STAAR Surgical Company (STAA) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the STAAR Surgical Fourth Quarter and Full Year 2014 Financial Results Conference Call and Webcast. My name is Derrick, and I will be your operator for today. At this time, all participants are in a listen-only mode. We shall facilitate a question-and-answer session at the end of the conference. [Operator Instructions]. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Doug Sherk. Your may proceed.

Thank you Derrick and good afternoon everyone. Thank you for joining us for the STAAR Surgical conference call to review the company’s financial results for the fourth quarter which ended on January 02, 2015, as well as recent corporate developments. The news release detailing the fourth quarter and fiscal year results was issued just after 04:00 PM Eastern Time this afternoon and is now available on STAAR's Web site at www.staar.com. In addition, a slide presentation, the accompany management management's remarks during today's call. To access both, the webcast and the presentation slides, go to the Investor Relations section of STAAR’s Web site at www.staar.com. If you are listening via telephone to today’s call and would like to review the slides that accompany management’s remarks, please navigate to the live webcast as I’ve just reviewed, and choose the no-audio/slides-only option. In addition, an archived replay of the event will be available on the STAAR Web site. Before we get started, during the course of this conference call, the Company will make forward-looking statements. We caution you that any statement that is not a statement of historical fact is a forward-looking statement. This includes remarks about the corporation’s projections, expectation, plans, beliefs and prospects. These statements are based on judgment and analysis as of the date of this conference call and are subject to numerous important risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These risks and uncertainties associated with the forward-looking statements made in this conference call and webcast are described in the Safe Harbor statement in today’s press release as well as STAAR’s periodic filings with the SEC, including the discussion in the Risk Factors section of our 2013 Annual Report on Form 10-K and our quarterly report on Form 10-Q for the period ended July 04, 2014 as well as for the third quarter. Investors or potential investors should read these risks. STAAR assumes no obligation to update these forward-looking statements to reflect future events or actual outcomes and does not intend to do so. In addition to supplement the GAAP numbers, we have provided non-GAAP adjusted net income and diluted net income per share information that excludes manufacturing consolidation expenses, Spain distribution transition expenses, gains or losses on foreign currency, fair market value adjustments for warrants, stock-based compensation expense and FDA panel and remediation expenses. We believe that these non-GAAP numbers provide meaningful supplemental information and are helpful in assessing our historical and future performance. Also, in order to compare our performance from period-to-period without the effect of currency fluctuations, we apply the same average exchange rate application to the prior period or constant currency rate to sales. A table reconciling the GAAP information to the non-GAAP information is included in our financial release, which is available on our Web site and in our slide presentation. Now, I would like to turn the call over to Barry Caldwell, President and Chief Executive Officer of STAAR Surgical.

