Good day, and thank you for standing by. Welcome to the Q3 2023 IRIDEX Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Trip Taylor, Investor Relations.

Thank you, and thank you all for participating in today's call. Joining me are David Bruce, Chief Executive Officer; and Fuad Ahmad, Interim Chief Financial Officer. Earlier today, IRIDEX released financial results for the quarter ended September 30, 2023. 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 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 are not statements -- that are not statements of historical fact, including, but not limited to, statements concerning our strategic goals and priorities, product development matters, sales trends and the markets in which we operate. 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 reliance on these statements. For a discussion of the risks and uncertainties associated with our business, please visit -- please see the 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, November 14, 2023. And with that, I'll turn the call over to Dave.

Good afternoon. Thanks, Trip, and thank you all for joining us. Today, I'll discuss recent corporate and Medicare reimbursement developments and our business progress then Fuad will provide details on the third quarter financials, and we will open the call for questions. I'll start with the topic I expect people are most interested in learning more about. That's the Medicare coverage policy that was the subject of our recent 8-K and the potential impacts to our business. On October 26, WPS, a Medicare administration contractor or MAC was the first to issue an LCD, changing its coverage related to minimally invasive glaucoma surgery or MIGS procedures. Last week, as expected, 4 other MACs released similar LCDs, and all will become effective December 24, 2023. While the clear focus of the 5 LCDs was MIGS device use, they also changed their coverage criteria for cyclophotocoagulation or CPC, which is the basis for IRIDEX' MicroPulse and continuous-wave glaucoma procedures. While MIGS are incisional surgical procedures predominantly done coincident to a cataract surgery, the CPC procedures done with IRIDEX devices are neither incisional nor are they commonly done coincident to cataract surgery. While the MACs provided little context or explanation for their motive in coverage changes, it's believed they were reacting to the rapid rise in volume and cost of MIGS procedures particularly driven by multiple MIGS devices deployed during one cataract intervention. This drove an increase in surgeons submitting multiple billing codes and a large increase in reimbursement expense per procedure and in total. The LCDs limit MIGS procedures concomitant with cataract surgery to a single device and specifically call out newer MIGS devices that enable both a canaloplasty and a goniotomy procedure to be performed with a single device. These and several other procedures were labeled as investigational, which means they…

Thanks, Dave, and good afternoon, everyone, and thank you for joining us today. I would like to begin by reviewing our financial performance for Q3 of fiscal 2023. Let me start by providing a high-level summary. We generated $12.9 million in total revenue in Q3, which was flat sequentially versus Q2, important because it is typically a seasonally lower quarter. However, it was down $1.8 million from the prior period, continuing the overall softness in capital equipment market in '23. A significant part of the decline, approximately $500,000, was due to loss in royalty revenue, as we previously mentioned. And this will be a drag until we lap it next year. On both the G6 and retina side of the business, the macroeconomic -- the macro and the probe adoption headwinds in 2023 we discussed during the August second quarter results call continued to affect overall sales in Q3. Our retina segment revenue in Q3 was $7.9 million compared to $8.8 million in the prior year period. In the quarter, we continued to see stronger and longer capital sales cycles. And strong dollar made pricing challenging internationally and has persisted throughout 2023. While these dynamics contributed to lower sales in retina systems, we aren't seeing customers cancel their capital purchase plans, and we are maintaining a solid pipeline, and our strong market share in the U.S. looks stable. In glaucoma, system purchases were significantly slowed as capital sales were impacted by higher interest rates and economic certainty contributing to elongated sales cycles. This weakness led to system sales of 27 units in the quarter compared to 54 systems in the prior year period. The system sales shortfall accounted for the decline in overall Q3 Cyclo G6 revenue to $3 million from $3.5 million last year. Overall, we saw glaucoma probe…

[Operator Instructions] Our first question comes from Tom Stephan with Stifel.

I'll start with the LCDs. I mean just a couple here. Dave, what's the mix of moderate versus severe patients for Cyclo G6 today? I think in the past, you've talked about moderate being a very large opportunity for G6 as it was maybe no more than 25% of volume today. So I guess if the majority of your volume is that refractory patient, I'm just curious why the coverage criteria would be such a headwind. And then I have a follow-up.

Thanks for the question. Yes. So the very late-stage patients -- and the criteria calls for, for example, very limited visual potential and pain among the list of various things. They also call for having had a prior trabeculectomy or tube-shunt procedure. So these are all restrictions that would eliminate a lot of the later-stage procedures as well. So we think it's probably in the 25% range that would qualify under this strict criteria and about 75% of our procedures in advanced-stage patients but in front of these kinds of criteria. So in the payer places where the MACs are the insurers of the patients, we think it's pretty restrictive. That said, if the clinicians understand the coverage that their patients have, on average, it's going to be 2/3 that maintain coverage. And so we think it's important to work with clinicians so that they understand what their coverage of their patients is. And if they aren't in the practice now of knowing their coverage, it might be something they might want to take up.

