IRIDEX Corporation (IRIX) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the 4Q '12 Earnings Release Conference Call. [Operator Instructions] This conference is being recorded today, February 28, 2013. I would now like to turn the conference over to Will Moore. Please go ahead, sir.

Thank you, George. Good afternoon, and thank you for joining us as we discuss the results for the fourth quarter and full year of 2012. My name is Will Moore, and I'm the CEO at IRIDEX, having taken the role in the last fall -- or the fall of last year. Today I'm joined by Jim Mackaness, our CFO and COO. Jim and I will both be delivering some prepared remarks related to the quarter and the business, then we'll open the floor for questions. But before we get started, Susan Bruce, our Executive Administrator, will read the required Safe Harbor statement. Susan?

This conference -- thank you. 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 and technology investments, OEM revenues, global and domestic market trends and conditions, health care spending, growth margins, operating expense controls, share repurchase program, product strategy, including demand and pricing, and the company's first quarter revenues. 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 the quarterly reports on Form 10-Q for the quarterly periods ended March 31, 2012, June 30, 2012, and September 29, 2012, each of which are filed with the Securities and Exchange Commission. Forward-looking statements contained in this conference call are made as of this date and will not be updated.

Thank you, Susan. I'm pleased to begin this afternoon by saying we had a very good fourth quarter. Our $9.2 million in revenue for the quarter is a record for IRIDEX in terms of ophthalmology sales, which is a testament to the work of our entire team and a great way to finish the year. I'm also pleased to report that much of that momentum is carrying on into the first quarter of 2013, and sales continue to track well, both domestically and internationally. So we feel very positive about some of the recent changes in the directions we're taking as an organization. As most of you know, I have now completed almost 6 months as CEO of IRIDEX, and I believe we have made important strides in our most immediate goal for this company. First, changing its basic DNA. We have been shifting the clinically-driven scientific company of the past to a customer-focused, commercially-centric company. This is how we will unlock potential in the value that so many of us believe is inherent in this company. We have an established and emerging product line to target large and growing markets. Our focus now is on taking advantage of the value of assets we have here, while at the same time running the business in a profitable and predictable fashion moving forward. During my first call as CEO at the end of the third quarter, I laid out 3 principal ways we plan on delivering value for our shareholders. Today, I'd like to review each one and comment on the progress we have made. First, we promised to return the company to profitability and operate the business in a profitable fashion going forward. As I've already mentioned, we are making great strides on growing our top line revenues. Now we need to do a better job on increasing our gross margin, in part by focusing on our supply chain and eliminating unproductive costs as well as improving pricing discipline. I can tell you that we already made great strides in these efforts as well. We have eliminated several positions and significantly cut our operating expenses, the effects of which will begin to show throughout the year. As a consequence of this streamlining, I also believe we have improved our decision making. By breaking down the silos here at IRIDEX, we are now a flatter, leaner company with a much better internal reporting process. This allows us to make better, much more rapid decisions based on current data, which are important achievements on our way to fulfilling our goal of being a more commercial-centric company. Second, we promised to take advantage of our strong position in the market, to be opportunistic in acquiring or partnering with other companies that have new technologies or products that will benefit from reaching more established sales channels. I can say that we aim to be active in this area and have initiated the discussions with more than one additional partner. We do not intend to rely on one key distribution relationship, nor do we believe that we need to make numerous or large acquisitions to drive growth and leverage our commercial position. Anywhere we see an opportunity that can deliver value to the organization, whether it be a license agreement distribution or it's a sensible acquisition, we will act. Third, thanks to our strong balance sheet, we promised to explore all avenues that would directly benefit our shareholders through our share buyback program. As most of you know, we successfully executed a tender offer to buy back IRIDEX stock in the fourth quarter, and we are very pleased with the success of that project and at adding [ph] -- delivering shareholder value. The original plan ran for 2 years and allowed for $4 million to be invested in stock repurchase. That has expired. Today, we announced a new plan for 1 year that will allow for up to $3 million to be invested in our stock. We view this as an example of how we wish to execute on multiple options to return shareholder value. Now I'd like to turn the call over to Jim, who will fill you in on the operational and financial highlights for the quarter and the year. When he's finished, I'll return and make some closing remarks. Jim?

Thanks, Will. Just to remind everyone, in the first quarter this year, we sold our aesthetics business to Cutera. And therefore, we're presenting and commenting upon our results of our continuing Ophthalmology business. As Will indicated, we had a strong 2012 fourth quarter as revenues reached $9.2 million, up 7% from $8.6 million in Q4 2011 and up sequentially 17% from the $7.9 million reported for the third quarter 2012, as this represented a record revenue quarter for our ophthalmology business. Of that total revenue, system sales for Q4 2012 were $5.0 million, up from $4.4 million in Q4 2011 and up from $3.7 million in the preceding quarter. Sales were strong across all geographies but especially in the U.S., where we were candidly surprised at the robust response to the special promotion that is a traditional part of our AAO program. For the year, revenues were $33.9 million. And due to the strong fourth quarter, we were able to show a modest growth in revenues over 2011 revenues of $33.2 million. And so we feel we're exiting the year with momentum. Recurring revenues in the fourth quarter 2012 represented the balance of the revenues, or about 45%, which is down as a percentage from prior quarters simply due to the strength in system sales. And as Will indicated earlier, we're looking at a number of additional means of getting additional consumable products to market, both directly and via partners. For the year, recurring revenues were 50.4% of total revenues for 2012 compared to 48.8% of total revenues for 2011. Gross margins were 47.0% for the 2012 fourth quarter, down from 49.6% from both the preceding quarter and last year's comparable period. The majority of the margin impact was the result of the product mix with the growth in system sales and compounded by an especially high number of IQ532 systems sold at promotional prices during this year's AAO conference. And we did see some increase in cost of goods that we're addressing as we speak. With the market strengthening and the value of MicroPulse being recognized, we expect to have more pricing leverage going forward. That and continued work on our cost structure and manufacturing process makes us confident in being able to reverse this dip and achieve gross margin that's closer to 50% by year end, subject to how weighted towards system sales we'll remain. Gross margins for the whole year 2012 were 48.3% compared to 49.1% for 2011. Operating expenses continued to trend in the right direction as we came in on target at just about $4 million in the period, allowing us to generate a net income from continuing operations of $0.3 million, or $0.03 per share, reversing a loss in the 2012 third quarter of $0.6 million. Net income from continuing operations was down from the prior year period in which we posted a profit of $0.8 million, but it's worth noting that we did receive a onetime payment of $1.3 million from Alcon in the prior year period that void those results. Looking to the first quarter of fiscal 2013, we are projecting revenues between $8.7 million to $9.0 million, gross margins between 47% and 49%, and operating expenses between $3.8 million and $4.0 million and anticipating generating operating income. We have also received $0.5 million in the form of a distribution payment from an insurance carrier in the current quarter, which will benefit our earnings for the period. From an operations perspective, the last 6 months have been a period of change in the company, as Will has indicated. And having assumed the COO mantle in the second half of the year, I thought it would be appropriate to amplify some of Will's comments and highlight some of the changes we have made to the organization. We have eliminated 4 VP-level positions at the company in the last past couple of months. And that's not simply a cost-saving exercise but a true structural streamline. The marketing and R&D groups have been consolidated from organizations that contains different silos to single organizations and each function reporting to a single leader. And it's worth noting that 4 of the 7 executive-level positions that we have today are filled by someone that has joined the company in the last 2 years. These changes have resulted in a more nimble organization able to make decisions more rapidly and take more direct responsibility for success and failure of decisions. One visible example of these changes is the way our website and our other marketing materials now focus on the many reasons for our customers to purchase IRIDEX products instead of purely presenting a clinical focus of what our products do. The new structure and mindset have led to lower costs overall. But more importantly, we believe we are well positioned to take advantage of the early but growing tailwinds that we are beginning to see in our core market and to more rapidly take advantage of partnering in new product opportunities that emerge. On a final financial note, as Will mentioned, in December, we completed our tender offer and repurchased 487,500 shares of our common stock at $4.10 a share for a total investment of $2 million. As a result, our outstanding common stock reduced from $8.9 million to $8.5 million. The 2-year program has expired, and today, we announced that the board has approved a new share buyback program that allows us to invest up to $3 million in the forthcoming year. We remain committed to explore multiple opportunities to return shareholder value, including stock buybacks and tuck-in acquisitions. And with that, I'll turn the call back over to Will.

