STAAR Surgical Company (STAA) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the STAAR Surgical Second Quarter 2016 Financial Results Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the will be open for questions. [Operator Instructions] This call is being recorded today, Wednesday, August 3, 2016. At this time I would like to turn the conference over to Mr. Brian Moore with EVC Group.

Thank you, Michele, and good afternoon everyone. Thank you for joining us on the STAAR Surgical conference call this afternoon to review the company’s financial results for the second quarter which ended on July 01, 2016. Joining me on the call today are, Caren Mason, President and CEO of STAAR Surgical and Steve Brown, CFO. The news release detailing the second quarter results was issued just after 4:00 PM Eastern Time and is now available on STAAR’s website at www.staar.com. Before we get started let me quickly remind you that 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 and historical fact is a forward-looking statement. This includes remarks about the Company's projections, expectations, 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 risk and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. The risk 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 public periodic filings with the SEC. 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. 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 applications to prior periods or constant currency rate to sales. A table reconciling the GAAP information to the non-GAAP information is included in today’s financial release, which is available on our website. Now, I would like to turn the call over to Caren Mason, President and CEO of STAAR Surgical.

Thank you, Brian and good afternoon, everyone. I will begin our discussion with general commentary on the state of the business. Steve will then review key second quarter 2016 financial results, before we open the calls for your questions. Q2 2016 results signified solid growth and a broadening momentum for the company. For the second quarter, we achieved record net sales of $21 million and record ICL sales of $15.4 million. We also achieved record ICL units, which brought our total implant to ICL since introduction to well over 600,000 lenses. We are also pleased to report that the strategic priorities we have committed to achieve in 2016 are on track and delivering value to STAAR. I will spend a few moments highlighting our progress on selective key initiatives. FDA remediation and continuation of quality systems overhaul remains at the top of the list of our strategic priorities. The achievement of remediation and quality system plan commitments has submitted to the FDA and assuring that our global quality certifications are maintained remain as essential goals. In Q2, our internal goal achievement was on target. We expect not to exceed our remediation budget of $2.2 million for 2016. Two major areas of emphasis for the remediation plan and quality system builds include the acquisition of a new quality management system and building monitoring system. Both have been acquired and qualification and implementation is progressing well. Creating the visual freedom market for implantable lenses is an essential strategic priority and we have made great strides so far this year. STAAR successfully introduced its new global branding at the ASPRS Meeting in May as reported during our last earnings call. The evolution in visual freedom initiative includes the introduction of the new EVO + line of expanded optic ICLs to our international surgeons. We have received positive reports thus far and will be highlighting the surgeon and patient experience with EVO + at our ESCRS Meeting and the European Congress in September. One of our most prominent and prolific ICL surgeons implanted the EVO + lenses as the birthday gift for his daughter. He was compelled to write to us expressing in his words that father and daughter are both over the mood. The approval of our EVO lenses in Canada in mid-May resulted in our first EVO implant surgery in the North America which were well received with high surgeon and patient satisfaction. As we are anticipating the EVO Toric approval for Canada, we expect that the implant momentum will pick up in Q3 and especially in Q4. We are planning high profile digital and media campaigns for major markets in Canada in the months ahead. The global growth statistics regarding myopia which I have routinely shared and continue to update, now includes a new study regarding the rate of myopia in the United States. The Journal of the American Academy of Ophthalmology published a study in its June 21 issue and issued a news release announcing the publication of the study with the headline and I quote “nearly 10 million adults found to be severely nearsighted in the United States. Largest US study of this kind using the American Academy of Ophthalmology’s National Ophthalmic Database also finds women at a higher risk of blinding complications”. This study was conducted jointly by AAO, Genentech, NIH and UC Davis. Among the findings, nearly 9.6 million people in the US have high myopia at minus 6 diopters and above. This challenging statistics further reinforces the opportunity for their prescriptive and visual freedom value of our implantable Collamer lenses. The significant investment we are making in clinical validation and clinical utility, medical affairs expansion significant meta analysis of all published data, upgrading of our own safety and effectiveness database and continued expansion of our myopia implantable lens line including delivery systems is an intense news in anticipation of the essential pick up of the ICL as a premium and primary refractive vision enhancement and choice for surgeons and their patients globally. Significant strategic priorities for 2016, which also advanced during the quarter include the finalization of four additional strategic cooperation agreements in the Asia-Pacific region. These new partners are comprised of large clinics and hospitals which we anticipate will help to create a foundation for meaningful sales growth in the coming years. We now have six strategic cooperation agreements and several others are in development. These agreements include a strong collaboration with a strategic partner where STAAR provides certified surgeon training, marketing and pricing support, in exchange for specified unit growth of our products, as well as potential participation in our patient registry, clinical data and new product development efforts. We are very pleased with these transformational partnerships and what they can achieve for our partners, their patients and for STAAR. The clinical study agreements for our first in man implants at the presbyopic ICL were finalized and we are on schedule to provide lenses for surgeries scheduled during the third quarter. We will conduct a presbyopia working group with outstanding implant surgeons to continue to advice us regarding their requirements for the first bilateral presbyopic ICLs with EDOS or extended difficile. We plan to share and evaluate the findings from our first in man implants during this working group session. As previously announced, we have been reviewing the commercial fitness of certain cataract lens offerings and evaluating our approach to the cataract care market. As a result of these activities, we have decided to focus on Collamer IOL lens implants and to – manufacturing of our Silicone IOL products from the North America market. We will continue to manufacture and market our preloaded Silicone IOLs which have higher technological differentiation in overseas markets. Silicone IOL usage has been declining globally for years and market scope has forecasted that Silicone IOLs will garner less than 5% of global IOL units for 2016. Collamer material is proprietary to STAAR and is used in both our ICL and certain IOL lines. Key features of Collamer include, 20 years of proven history with over 1 million nanoFLEX Collamer IOL lens implants worldwide. Collamer is a biocompatible material inhibiting inflammatory responses to achieve a post-operative quiet eye. Collamer has inherent anti-reflection properties enabling sharper vision and less higher order aberrations. We believe there is growth potential for nanoFLEX Collamer IOLs as potential applications of Collamer materials for other cataract IOL technologies such as lenses for the treatment of presbyopia. Several Collamer IOL product expansion projects are under consideration, further elements of our cataract care strategy will be determined as previously discussed by the end of 2016. And finally, during the quarter, we strengthened our cash optimization strategy and increased our cash at the end of Q2 to $12.7 million. We are also pleased we have generated $2.5 million in operating cash flow for the quarter. I will now turn over the call to Steve for a review of our second quarter 2016 financial results. Steve?

Thank you, Caren, and good afternoon everyone. From my prepared remarks today and consistent with feedbacks from shareholders, I’ll touch on the more significant aspects of our second quarter 2016 results. I’ll start with a summary of the top-line results and then provide more details by product and markets. STAAR achieved record sales of $21 million in the second quarter of 2016, an increase of 12% over the $18.7 million of sales reported in the second quarter of 2015. The sales increase was driven by ICL revenue and unit growth of 26% and 18% respectively with strong double-digit unit growth in all of the Asia-Pacific markets and in Germany. These increases were partially offset by lower IOL revenues and lower injector part sales. For the first half of 2016, ICL revenue and unit growth was 17% and 9% respectively. For our ICL product line total sales were $15.4 million for the second quarter of 2016, increasing 26% from the prior year period with units increasing 18% compared to the prior year period. Asia-Pacific ICL sales were $8.4 million during the second quarter, an increase of 40% compared to the prior year period driven by strong double-digit unit growth in each of the region’s markets as follows: China increasing 48% as our strategic cooperation agreement helped drive growth, Korea increasing 32%, India increasing 17%, Japan increasing 81% and other Asia-Pacific territories increasing 17%. The ICL unit growth in region averaged 38% over the prior year quarter. EMEA ICL sales were $5.5 million during the second quarter, an increase of 16% compared to the prior year period due to unit growth of 20% in Germany, achievement of planned unit growth in the other European markets and Latin America and higher average selling prices. Overall, ICL unit decline of 2% for EMEA was impacted by a significant decrease in the Middle East that is expected to normalize in the second half of the year. North America ICL sales were $1.6 million during the second quarter, up 1% in revenue and down 9% in units from the prior year period. Unit softness can be attributed to the announcement of the Canadian approval of EVO lenses as surgeons chose to wait for the spheric and Toric availability and to the US military order now anticipated to be booked in August. For our IOL product line, total IOL sales were $5.1 million for the second quarter of 2016 and down 3% from the prior year period with units down 15%. The decrease was due to the phase out of IOL sales in China and silicone IOL sales in North America. IOL revenue in Japan, Europe together increased 14%. Turning the discussion now to margins and spending. Our gross profit margin was 69.7% compared to the prior year period gross margin of 66.3% or an increase of 3.4 points. This improvement resulted from a favorable mix of higher margin ICL units that added 3.7 points, higher average selling prices that added 2.1 points and lower ICL unit cost that added 1.2 points. These improvements were partially offset by higher IOLs and other product unit cost of 1.9 points and 1.7 points in higher other cost of sales attributable to an inventory reserve taken for the discontinuation of silicone IOL manufacturing for North America distribution. Operating expenses for the second quarter of 2016 increased $2.7 million to $16.8 million from $14.1 million in the prior year period primarily due to cost related to quality system improvements and investments made in the international selling and marketing organizations. General and administrative expense was $4.9 million and the change from the prior year quarter was not material. Marketing and selling expense was $7.2 million, was $1.3 million higher than the prior year period due to the investments made in international markets and the cost of direct selling in Germany. Research and development expense was $4.7 million, an increase of $1.1 million due to investments in quality system improvements, regulatory and clinical fairs and project-related spending, partially offset by lower remediation expenses. Remediation expense for the year was on budget. Now turning our attention to the bottom-line. The net loss for the second quarter of 2016 was $2.1 million or $0.05 per share, compared with a net loss of $1.6 million or $0.04 per share for the prior year period. The charges associated with the discontinuation of the silicone IOL product line totaled $426,000 or $0.01 per share. The higher net loss for the second quarter of 2016 versus the prior year period was primarily due to higher operating expenses and lower other income, partially offset by increased gross profit from sales volume and improved margins and a lower tax provision. On a non-GAAP basis, the adjusted net loss for the second quarter of 2016 was $936,000 or $0.02 per share, compared with adjusted net income of $167,000 or breakeven per share for the prior year period. These adjusted figures exclude non-recurring expenses such as FDA remediation expense, gains and losses on foreign currency transactions and stock-based compensation costs. Now turning our attention to the balance sheet. We continue to focus on optimizing our cash position through revenue growth, expense mitigation, working capital management and equipment leasing. These efforts yielded an increase in our cash at the end of the second quarter to $12.7 million, up from $9 million at the end of the first quarter of 2016. The company generated $3.7 million in cash during the second quarter of 2016, which includes $2.5 million provided by operating activities, $1.8 million provided by financing activities from capital leases and the proceeds from stock option exercises, $1 million used for purchases of property and equipment and $400,000 provided by the effective exchange rate changes on cash. This concludes my comments and with that, we are ready to take your questions. Operator, please open the line for questions.

Thank you. [Operator Instructions] Our first question comes from Raymond Myers of Benchmark. Your line is open.

Thanks for taking the questions and congratulations on a successful quarter.

Thank you.

If I could ask about the strength you had in Asia, particularly in China, was that related to these new partnerships that you’ve been signing? Or is that the underlying growth of the business that has been there?

It’s a combination that is definitely being led by the strength of the strategic cooperation agreement with Aier followed by the addition of other agreements that have been signed. But our success with Aier is beyond our expectations in terms of growth and I would say that, we are more than doubling our growth with them through the successful aspects of the partnership and we see the momentum continuing going forward.

That’s great and the growth in Japan of 81%, that was really high, what’s driving that one?

In Japan, we have had a resurgence, we actually added marketing and sales support in our Japanese business. We have signed a strategic cooperation agreement in Japan with a large clinic. Some of that came to fruition. We also have had some very nice growth in our IOL product line in Japan.

That’s all great. Now help us understand whether some of this resurgence is one-time stocking shipments or is this truly a new base that we can build from?

No, this is a base that we can build from and we are looking at other ways to expand our business in Japan as well. And so, as we get closer and have a determination of what those partnerships will be, we will speak to them. And just by the way, some of the strategic partners prefer to not have press around them or to be followed by our investors on a case-by-case basis. Where we can and we do get approval, we definitely will make sure that our investors understand how we are doing in these major new accounts.

That makes sense. Now shifting gears to the remediation budget. Is there you are on track and on plan there? Can you remind us how much you spend year-to-date in remediation?

Yes, sure, year-to-date, just to touch over $1 million.

Okay, so, about half way. Where do you expect that to trend there or maybe better said, at what quarter do you expect that to peak and when can we think about that expenditures starting to decline?

Well, at this point in time, we are not going to determine whether there will be continued remediation expense in 2017. As soon as we have clarity on that, we will make sure to release that information. But, our expectation on comfortable saying will be that in 2017 we will spend less than we have spent in 2016.

That’s great. Next, shifting gears to the silicone IOL discontinuation. How much revenues do you currently generate in the United States in that business? And I assume that’s all potentially to be less or how much do you think you can ship to Collamer?

Well, we will continue shipping the silicone through the end of this year. The business has been in decline and this year, it was only about $1 million.