That makes sense. And then with the LCDs, just regarding the timing of the 8-K, the proposed LCDs obviously came out starting in June, and CPC wasn't even determined to be covered at that time. So why is it now expected to be a 2023 headwind or issue? And maybe why wasn't that the case or the thought, I guess, it was 4 or 5 months ago?

Yes. So the proposed LCDs came out in the June time frame. We responded with an appeal, and I described some of the clinical evidence that we submitted and a number of other arguments to retain coverage. We were somewhat successful in that in the original LCDs, they had classified all cyclophotocoagulation as investigational and now that -- there is a coverage but with a lot of restrictions associated with it. And we think erroneously assumptions went into creating that list. This happened 2 years ago, one of the MACs had proposed it be -- cyclophotocoagulation be investigational during the proposed period. We sent back responses and were successful. And there was no change, no mention in the finals. So in the time frame when this year's LCDs were submitted as proposed and we put in our responses, we deemed that it was not likely that there would be some incremental restrictions that came to us. So we didn't put out an 8-K at the time. And frankly, a lot of the clinicians are unaware of that whole sequence of events and are just now learning that new LCD final determinations are going into effect. And it's almost real time here how they're considering it and learning about it, considering it, displaying some outrage but then trying to figure out, okay, what am I going to do going forward? So for us, in cyclophotocoagulation, it really didn't become an issue until the actual determination came out. Now that the actual determination has come out and we have a significant restriction, we think there's 2 potential short-term impacts that have a wide range of variability here for Q4. Number one, I think in a lot of the areas where MAC coverage is restricted that clinicians will reconsider or extend the consideration whether to adopt and buy a new system and probes or not. And we think it's likely that they'll take their time. And so those potential purchases will be deferred out of this year for sure. The second is that in those areas where the decision is -- well, if I've got only partial coverage, I'm not going to offer it to patients. So I'm going to use up my inventory. I'm not going to be ordering to replenish. So I will significantly reduce the orders from -- for the remainder of the year as I use up the probes I have before restrictions come into place and I stop offering it. And we've had conversations with a number of clinicians, and frankly, they're all across the board on what they may or may not do going forward. So rather than try to put a very broad range of potential outcomes in the quarter, we just withheld the guidance -- suspended the guidance.

Got it. That's great color. And then last question, just pivoting to retina, modest upside in the quarter relative to our estimates, and sequential growth was very strong. I guess, Dave, can you talk about how you're executing in that business and you're now lapping, I think, some tougher comps. So what do you believe is a sustainable growth rate for that segment kind of as we, I guess, sit here today?

Sure. The retina business is strong. The weakness in kind of macro environmental considerations that really proliferated across the start of the year demonstrated to us that clinicians were deferring -- were not canceling but deferring their decisions to buy. And I think part of that might be -- the third quarter performance might be deferrals from the second quarter that came in, in the third quarter. And so we feel like maybe we're passing that uncertainty period. We also introduced our new IRIDEX PASCAL platform, and that's been very well received. And so we're seeing people having the opportunity to evaluate that and decide to purchase. So we think the capital equipment side is solid in the U.S. Internationally, I can't claim that we've seen that kind of, I'll call it, recovery of the purchase mentality, and we've got the inventory swings that occur in distributors. So we can have a higher quarter and then the next quarter lower then the next quarter higher. There's a little bit of increased volatility as distributor inventory varies from quarter-to-quarter as well. So all in all, we think that glaucoma -- or sorry, the retina business is strong, and we can look forward to solid growth in the future. It's a mature segment of the industry. The approximate long-term growth rate is in kind of the mid- to lower single digits. We think we can grow at that rate or better. And I think we will continue to see a little volatility quarter-to-quarter, and it's the moving average that's probably more indicative of how the business is doing. But we're quite comfortable and confident in the retina side of the business.

Our next question comes from Scott Henry with ROTH Capital.

Dave, I just wanted to -- did I hear you correct -- with regards to the retina business, when we think about organic growth there, did I hear you correct, mid-single digits is what you would be shooting for or the category? Is that -- I just wanted to make sure I got...