Thank you Doug and good afternoon everyone. Thank you for joining us on the call and the webcast this afternoon for a review of our fiscal year and fourth quarter 2014 results, as well as a general business and regulatory update. With me today on the call is Steve Brown, our Chief Financial Officer; and Sam Gesten, our General Counsel. I will begin our discussion with an overview of the headwinds affecting sales, and then Steve will review fourth quarter and fiscal year 2014 financial results. I will then come back and provide a regulatory update before we open the call for your questions. For 2014, our total sales increased 4% as reported or 6% on a constant currency basis to approximately $75 million. For the year, overall ICL sales were flat, while IOL sales increased 1% as reported or 5% on a constant currency basis. The other product sales category which generates lower gross margins increased 68% as reported. For the fourth quarter, our sales were 16.6 million, which we previously reported and was down from the fourth quarter of 2013, which was 18.9 million. ICL sales were 9 million versus 11.5 million in the fourth quarter of '13, whereas IOL sales were 5.5 million as reported or 5.8 million in constant currency versus 6.6 million in the fourth quarter of 2013. The other product category was at 2 million versus 800,000 in the prior year fourth quarter. Now the challenges impacting sales during the fourth quarter included; first of all a voluntary hold on several thousand ICLs from shipment. This hold resulted in back orders totaling over 2,000 ICLs at the end of the quarter. Second, the timing of the 2,500 ICL lens order from our Korean distributor which moved from the fourth quarter to the first quarter of this year. Third, foreign currency exchange reduced fourth quarter sales by over $500,000, and we did have five fewer shipping days during the fourth quarter of 2014 versus the fourth quarter of 2013. Now let's go back and talk about the voluntary hold on ICLs. In terms of the ICLs placed on voluntary hold, we have determined now and have corrected the root cause of the issue. Since determining the root cause, we presented to the FDA voluntary protocols for testing the product held to verify that it needs our standards for quality. We are waiting to learn if the FDA will provide any feedback on our protocols. The FDA may choose to offer no comment or may ask us to revise our protocols or otherwise. The company meanwhile is working to fill these back orders as it manufactures product, not subject to the voluntary hold. We continue to work toward a resolution of the voluntary shipping hold. Next I'd like to provide you with an update on the Korean market and our distributor's efforts to address the decline in the end consumer demand caused by the negative press on LASIK complications, which began during the third quarter. As we reported on our last call, during October we started to see the rate of decline in the number of patients coming in the door decrease. While the rate of decline of ICLs out the door to the end customer was down 49% in September, the rate declined to 27% in October, 24% in November, and then 18% during December. You may recall that we have worked with our distributor on the messaging regarding the advantages of the ICL for a direct-to-consumer campaign in Korea to combat the negative LASIK press. That campaign began the 1st December and consists of cable television commercials, movie theater commercials, bus wrap advertisements, journal, and magazine advertisements, and standing banners for key ICL centers. The theme is consistent throughout these forms of advertisements. The advertisements feature a famous Korean actress who had ICLs implanted over eight years ago and is very happy. The total investment of our distributors Woo Jeon is around $2 million to this campaign. In November, we received approval from the China FDA for the Visian ICL with CentraFLOW. We've seen the advantages and the increased penetration of the ICL in other markets with this new technology. This approval in China also expanded the range of approved ICL treatment for both myopic and astigmatic corrections. In conjunction with our distributor, we've now trained over 200 ophthalmic surgeons on the new technology. And during the month of January, 51% of all the ICLs shipped from the distributor to end customers were the CentraFLOW technology. You may recall China is the largest refractive market in the world according to Market Scope, and these approvals enable a significant future potential opportunity for the company to expand our market share which is currently estimated at less than 2%. I'd now like to turn the call over to Steve Brown who will provide additional financial details for the fourth quarter and fiscal year 2014. Steve?