In terms of the Collamer IOL, we are putting together an aggressive plan and actually slotting the Collamer IOL as kind of a basic plus entry into the IOL cataract market. We know it performs very, very well as we said, we had 1 million implants of this lens in the IOL patient Collamer material and our expectation is that by right pricing and right positioning the nanoFLEX, we will be able to put it in this place with much higher market share than we were able to enjoy with a declining material in terms of perception which is silicone.

That’s great. And then, remind us of the margin profile of the two products and they are just staying where they?

No, no, no, the silicone IOL had a surprisingly positive margin for in terms of the acceptance in the marketplace. It was profitable for us. Our expectation is that the advantage with the nanoFLEX, the expansion of the nanoFLEX and on a net basis, we will have more margin dollars from that product over the silicone.

Okay, good, good. And then, last on the regulatory front, you made a mention recently that you would – you requested a pre-IDE meeting of the FDA for the EVO ICL. Can you elaborate on that and just what is the implications of that request?

Well, fundamentally, the way it works to that, you have an opportunity should you choose to schedule a meeting with the Office of Device Exemption to speak to them about the parameters of what a clinical study would need to comprise in order to meet what they believe they need to understand about the safety and effectiveness of the EVO lens. So, we did submit a – what’s called a pre-IDE package and that package was accepted for review. We have had informal communications regarding a potential pre-IDE meeting with the Device Review Division and we understand that several issues should we go forward with the meetings could be discussed including even our manufacturing. So, at this time, we kind of limit our comments to just that, it is improvement for us to comment any further.

That makes sense. Thank you for taking the questions and congratulations on the great progress.

Ray, we look forward to the Non-Deal Road Show with you coming up in mid-August.

Okay.

Okay.

[Operator Instructions] Our next question comes from Jim Sidoti of Sidoti & Company. Your line is open.

Good afternoon. Can you hear me?

Yes.

Great. I am sorry, I missed the first part of the call, so I am sorry if am going to ask things that you’ve already said, but, in the past, most of the communication with the FDA has been pretty one-sided you reporting your remediation efforts to them and has that changed in the quarter? Have you heard anything back from them during the quarter?

We have not had any formal communications with the FDA regarding the warning letter or our remediation activities. No change there.

All right. And the presbyopia and you said in the press release you are going to begin shipments in the third quarter it sounded like. So does that mean that that product is approved?

No, no, no. Of that we have in our efforts as far as developing a presbyopic ICL which has to go through all of the evaluation process and clinical study et cetera going forward, what you want to make sure of is that the way that you’ve designed and powered the lenses in effect actually working in a human and so as a result of that it’s called first in man. So those first in man implants are usually very few and then you study the effects and make a determination whether you are at the point of design free, post. What you learned from that clinical evaluation. And so what we are saying is, we are far enough along now that we are ready for that testing as a lens.

Okay, so you start to go through a clinical trial?

Absolutely, yes.

Right, so it’s probably more like a 2018 kind of product. Is that the feel we can get?

Well, we don’t predict because there is so many moving parts. We were just really happy to be at this point.

Okay, all right. And what countries had the best growth for the ICL in the quarter? And then what prompted that?

Well, Japan had the highest growth, but it’s on a relatively small base. The strongest growth is in China where we…

How much was it up in China?

So, China, revenue growth as we recorded was – what’s the – in China alone…

48%.

Yes, 48% in China, Jim.

And is that with new agreements that prompted that or?

It’s largely driven by the strategic cooperation agreement we have with Aier. But it’s also our other businesses in China.

All right, and how was Korea?

The Korea business was also up 31%.

And is that attributed to some of the direct to consumer campaigns you were doing or any new agreements in Korea?

No new agreements in Korea. It’s just the business there.

Are you continuing with the direct to consumer campaign in Korea?

Well, if you recall, we weren’t conducting that direct to consumer campaign. Our distributor was doing that. And don’t know what the future plans are for the distributor, but currently, there is not the DTC that the distributor was running several months ago.

All right. Thank you.

Welcome.

Our next question comes from Chris Cooley of Stephens. Your line is open.

Good afternoon, Caren, Steve. Thanks for taking the questions.

Hi, Chris.

Just a couple for me, there is a lot of already been asked. Just, when I think about the growth in the quarter, really strong there of almost 12.5%. Help me think about the contribution to reported sales, both from the conversion of the German distributor to direct and higher ASPs that we started really in the first quarter in the Asia-Pac region? And then I’ve got one other follow-up.

Sure. In the quarter, for Germany, revenue growth for ICLs was up 132%. The unit growth was up 20%. So it was – in Germany, both a combination of good unit growth and also the distributor to direct conversion.

And higher ASPs in Asia-Pac?

Yes.

Yes, Asia-Pac in total, higher ASPs but as we reported strong unit growth in Asia-Pac.