Well, we think the long term -- in that space, the long term is in that range. So it's a mature segment. There's replacement cycle, and there's expansion -- at least domestically, there's replacement cycle and there's expansion as a group practice or, say, a university in a metropolitan area open satellite facilities in the suburbs, they want the same equipment. And so that's the nature of that market. At this stage, while we feel like we have the leading technologies, there's not a new cycle being created to replace older equipment because of extraordinary new capabilities. We're in the lead for a replacement, and we actually think we can look forward to a replacement cycle because there are so many greater than 5 years old and even a lot of PASCAL systems that are in the end-of-service period where if that system breaks, it simply can't be repaired. So we think that we can have some opportunities for growth above trend and, if we get a more conducive capital equipment environment, that we could see growth -- higher growth in that, but we do think that there's still going to be volatility quarter-to-quarter. And if one is particularly strong, as we, for example, saw last year's third quarter, the comparisons and the subsequents might be on the weaker side. So the long-term trend is up and the short-term moving averages are up in that mid-single digits or better range.

Okay. And then with the other line, it declined sequentially from 2Q to 3Q. This kind of $1.9 million number, do you think we're -- do you think that's the base? Or should we expect to decline more? Just trying to get a sense of where the bottom is for that category. I know there's some things that went away and they'll annualize, but just trying to understand what the base level is.

Yes. The 2 drivers of volatility in that number are the change in elimination of a long royalty contract that we had. So the patent expired, and so the contract expired. And that was about $500,000 a quarter. And that's why the comparison to last year was a dip of about $500,000. Also in that other category is service revenue. So we have a strong service business where most of it is depot service. They ship a system back to us, we repair it and ship it back, and we sell extended warranty contracts. So we're booking revenue accruing it quarterly for those extended service warranty contracts. And then we're also doing individual service on a nonfunctioning system as well as preventive maintenance. So there are regular preventive maintenance cycles, and certain states are stricter than others, but we have a steady flow of systems that need to be checked, calibrated and recertified and sent back. So that business goes up and down, and that can vary by $100,000 or more in any 1 quarter. And so that can contribute to that number.

Okay. And then on the G6 business, I'm not going to ask you for guidance. I know you're not going to provide that. But when you think about Q4, which I guess we're about halfway through, what should we think about from that perspective? I mean has systems sold? Has it just kind of fallen apart? Like how do we -- just trying to get a sense of, at least in the next month, what kind of reaction you initially saw.

Well, I mean frankly, so are we. It's all across the board, and you feel like a play-by-play announcer because you have one conversation with someone who is from a state where there is no change to coverage. What's the issue here? And then others that just fear this is very restrictive, that it could extend to additional payers and are very seriously considering eliminating or at least very significantly restricting their offering of CPC. And those are the factors that make it very difficult. And so as much as we tried to really put together scenarios and identify a range, it's a little bit difficult here. I mean this news is 2 weeks old. So that's the problem with trying to do guidance. Clearly, people have said, I got to wait. Let's see what happens in terms of system purchases and adoption, if a significant chunk of their intended procedure volume isn't going to be available because it's restricted on reimbursement. So we will obviously stay very focused on it. And as we can develop a picture, we'll take a look at when it's appropriate to reinstate guidance.

Okay. And I'm going to ask you another question you may not answer, but you might. If I think about your prior guidance before everything happened with G6, at least in my model, the implication would have been that retina would have been strong in Q4, sequentially stronger in Q4 than Q3 even with the numbers that came in this quarter. Should we still -- I mean is that a reasonable assumption? Or retina, is it a seasonally strong Q4 typically? I'm just trying to get a sense of how we can take some of the variability out of the model.

Yes. Without guiding in the fourth quarter, it is the strongest quarter of the year typically. It is above what usually is the second strongest quarter, which is second quarter. I mean this year's second quarter, we experienced some weakness. And every year is a little bit different. But if you look back historically, the fourth quarter is the strongest. And I actually don't remember the percentage difference between the weaker and the stronger, but it is stronger. So we think that dynamic is going to be consistent this year, but we're only halfway through. And capital equipment happens at the end of the quarter. It's the typical pattern where most of the ordering happens later in the year.

Okay. Fair enough. Final question. With regards to the appeals process, what would be our next data point?

Well, as I said in the comments, we submitted an appeal on the grounds of misinterpretation of the actual study that they quoted to set the definition of the criteria. And that's in the hands of the various MAC administrators, and there is no defined schedules that they must act under and respond under. So it's difficult to know whether they will respond immediately. That's what we seek. We think it's compelling that they do. It's very unusual. I can't say I've seen it in any other types of situations where the specific paper that you quote, you change the criteria that was written in that paper. And it just seems highly unusual to us and to everyone that we've discussed this with and seems like an error in interpretation that should be corrected. And we hope they see it that way.

I would now like to turn the call back over to Dave Bruce for any closing remarks.

Thank you. And thank you all for attending. I know it's a bit of a turbulent time. There was a lot of information that came our way, and we tried to share with you. And we'll stay focused on managing through this situation and look forward to updating you in the future. Thank you.

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect.