IRIDEX Corporation (IRIX) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to IRIDEX Corporation's Third Quarter 2012 Earnings Release Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, November 1, 2012. I would now like to turn the conference over to Mr. Will Moore. Please go ahead, sir.

Thank you. Good afternoon, and thank you for joining us as we discuss the results for the third quarter of 2012 and other recent developments at IRIDEX, including the recent changes at the company and the resulting shift in priorities and directions for the long term. My name is Will Moore and I'm the Chairman of the Board and Interim CEO. Today, I'm joined by Jim Mackaness, our CFO and COO. Before we get started, Susan Bruce, our Executive Administrator, will read the required Safe Harbor statement.

This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Act of 1934 as amended relating to the company's growth strategy including acquisitions, the success of the company's marketing and sales efforts, MicroPulse laser therapy, technology investments and strategic relationships, global and domestic market conditions, health care spending, market direction and trends, product demand and market acceptance of new products, gross margins, operating expense control, profitability, the company share repurchase program and the company's financial outlook and performance in 2012 and future periods. These statements are not guarantees of future performance, and actual results may differ materially from those described in these forward-looking statements as a result of a number of factors. Please see a detailed description of these and other risks contained in our annual report on Form 10-K for the fiscal year ended December 31, 2011, and quarterly reports on Form 10-Q for the quarterly period ended March 31 and June 30, 2012, which we filed with the Securities and Exchange Commission. Forward-looking statements contained in this conference call are made as of the this date and will not be updated.

Thank you, Susan. And since this is my first earnings call as Interim CEO, I will begin with a few words of introduction related to my background and my experience at IRIDEX. Jim will then walk through the operational and financial highlights for the quarter, and I will wrap up with some commentary about specific plans at the company moving ahead. My background is more than 30 years working at or with medical device companies such as Johnson & Johnson, Nellcor and Natus Medical. My role with these companies has generally been sales and marketing. As a cofounder of Natus Medical, I helped to assemble the operation of commercial organization of the company, and the company has grown from inception to revenues of greater than $200 million, with a market cap of more than $300 million. And I have served as a board member at a number of additional medical technology companies where I've helped management to focus on delivering results and value to shareholders. I first became involved with IRIDEX in 2007 when I joined the Board of Directors, and in 2011, I became Chairman of the Board. In initial years, the company was in survival mode, digging its way out of financial distress brought on by an acquisition completed prior to my involvement that nearly bankrupt the organization. Management, including Jim, did a marvelous job rightsizing the operation, conserving and then producing cash and finally emerging as a debt-free growing and profitable organization in 2010. I see IRIDEX, today, an opportunity to unlock significant value, and thanks for the efforts of success of management without the high level of risk we saw 5 years ago. In August, the Board of Directors acting on the interest of all shareholders determined that a more focused approach was needed to unlock this value and appointed me to the role as Interim CEO to implement a number of important strategic and operational realignments of the company. These realignments include the elimination or reassignment of several senior executive positions. These personnel change had been accompanied by an assessment of the company's revenue and spending plans in order to give priority to investments that have the potential to deliver significant near-term shareholder return. The combination of changes was designed to improve performance and accountability at all levels of the organization. The company's products, brand, employees and sales channels are valuable assets. What is needed is the clear path to taking advantage of these assets while running the business in a dependable, profitable and predictable fashion as we move forward. This is the basis what Jim and I have already set in motion as of this call. I will give a few more specifics before we conclude our prepared remarks, but in general, going forward, we plan to deliver shareholder value in 3 principal ways. First, we will return the company to profitability and operate the business at a profitable fashion going forward. Many of the adjustments necessary to deliver on this objective have already been implemented. We will continue to review and eliminate unproductive cost at the company, focus our investments until we get the greatest returns and reenergize the commercial organization to meet this goal while growing at a rate that is greater than the market. Second, we'll take advantage of our strong position in the market to be an opportunistic in acquiring or partnering with ophthalmic companies that have developed new technologies or products that will benefit from leveraging the IRIDEX's sales channel. Third, we will deploy cash from our strong balance sheet and profitable operations to directly benefit our shareholders through our share buyback program. We are exploring all avenues open to the company to make the ongoing buyback program more effective. We believe our buyback represents a direct way to deliver value to those who hold the stocks while keeping plenty of cash available for investments in development and acquisitions that make sense. I would now like to turn the call over to Jim who will fill you in on the operational and financial highlights for the quarter. Jim?

Thanks, Will. Just to remind everyone, in the first quarter of this year, we sold our Aesthetics business to Cutera, and therefore, we are presenting our results for our continuing ophthalmology business. Revenues for the third quarter 2012 were $7.9 million, down 4.8% from $8.3 million for Q3 2011 and down 6.0% from $8.4 million reported for the second quarter 2012. System sales for Q3 2012 were at $3.7 million, down from $4.2 million for Q3 2011 and down from $4.0 million for the preceding quarter. Last year, we commented that our international system sales benefited from strong sales in Turkey which should not repeat this year. In addition, we saw softness in the Middle East and South America. However, domestic system sales were up modestly over last year and Q2. And approximately $100,000 worth of orders were held over at the quarter end due to certain part shortages. Recurring revenues for the third quarter 2012 were $4.1 million, representing 52.3% of our total revenue. This is up $0.2 million or 5.1% from Q3 2011, but down $0.3 million or 7.3% from $4.4 million reported for Q2 2012. For our retina consumables, we are benefiting from the ramp up in sales from our distribution partner, Alcon, who are benefiting in the increase in sales of our glaucoma consumables, driven in part by the launch of recent marketing projects. Gross margins were 49.6% for the third quarter 2012, reflecting an improvement from 48.3% at Q3 2011 and from 48.7% in the preceding quarter. We were pleased to see our margins improve even though our revenues were lower. Our direct margins improved. And although as a percentage of revenues, our manufacturing and service expenses increased over last year, this was the result of the lower revenues. In absolute dollar terms, our expenses in these areas reduced, which is the direct result of a number of manufacturing efficiency programs we have mentioned previously that we've put in place. And therefore, we feel comfortable being able to achieve our short-term target for gross margin of 50%. Excluding onetime severance expenses of $0.7 million, operating expenses were $3.8 million for the quarter, up from $3.7 million for Q3 2011 but down from $4.5 million for Q2 2012. These results reflect Will's earlier comments about focusing our spending plans on near-term opportunities. Including the onetime severance expense, we did generate a loss from continuing operations of $0.6 million or $0.06 per share compared with income from continuing operations of $0.3 million or $0.02 per share last year and income of $0.4 million or $0.04 per share in Q2 of this year. With regards to discontinued operations, we booked a loss, net of tax, of $0.2 million in the quarter, which is primarily the result of the tax provision which is adjusted each quarter to trade-off on a year-to-date basis. Looking to the fourth quarter of fiscal 2012, we're projecting revenues between $8.4 million to $8.7 million, gross margins between 49% to 51% and operating expenses between $4.0 million and $4.2 million, and anticipate generating operating income. Please note that our fourth quarter has additional marketing expenses attributable to our attendance at the American Academy of Ophthalmology, which is our major trade show of the year. And also is the onetime expenditures we are incurring to ensure we are ISO 60601-compliant, which is the new quality standard our products have to meet. On a final note, we've continued to execute on our stock buyback program. Our trading volume has been ticking up of late, and this has allowed us to participate. For Q3, we repurchased 76,000 shares at an average price of $3.65, bringing the total number of shares repurchased through Q3 to 241,000 at an average price the $3.82. And with that, I'll turn the call back over to Will.