But I guess, I am – if I heard you probably not willing to teeth out kind of a contribution to growth in pricing versus underlying volume.

Well, if you look at Asia-Pac, and I give it to you for the quarter, we had a overall 40% increase in ICL units – I am sorry 38% increase in ICL units, a 40% increase in sales. So it was mostly unit growth in Asia-Pacific.

Okay. And then just lastly noticed that looking at the balance sheet here, inventories came down sequentially. Just curious if you could give us an update, I remember in the prior quarter’s call, you had an IOL pullback there from a quality standpoint. Has that issue been resolved with those shipped or are those still, maybe just give us a general update there?

Well, actually, it wasn’t quality-related. We had a silicone IOL hold. We were making a determination going forward of what we wanted to do with the line in terms of reinvesting for additional equipment and revalidation of that equipment for the silicone IOL line and made the decision not to go forward. So that was today’s announcement. In terms of billing, all of those units that during our manufacturing timeframe pre-August of last year that are in inventory as well as consignments that we are collecting and then redistributing as we can. All of our inventory we expect to move out in the silicone IOL by the end of December for the North American market.

Okay. And – I’ll go back, I have to look at that. And then, I guess, just lastly from me on first in man, can you give us a little bit more color just in terms of maybe the total number of – obviously the first to man is the first, but will this be a set of five bilateral implants, ten, and just kind of give us an idea of maybe where this begin or occurring and kind of the initial follow-up period there? And then I’ll get back in queue. Thanks.

We do have two international locations where we plan to conduct our first in man studies. We are going to start with one of these locations by the end of the third quarter. We do have multiple patients that are being signed up and then as we go through on a consecutive basis, assuming that those first implants are successful are performing as we expect, we would continue on until we complete. So, fundamentally, you could talk about five patients, ten eyes, ten patients twenty eyes. It just really depends, but the protocol is very strict and stringent and the testing that we want to do not only in terms of the way that patient is prepared for the implant, but the procedure itself, we have a very successful surgeon who has a very great track record. And remember that the Presbyopic ICL is really EVO being powered with EDOS for a Presbyopic multi-focal experience. So, we also have the post-implant study where you need to determine, have we prepared this patient for what the new experience will be at all three correction levels and what was their experience post. So this is very critical and an important process for us. And we are really looking forward to the results which as I said in my prepared remarks, we plan to share with some of the most prominent refractive surgeons globally who sit on our Presbyopia working group to share the results with them.

Understood. Thanks so much.

Thank you, Chris, very much.

[Operator Instructions] I am showing no further questions. Like to turn the call back over to Caren Mason, President and CEO of STAAR Surgicals for closing remarks.

Operator, I think, we do have one person in queue.

We do have one question from Brian Weinstein of William Blair. Your line is open.

Hi, good afternoon. This is Matt Larew. I appreciate you sneaking in. First, I just wanted to ask about EVO + have been launched in Europe, with the first launch in April in Spain I think, and then ongoing other geographies. Just wondering, Caren if you could maybe let us know if there are particular geographies where you are seeing lot of success with that launch?

Yes, the initial countries in Europe, Spain, Italy, Belgium, et cetera very good results and we’ve had some implants in the Middle East. We expect to open up Korea soon. And the feedback has been extraordinary. We are very excited about EVO + and the rejuvenation opportunity for example in Korea which we talked about earlier. We believe with our distributor who is equally excited that Korea will especially benefit from having this larger optic zone which also helps with any nigh aberrations et cetera associated with halo and glare. So there is a really great opportunity for us, I think with EVO + and we are real pleased with our initial rollout.

Okay, thanks. And then, just one more for Steve on gross margins, obviously, some pricing benefit, but also better since what you guys are doing internally led to nice sequential growth there. Should we expect that same level of sequential growth throughout, you obviously that the guide initially was to move up throughout the year, but if you can just help us with how to think about sequential gross margins that you are getting with what you guys are doing?

Well, we continue to expect the gross margin expansion and it’s going to come from the favorable mix to ICLs and there is still yet some to come from quarter-over-quarter prime. And also, this is now the fourth straight quarter that our ICL unit cost have gone down quarter-over-quarter.

Okay, that’s all for me. Appreciate it. Thank you.

Thank you, Matt.

Okay, I’d like to close the call operator. I would like to thank everyone for their participation on the call today. One final note, during the third quarter, we look forward to attending the Canaccord Genuity Growth Conference in Boston and Non-Deal Road Show scheduled in Salt Lake City in the Midwest. We appreciate your interest and investment in our company. All the best to all of you.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.