Thank you Barry and good afternoon everyone. I'll focus my comments on several areas, GAAP and non-GAAP P&L results, gross margin, operating expenses, the tax benefit in the fourth quarter, and our cash. First let's review the fourth quarter P&L results. Revenue in the fourth quarter decreased by approximately 13% as reported and 10% in constant currency. Gross margin decreased over 11 percentage points to 56.7% due to a combination of factors. I'll review the gross margin profile and operating expenses in a moment. The GAAP net loss for the fourth quarter 2014 was $2.5 million or $0.07 on a per diluted share basis compared with a net loss of $876,000 or $0.02 per share on a per diluted share basis in the fourth quarter of 2013. On a non-GAAP basis, adjusted net loss for the quarter was $1.2 million or $0.03 a share as compared to adjusted net income in the year ago quarter of $850,000 or $0.02 a share. On a GAAP basis for the full fiscal year 2014, sales increased by approximately 4% as reported and increased 6% in constant currency. Overall, we lost $0.22 per diluted share as compared with net income of $0.01 per diluted share in the prior fiscal year. This loss resulted from lower gross profit and higher operating expenses driven by FDA panel, inspection, and remediation expenses of $3.3 million, additional investments in selling and marketing of $2 million, other research and development investments including new product development of $2.3 million, and a loss on foreign exchange of $900,000. The higher expenses were partially offset by $1.9 million decrease in manufacturing consolidation expense. On a non-GAAP basis, the net loss was $779,000 or $0.02 per diluted share for the year versus adjusted net income of $7.5 million or $0.19 per diluted share during the fourth quarter of 2013. Now taking a closer look at gross margin in the fourth quarter, there were several factors negatively impacting gross margin by over 11 points from 68.5% in the fourth quarter of 2013 versus 56.7% in the fourth quarter of 2014. Approximately 660 basis points of the decline in gross margin was due to recording inventory reserves, the majority of which was for Toric ICL inventory that had been built in Switzerland in anticipation of the U.S. launch. The inventory reserves were based on company accounting policies regarding slow moving inventory and projections for timing and the amount of sales. Other negative impacts included higher ICL unit costs of about 210 basis points, a higher mix of low margin IOL injector sales of about 130 basis points, and lower average selling prices of about 110 basis points. The higher ICL unit cost were driven by lower manufacturing yields and higher cost inventory made during the manufacturing transfer earlier in 2014 that sold through the P&L in the third quarter and fourth quarter. The root cost for the lower yields was corrected in return to normal levels in January and the higher cost inventory has sold through giving us confidence we will achieve lower cost in 2015. Lower average selling prices were due to product and geographic mix of unit sold and primarily of IOL prices in Japan impacted by foreign currency exchange rates. For the full fiscal year 2014, gross margin declined from 69.7% in 2013 to 65.1% in 2014. The negative impact for the year was similar to those for the fourth quarter but lesser in degree. I'd now like to provide a bit more color on our fourth quarter operating expenses which declined by $1.1 million to $13.1 million as compared to the prior year quarter. The primary driver of this decline was lower stock-based compensation expense of approximately $1.1 million and that spread throughout general and administrative expenses, selling and marketing and research and development expenses. Selling and marketing expense declined $1.7 million primarily from lower stock-based compensation expense of $470,000. The timing of the ESCRS conference expenses of $790,000 recorded in the fourth quarter in 2013, but the third quarter of 2014 and lower commissions of $300,000. General and administrative expense was $350,000 lower than the prior year period largely due to lower stock-based compensation expense and that was partially offset by higher legal and recruiting fees. Partially offsetting these lower costs was the $1.3 million increase in research and development spending which was primarily driven by $1.2 million spend for remediation activities and response from the FDA warning letter and cost related to the FDA inspections in the fourth quarter. For the full year 2014, FDA panel, remediation and inspection costs totaled $3.3 million. Now turning to other financial items. During the fourth quarter, the company recorded a $1.4 million income tax benefit as compared to a benefit of $172,000 in the prior year period. The tax benefit in the quarter was driven by finalization of Swiss tax authority rulings in connection with our manufacturing consolidation project which was completed in June of 2014. Cash and cash equivalents at the end of the year January 2, 2015 totaled $13 million. During the quarter ended January 2, 2015, the company used $3.5 million in cash for operating activity and $1.5 million for the purchase of property and equipment. Cash used for operating activities during the quarter resulted primarily from payments made for FDA remediation and inspection activities and an $800,000 increase in inventory. This concludes my comments and I'd now like to turn the call back to Barry. Barry?

Thank you Steve. I would now like to go through a regulatory update and concluding remarks before we take your questions. As our team has continued to work on resolving the observations issued in the May 2014 FDA warning letter and completing our remediation activates the FDA began two inspections that started in mid-November. One inspection conducted was a follow-up to the warning letter and the second was post approval inspection on the transfer of the ICL manufacturing to Monrovia which was approved by the FDA in August of 2013 without a site visit at that time. These inspections concluded on February 04, with 10 observations on an FDA Form 483. The observations focused primarily on the needs for adherence to an improved procedures, processes and documentation relating to design change, design transfer into specifications and production, improvement and good documentation practices and broader environmental monitoring. We plan to submit our response to these observations by tomorrow. As stated in our previous monthly updates to the FDA, we still continue to address issues from the May warning letter on which we continue to work. We have enhanced and will continue to enhance our overall quality and compliance program as we focus on these corrections. We are committed to a successful resolution and will continue to work towards that goal. So there can be no assurance the FDA will be satisfied with our response and they may take further action that may adversely impact us. We spent much of this call discussing the headwinds and challenges we faced during 2014, and certainly some of those will continue to face us during 2015. At the same time there are number of reasons for significant and continued conviction in the future growth of STAAR. For instance, tomorrow here we will be celebrating the fact that there are now over 500,000 Visian ICLs have been successfully implanted throughout the world. You will also see that this will be one of our major themes at the ASCRS meeting in April. As we just discussed as well the company is diligently addressing the outstanding observations made by the FDA and we remain committed to the quality of our system and our products. In November we received final approval for the Visian ICL with CentraFLOW in China, representing a growth opportunity in the largest refractive market in the world and one in which the ICL currently has less than a 2% market share. Also as mentioned in previous quarters and as the company has consistently demonstrated, we do anticipate that further adoption of our new technologies like the ICL with CentraFLOW and the future launch of the preloaded ICL system in Europe will drive ICL growth as we move forward. Finally before we open the line to your questions, I would like to briefly take a moment to thank the team here at STAAR for their dedication, enthusiasm and hard work during my tenure as CEO. It’s been an honor to lead such a talented group of people and I believe great things remain in store for our company. The search for new CEO is in the advanced stages and developments will be announced as they are finalized. And with that operator we're ready to open for questions. Thank you.