Thanks, Jim. As I mentioned earlier, I would be giving some more detail around our plans. During the next several months, our revenue growth will remain our top priority. Therefore, we'll be focusing on the following areas to make improvements. First will be in sales. Together with Eduardo Arias, VP of Global Sales, I'm going to be spending time in the field with our representatives to make sure that we have the correct distribution model. Second, in the area of product development, expectations and reality are out of alignment, so Ken Peartree has taken on the role as VP of R&D and would be bringing a new business approach to the department. Third, in marketing, MicroPulse is reaching a tipping point so I'll be spending time with Tim Buckley, our VP of Marketing, establishing new approaches generating pools to make sales representatives more effective and efficient to create a new standard of care. Four, M&A. With the state of the D.C. and capital markets for emerging medical devices, we will have an opportunity to use our balance sheet to acquire small companies. And to improve performance and accountability by the end of the year, we will have eliminated 3 VP positions and 1 director position. As a consequence, we'll have 1 VP responsible for each functional area, making it easier to understand who is responsible, thus reducing inefficiency and even costs. With that, I thank you for bearing with us and for spending a lot of time, extra time, going through our strategy. So at this point in time, I'd like to conclude our prepared remarks and open the call for questions. Operator?

[Operator Instructions] Our first question is from the line of Joe Munda with the Sidoti & Company.

Real quick. I got a couple of questions for you. Will, do you prefer Will?

Yes, it is.

Okay. Will, how is the search for the new CEO going, and how long do you plan to -- any plans to step in a full-time role? Or are you just kind of locked in as the interim?

There is no search at this point in time, and I'm the Interim CEO and will be serving as long as the board believes it's the right thing to do. I'm not the permanent replacement on a long-term basis, but at this point in time, there's no search.

Okay. In your prepared remarks, you were talking about looking for new partnerships in the space. Is there possibility to expand on your relationship with Alcon or a possibility of a partnership with, let's say, a small company like Synergetics or even CooperVision. Is that the type of partnerships you're looking for?

Yes. I think it's fair to say we do enjoy relationship with Alcon. We're certainly open to continue to explore broadening that. And you mentioned couple of other good players in the market who we think -- there's always opportunities if we can find commercial reasons to hook up where it makes sense. So that's the right sort of target list, yes.

Okay. I missed the part on right before you were talking about softness in the Middle East and South America. What -- sales decline because of Europe. Is that mainly the main factor? I'm sorry, I got cutoff there.

Yes. On the system sales, domestic was modestly up. The weakness we saw was international.

What was the domestic number? Do you guys break that out?

Yes, it's in the Q. It's about 1.65, I think, from the top of my memory. And so the weak was international. A couple of different components there. As we mentioned last year, we actually benefited from a strong order out of Turkey, so the classic lumpiness that we sometimes face with our distributors sort of came back this time of the year because we didn't see a repeat order from Turkey of that magnitude. So that was one effort. We did see a little bit of weakness in the Middle East and South America where we had been running quite strong previously.

How much of the Middle East is your, let's say, percentage of revenue?

We don't typically get into that order of magnitude. I would say it's fair to just probably -- overseas, it's probably 1/3 or 1/4 down, Europe being one of the bigger ones.

Okay. And is it just because of the situation there with the deterioration and what's going on that you're seeing softness there? Or is it more -- why is there softness in the Middle East?

I would attribute it to debt being settled. A lot of the areas are in turmoil, and therefore just the placing of orders and who you're dealing with is changing.

Okay. And do you break out the growth of the consumable sales number? You guys didn't release the Q yet, right?

Q is being filed as we speak. It will go through the XBRL machine and probably show up on the SEC early next week, by the time it gets out the other side. We do -- we aggregate our recurring revenues, and I think I commented that they were about -- I'm looking back at my comments -- 52.3% of revenues overall and $4.1 million.

And it seems in your guidance, you seem to be thinking gross margin is going to be trending up. What is leading you that assessment?

Well, as we mentioned in the prepared remarks, we have been putting some efficiency plans in place in the operations, so we're seeing a reduction in absolute dollars. And as we expect our revenues to be in the 8-point something range for Q4, we would expect that to help. And also there are various things that are happening within the direct margins which are trending positive.

Okay. Is that an ERP system that you guys are putting in place? Is that what that is?

