was -- historically, a continuous wave cyclo photocoagulation was a late-stage therapy. And since it's a similar type of technique and we call it MicroPulse version, we've tended to have physicians initially think, okay, that's where I should start with this. And as the safety profile and experience base is built up, it's clear that with a benign safety profile that we have, evidence that people have managed over an extended period of time with a few repeat procedures, we think that, that's just a much broader swap of patients. And we don't think we can get the broader adoption unless we're really accomplishing that in the hands of the actual users. So that's the shift in focus and what go with that are maybe a little bit fewer systems placements. But we're going to target those people who would have the volume that justifies adopting and using on their patients. So we think we'll get a higher average usage for new systems placements.

Okay. But now given all of that, when do you think you would start to see the return on that strategy? Would you expect it kind of beginning of next year when it really becomes more apparent? But just trying to get a sense of that.

Yes. Whenever you start with a customer and you take them through a process where they believe in the benefits that you are describing would be applicable on their patients, we want to talk about a validation process on a representative set of patients, not a couple of patients and try out the probe and see what they think. We know that it works. We have the history and the studies behind that. And so as you take them through that and patients typically get initial results but the final results really take a month. So by the time you get through that process, you are several weeks down the line, months down the line plus, so it will take a little bit to get through that process and then have them start ordering and using on patients. So we do think it's going to take a little bit of time for this to show up in the outcomes. But in the meantime, we'll be able to look at how many of these kinds, how many validations, how many new ongoing customers are we signing up per territory in the U.S. and really focus on productivity of that sales team. Internationally, we go through distributors and we do some of the same efforts in training on the process and how to bring end users along to a broader set of patients, we have less visibility to the end users there.

Okay. Great. And shifting gears to retina. Last year, retina was strong in the second half of the year. But given the dynamics that you spoke about, should we think of revenue up-ticking in second half of 2019? Or should we think about maybe that $5.2 million as a new base for that segment of the business?

Well, last year's second half was strong because we had a -- there was a voluntary recall, where we held back shipments. And we had some orders in the backlog that we were able to ship once we ended the recall. So that shifted some revenue from the early part to the later part and made it look stronger. It's a competitive marketplace, and we're looking at ways that we can improve our competitive position there, obviously systems with better margins will help us be more aggressive in pricing and still gain incremental gross margin and reduce cash burn. But it's a more mature market. And while we have a strong name in that space, we need to do some development and work on some of our delivery devices to enhance their appeal for customers. We think it's still a reasonable opportunity, but we think we can enhance the value of that business by improving the margins and modernizing those systems and make them more appealing for customers as well.

Okay. And then just a couple of final ones. When I look at sales and marketing, $3.5 million down about $0.5 million sequentially, $600,000 year-over-year, are those -- I know you talked about cost savings, is that $3.5 million for that line item? Is that reflective of what we should think about going forward?

Yes. We're trying to be sure that we put effort behind this process of spending time with customers, that's manpower in the field at customer sites. We do want to focus on the productivity of that sales team. And one of the ways we'll know we're making progress there is as we sign up new ongoing customers in each territory at some rate and have a larger and larger sustaining base of customers, the revenue per territory will grow and the average cost of selling in that territory will go down as a percentage of the total revenue. We're -- we have been more judicious and we'll continue to be judicious on the marketing spend, the trade shows and other areas while we try to leverage things like webinars and regional seminars, which can be quite cost-effective.

Okay. Great. And it looks like -- the final question. It looks like the burn went down in 2Q from Q1, continues to go in that direction. How do you think about when you would target cash flow breakeven? And are you comfortable, you have the cash resources currently to get there in your opinion?

Yes. We're coming off a quarter with a nice reduction, down to $1.6 million. It's a bit early to try to set a breakeven prediction. We're optimistic of the growth in our higher-margin MP3 probe business, but reductions in our expectations for retina, China launch, push -- counters the timing for that. And so it's just difficult to give you a concrete answer on that right now. We're maintaining a focus on reducing the cash burn rate and growing the margins to stretch our existing cash. End of Q&A

Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to David Bruce, Chief Executive Officer, for any closing remarks.

Thank you. And thank you all once again for joining the call today. I'd also like to thank the IRIDEX team stepping in and joining this team, I've been welcomed and the efforts are strong and we're all targeting a successful growth for the company. And finally, let me thank the shareholders for your continued investment in the opportunities of the future. I'm focused and the team is focused on it and looking forward to delivering progress updates in the future.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. Everyone, have a wonderful day.