[Operator Instructions]. Our first question will be from the line of Chris Cooley from Stephens. Please proceed.

If I may just two quick questions, then I'll get back in queue. It may be a bit reticent to do it at this juncture with the transition taking place, but help us think a little bit about the outlook for 2015, and I guess specially in the company’s prior communications via the 8-K about lack of visibility here in the first quarter. Just trying to think through the various puts and takes here in the 4Q, what still resonates here in the 1Q? Help us think about kind of what to expect here as we start the calendar year from a growth perspective? And then I have one follow-up.

Let me first comment that I think it will only be appropriate to talk about outlook for 2015 when new management is in place. So, at this point in time, I wouldn’t take that one on, but I would like to speak to the lack of visibility, because I think this still is an issue. In terms of how it relates to the several thousand ICLs that we have on voluntary inventory hold. As you know, this created a backlog at the end of fourth quarter, it continues into the first quarter though we're working diligently to increase our manufacturing and we've been able to do that, but we're still running behind in back orders. In order to likely fulfill all of those back orders during this quarter, we're going to need to get some release of those products on voluntary hold, and we just don’t know the answer to that at this point in time whether they'll be released or not. So, I think that’s the visibility that we're lacking in terms of actually how much product we'll have to ship.

And then if I could? Help us a little bit as well with, I know this just may be a little bit nebulous here on how you can address it, but from the FDA's perspective, you mentioned that you're still obviously almost a year now working diligently to address those initial issues in the warning letter. Can you maybe just give us some form of analogy to kind of help us understand where you are in this process relative to basically getting the ball across the goal line? And similarly, what do you think you have to do post to 483 from a remediation standpoint, are these material changes that you have to undertake at this juncture? Are these more process, it sounds like type changes that could be addressed hopefully without too much heavy lifting.

Since the ball has got to be transferred here, I'll let Steve first make some comments there and anything that Sam has.

Well I'll turn that to Sam then.

The answer is that we continue to work diligently in addressing all of the observations that have been made by the FDA both in 2014 and in 2015. It's difficult to say exactly when will it be done, we are working at a companywide priority to address and resolve them., When the FDA may decide that we have satisfied on our commitments and our substantial compliance is something that we just don’t know at this time.

Your next question will be from the line of Jim Sidoti from Sidoti & Company.

Barry, can you give us a little more color on the voluntary hold? When this was -- what's the issue and when do you think you'll get an answer from the FDA? I guess the last one is quite hard to answer but the first two.

I can take that Jim, this is Steve. As we said a voluntary hold was put on ICLs to go through some further testing to ensure the product meets our standards of quality, the product was made during production runs where deposits were found on product during inspection, and that product was rejected and scrapped. The remainder of the product from those production runs all passed final inspection, and the root cause of the deposits has been identified. To make a cautious product quality decision, we put them on hold to put them to further testing, and we took advantage of the fact that the FDA was on site for the inspection, and we presented them with test protocols to verify that product met our standards for quality. So, as Barry said, we're waiting to learn if the FDA will provide any feedback on this protocols and the FDA may choose to offer no comment or may ask us to revise the protocol or otherwise. So, we're not going to make any predictions regarding timing at this time.

So have you manufactured any new batches of those lenses since you indentified the problem?