No, nothing of that magnitude. A little bit more of just sort of working through our procedures and policies and just trying to make sure we have much more single touch as opposed to repeat touch wherever possible, which just reduce -- ultimately reduces a little bit of your personnel cost over time, temporary workforce, those types of improvements.

I just have a couple of more. Tax rate going forward, how should we model that? What do we -- I mean, what should -- what could be a baseline rate to look at?

So going into next year, there's a couple of things we have to bear in mind. So we would expect the tax rate in the P&L, initially, I would suggest to be a more normal tax rate in the high 30s. However, under the presumption that we keep the valuation allowance against our deferred tax asset, we would actually probably expect that the net number in the P&L will actually come closer to the low single digits. If you recall, I'm not sure how close you've been following us, but we have incurred a large NOL as a result of the sale of the Aesthetics business, so our cash tax is effectively going to be 0.

Okay, got you. And that leads me to my next question, how are you guys going to account for the med device tax assuming that everything goes as planned? How -- is that come into cost of goods?

Yes, if it comes in, it will basically have to sharpen in that area.

Is that in your forecast? Or is that something that as we come to it, that's something -- I don't know...

As we get closer, we may -- you may hear me making specific comments as to how it will impact us. I think, at this stage, we're all a little fuzzy on what this is really going to be.

Yes, you and everybody knows.

Yes, exactly.

I have just 2 others. What was CapEx to the first 9 months?

CapEx to the first 9 months was approximately $300,000.

Okay. And then the depreciation and amortization, do you happen to have that number?

That looks right off where I'm looking at, about $300,000.

Our next question is from the line of Stan Mann [ph] with Mann Family Investors [ph].

I have several questions. One, on your buyback plan, it's always been pretty difficult to by any large quantity of stock as we all know. But you did a crapulous [ph] buying of significant amount in the third quarter. So can you state or indicate where you would get that large quantity? Is it from a some holder or founder or blue line? Can you share that with us?

Sure. For Q3, this was -- we do have, as you mentioned Stan, we definitely have -- we have brokers active, tries to be in the market every day. And this really was just a fact that our volume has been ticking up. And so it just meant that, on a day-to-day basis, we have been able to move our participation up. So it's just the aggregate of being in the market on a repetitive basis. It is not attributable to any significant 1-block, 1-person, 1-entity sale.

Okay. Second question is you got available liquidity for, I don't know, 800,000 shares. And it seems to me that, that would be a very difficult task to accumulate over the time allocated. I mean, you've got $3 million left on your buyback. Can you speak to if there is some secret or way you're going to acquire that kind of volume?

I don't think there's any secret. You're absolutely right. We've been very disadvantaged, if you like, by the volume restrictions in the SEC in the past. Obviously, to the comments we just made, we've seen that improved. We do actively try and get the message out that if anyone is interested in selling blocks or shares should approach the company, so we'll continue to aggressively look at all the avenues to try and make sure that we can take whatever shares are available at the price we think makes sense and complete those purchases.

Okay. My next question is simple. You're looking for M&A or acquisition opportunities as I hear it. Are you using a professional search source, a paid source for the M&A? Or is it just a random tradeshows, et cetera?

Stan, this is Will. No, we're not using a professional source. And no, it's not a random process of doing so. I think there's a substantial disconnect today in the way people are financing their companies that are small. And we happen to have a very strong brand and people do call. They have ideas and products. They've been able to get them up, and maybe they have the FDA but they can't get the financing to the venture capital markets or private equity world. And they're looking for liquidity and they're looking for distribution channel.

But that's not an existing company with an existing sales volume.

That's correct.

Okay. So it's not a significant use of our capital? So we have $13 million, less $3 million possible but $13 million available. Do you see a use for that near term, the possibility of accretively using that near term?

That would always depend on time. I really can't answer the question, Stan. There will be companies out there. We'll take a look at them and we'll evaluate it, and we'll use what cash we believe is appropriate for the right transaction. But to say, anything else is impossible at this moment.

I hope it means something is in the oven. So my last question is would we be amenable to a sale of IRIX at a reasonable price?

I didn't hear. What was the first part of the question?