Yes we have, our manufacturing has increased, and we've been filling the back orders. Now just as manufacturing has increased so has the flow of incoming orders. So we continue to fill the back orders, and new orders continue to come in, and we're happy with where we are in production now.

But there is no regulatory issue that prevents you from shipping new active lenses to fill those orders and new orders.

No.

Just to remind you Jim this was a voluntary hold by the company. This was our decision.

And so really the issue was around some lenses that we're manufactured in the fourth quarter but there is nothing to prevent you from continuing to manufacture those lenses in the first quarter and ship production going forward.

Correct in fact we -- not only have we continued to manufacture but we've increased manufacturing so that we can start filling and have started filling these back orders. And as I've said you have new orders are coming in. So I can't tell you when we're going be out of the back orders because new orders come in as we fill the back orders.

Right now it's just a function of your capacity of manufacture.

Yes, and as I said that capacity has increased.

Then I want to ask you about the write-down on the Toric lenses. Can you give me the dollar amount of the write-down?

Sure, it was not a write-down, it's a reserve and on the inventory and it's about $700,000.

And are those lenses on the shelf somewhere?

Those lenses are in Switzerland.

So is there anything that would prevent you from shipping those lenses, should you get approval is there end of life to those lenses expiration date on them?

Well, there is an expiration date but the reason for the reserve is that to harmonize those lenses with our currently approved PMA would create a timeline where in those lenses would be within our returns window. And so by policy we have to reserve for them but they're still good lenses.

Those lenses have a two-year shelf life on them.

I am sorry what was the shelf life?

It's two years on the product that was made in Switzerland and it would have been made the first-half of last year or this year -- last year 2014.

So should you get approval mid 2015, would it be an option to ship those lenses?

Yes, we believe so.

As long as they are harmonized with our PMA.

I guess I need you to explain that one again, what does that mean?

The manufacture of -- when the FDA was in they observe that the manufacture of those lenses was not in harmony with our PMA. So they have to be harmonized first with the PMA to be released.

The FDA would basically have to sign off on them before you could ship them?

Yes.

Which is I guess a similar situation to the voluntary hold on lenses launches?

Well, I wouldn’t call it similar, they are two different things.

And then as far as cash on hand it sounds like you went to about $5 million in the quarter on the -- most of that was on the FDA remediation charges and now they were in your place I think for good five or six weeks in the first quarter of 2015. So I assume that there was some more cash burns or is being burnt in this quarter. Do you think you have enough cash on hand to get you through or do you think you’ll have to start to explore options from some capital?

Yes, we have enough cash on hand to execute our operating plan for the year and as you know we continue to have flexibility to access other financing if needed.

Jim, this is Sam let me just clarify something in it, while the inspection were not completed until February 4, in fact the FDA representatives didn’t come to inspect between January 9th through February 4th, they were not on site, just want to clarify that.

So it sounds like you booked a lot of the inventory reserve and a lot of these FDA remediation cost in the fourth quarter and we shouldn’t see those recur in the first quarter is that a fair assessment?

You're correct that they were booked in the fourth quarter. You remember panel expenses were largely in the first quarter, but we continue the remediation efforts.

Yes, the same amount of people have been here whether their inspectors were here or not, so we’re still spending on all the remediation efforts that we've committed to.

So, I guess I am confused to Sam’s point.

Only that the inspectors were not here during that period of time about a month, they weren’t here we still had teams of people here working though.

That’s correct.

So, I guess so my point you still being burning some cash in this quarter and I assume that’s going to continue until you get the issue resolved, but you're saying that the 13 million on hand is sufficient to see through the year?

It is.

And then Barry final question in the press release back in October you indicated you were going to leave as of March 1st and then stick around for month as a consultant, is that still the plan?

Yes, actually it's I think about 13 months through March of 2016.

I must have misread that, so as of right now you still plan on stepping down from the CEO role next week though?

That’s correct yes.

Our next question is from the line of Brian Weinstein, William Blair. Matthew O’Brien: This is Matt in for Brian, can you hear me okay? Understanding you're not going to give broad commentary about 2015 outlook, just maybe wanted to ask about a couple of the recent opportunities you’ve discussed one the KS-IOL product you mentioned last quarter that you’ll be looking to launch in a couple of new markets there in the fourth quarter and '15. Just wondering if there is any update there?

Actually we did one of the things that we or I should have pointed out in our commentary is that we shipped our first IOLs in the Spain market, which is one you may recall we're direct in. So, that was one that was high, very high on our priority list in terms of entry. I think I'd also comment that, during last year KS-OILs were right on target in terms of what our third party partner had promised us for the year. So that looks encouraging and we're going into the year with a healthy inventory of product. Matthew O’Brien: And then just on CentraFLOW adoption trending in here in China, just wanted to know -- we're seeing more broad based adoption there are few perhaps high volume customers that are driving a lot of that. Just if you could give any more clarity on sort of the early progress you've seen there since the November approval?

First of all one of the things to recognize which is a little bit different in the China market and lets Europe for example. In Europe we had a two step introduction; we first moved from sodium chloride stored lenses to BSS stored lenses. So surgeons made that transition they understood it. It was a much easier transition in Europe than the move to CentraFLOW, just with the port in there. In China it’s different, in China they are moving from the sodium chloride lenses to BSS lenses with CentraFLOW. So it’s kind of a two step move. So we need to make sure that we've adequately trained surgeons because the ICL will act differently in the eye coming stored in BSS versus the sodium chloride. And I think overall I was very pleased when I got the 51% mark for January that we had converted in terms of what the distributor actually sent out the door to end customers. That’s a higher rate than I had anticipated and we have trained 200 surgeons, we are going to continue to train the objective of the team is they have it 100% converted by the end of the second quarter. Matthew O’Brien: And the just the last one from me, you mentioned again that manufacturing yields kind of weighed on gross margin. Just wondering what the expectation is for how that might trend throughout 2015 and that’s if for my questions.

They actually improved in January, I won’t go into the details of why. But they improved in January back to normal levels and actually the high-end of normal level, and we expect that to continue throughout '15.

[Operator Instructions]. Your next is from the line of Larry Haimovitch, HMTC.

Are there any lessons that we can learn from the problems you had in China vis-à-vis bad LASIK publicity and how it wore-off and how China recovered versus what you are facing now in Korea. Because it sounds like a similar problem to me, doesn’t it, you're getting bad publicity that’s spilling over into ICLs.

Yes, you're very right Larry it is very analogous. With this exception I would Korea was the most brutal I have seen, and when I say brutal I mean in terms of how hard attacking it was concerning LASIK complications. Overall I am pleased with what we have seen in the Korean market in terms of the rebound and thus far I haven’t gone back and looked at the 2012 China example in terms of the return, but I think the reduced rate of refractive surgery and ICL implants has improved in Korea. Now I'll be very interested to see the January data, the February data to see if the direct to consumer can even push it more. But the fact that in September we had 49% decline in ICLs going out the door to end customers and that decline lessened to 18% in December. I think we suffered with like the 50% rate in China for six months or more before we started to see a decline.

So what you are saying is it seems to be recovering better in Korea than it did in China?

At this point I would say I am pleased with what I have seen. The rest of the story to come.

Barry CentraFLOW approved in Korea I can’t remember if it is.

Yes it is, and I believe for the year they were 91% CentraFLOW.

Follow-up question on CentraFLOW, anything you could tell us about your progress or lack of progress in the U.S. with the FDA vis-à-vis CentraFLOW Barry? We haven’t heard much about that recently.

No, the story is the same in terms of some sub-sizing protocols we're working on in some information for the agency.

Do you think it’s possible you will be able to open a clinical trial this year with the agency for CentraFLOW? It just seems it's gone on forever.

Larry I think this year job number one is to get through our remediation efforts with the FDA.

So that means that this is back [Steve]?

I think in terms of priorities where we’ve been focused on is what we need to continue to focus on, that’s remediation.

And then fortunately CentraFLOW and clinical trial setting is part of that remediation process or is affected by the remediation process?

Yes, we have only so many resources and we need to put them on job number one.

And at this time I am showing no further questions in queue. I will like to turn the call back over to management for any closing remarks.

I'd like to thank you for your participation on our call today and the team will look forward to providing you an update on our progress early next year. Thank you very much and have a good evening.