Would we in the board and the management be amenable to an acquisition approach of IRIDEX at reasonable price?

I think the answer to that is always yes. We will do what is in the best interest of shareholders.

Okay. So that's a possibility and nothing is occurring that we should know about?

Nothing is occurring that you should know about. And it's always been the case.

Okay. Just seems like we've got quite a struggle, I guess, significant. But hopefully something will happen.

[Operator Instructions] Our next question is from the line of Will Nasgovitz with Heartland Advisors.

I was just hoping you could elaborate on your comment that MicroPulse is at a tipping point. There was some discussion of it in the press release over the last 9 months. If you could elaborate on that, that would be great.

All right. So whenever you're looking at, the term tipping point to me is simply when you reach a level of usage that makes it difficult for positions that are not using it to really continue down the current path. For example, if I have 2,000 retinal specialists in the U.S. and all of a sudden I end up with 400, 500 that are using MicroPulse and are getting outstanding results. And someone does not use MicroPulse and end up with a situation where patient does not get the same benefit. They're at risk. And that's kind of how you start to move down to the standard of care. When we start approaching 150, 200 physicians, we are starting to reach a level that says we need to do a bit more because over that horizon. And if you think about it, well, it's kind of like being familiarized [ph]. If you think about -- being in canoes, they kind of rock back and forth. And if you can get that little ridge out of the water, it flips over. We're rocking the canoe at the moment. It's been 10 years of work with this, the clinical studies are supporting what we're saying, and we're getting traction both in the U.S. and outside of U.S. So for me, spending money to accelerate that process with more users will only benefit the company.

Can you perhaps update us on what the market opportunity for this product might be for the next 3 to 5 years?

Well, typically the way we look at it is we say that if you look at the expenditure on the system side of the equation, you got something like $150 million to $200 million spent on an annual basis. And historically, you could peg that there's the replacement cycle because it's predominantly replacement-driven, somewhere in the 7 to 8 years. So the other way of looking at what Will is saying is we're trying to get that tipping point to basically people are forced back into the market earlier because they don't want to get left behind. And so when you do the back of the envelope calculation, it sort of say, hey, if we can shorten this 10-year replacement cycle to somewhere like 5 or 4 years before people get back in the market, you can see that, that could make the market grow somewhere upwards of $20 million to $50 million on an annual basis. This is out in the years 3, 4 and 5. So we got to get that tipping -- we got to get those people moving over, have that impact replacement cycle. And as that replacement cycle shortens, anticipate that the market size for laser systems will increase significantly. And then obviously, we have to be in the position to capture that and win that market share to us to drive our revenues.

Great, that's good color. You mentioned the upcoming conference or perhaps it's already past. Is there going to be further research published on the product at this conference? Or was there research published?

I think definitely we can take this offline. You probably would be very interested in -- we have a speakers forum where we have a lot of physicians who will be speaking. And I think, off the top of my head, but we can look at it, you'll find that the majority of the talks happening at speaker forum relate around MicroPulse.

And Will, the answer is the show is coming up in another week.

And our next question is a follow-up from the line of Stan Mann [ph].

Obvious question, but do you have any near-term plans to expand your sales, direct sales force? And also, what is the size of our direct sales force?

The answer to your question, the first one is no. The size of the sales force is 12 in the U.S., augmented by another 4 outside the U.S., plus distributors. As I said in my comments earlier, I'm going to be spending time in the field looking at the distribution channel and understanding what is the right model. When you have a company where sales are flat and you need to get out to figure out what the issues are, and that's what I'll be doing. So hopefully in the next call, we then have better answers for you.

And I'm showing no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Okay, well, we just like to thank everyone for joining us on this earnings call, and there will be playback information for those who are interested. Thank you very much.

Ladies and gentlemen, this concludes IRIDEX Corporation's Third Quarter 2012 Earnings Release Conference Call. If you'd like to listen to a replay of today's conference, please dial (303) 590-3030 or 1-800 406-7325 with the access code of 4572831. ACT would like to thank you for your participation. You may now disconnect.