Thank you, Jim. As I promised our team when I came on board as CEO, I would spend a lot of time in the field talking directly to our customers, suppliers, partners and other sales -- and our sales team. I wanted to personally hear their thoughts about the marketplace and needs in terms of products and services. But I also wanted to emphasize personally to our partners the changes we are making here at IRIDEX, shifting to a more customer-centric and market-driven enterprise. We now have a more project management mindset in our operating company. We are making better and more rapid decisions with things like outsourcing development projects, that make sense from skill sets and match and -- financially. Our goal is to develop and create technology-advanced products and then be able to bring them to market more quickly and efficiently. We believe this new mindset will play out particularly well in the health care environment we have today. Because of the Affordable Healthcare Act, physicians today are more concerned and focused on overall cost. Diabetes and the subsequent onset of diabetic macular edema, or DME, is a case in point. The number of people that have diabetes for 10 years or more is increasing rapidly, and virtually all of these will develop DME. As you may -- as many of you may know, the pendulum in recent years had swung to drugs away from traditional lasers to treat conditions like DME. But we believe that with the passage of time, the shortcomings of relying on drugs as a simple panacea is all -- are becoming more and more apparent. And thanks to new payor restrictions in some geographic areas and new therapies like our proprietary MicroPulse technology, the pendulum is beginning to swing back. Basically, you can't afford to rely solely on expensive drugs and multiple doctor visits to treat DME on a going forward basis. Furthermore, our MicroPulse-based products and therapies will demonstrate that they are not only safe without side effects, yet with similar outcomes, but more cost-effective and efficient, thus providing a better solution today's -- in today's economic environment for many of our serious ophthalmologic conditions like DME and glaucoma. The promise of our products is particularly true in some of the emerging countries of the world. In India, for example, the rate of diabetes per capita is higher than ours in the United States, and the number of people who can now afford medical care like we offer is absolutely huge. On a recent field visit to a prestigious university, I was informed that our MicroPulse-based products, due to their safety and simplicity, are now taught to residents prior to teaching them drug injections. This is a major shift. And as Jim mentioned earlier, a shift in trade winds that will give advantage to our MicroPulse technology. The reduction of the anxiety to provide therapy that can -- at a reduced cost is exactly what is needed to solve this exploding diabetic edema problem on a global stage. In short, today, the trend or trade winds are shifting as they become a tailwind as the market will move to our solutions. More than any other time at IRIDEX's history, we are ready and have an efficient and competent IRIDEX team to capitalize on opportunities provided by these prevailing winds. With that, I'd like to thank you for tuning in and listening to the call and for your interest in IRIDEX. And at this point, I'll turn the call over for questions.

[Operator Instructions] And our first question comes from the line of Joe Munda with Sidoti & Company.

Real quick, you talked about stripping some costs out of the manufacturing side or the cost of goods side. And judging by your guidance, you expect that to be in the 47% to 49% range. I was wondering what those costs may be. And how should we look at gross margin going forward for the year? Are we going to see it steadily improve? Or is it going to be in that high 40 range?

Yes. This is Jim, Joe. Will and I are in different locations, so we have to steer clear of the traffic cop.

Oh, okay.

But I'll step in and have a first swing and then Will can comment as well. Yes, I think to your point, we've guided 47% to 49%. We have indicated that we think towards the end of the year, we'd like to get back to our short-term target, which was 50%. Part of the issue is -- the good news, if you like, which is the sort of the increased demand that we're seeing on the system side of the equation. So there's just the product mix that sort of knocked us down a little bit in the first place. We've got moves that put us, as I said, to try and build up the consumables as well. And then we are -- we did have a little bit of pricing through the promotional areas we look at. So we think we can recover that. We are looking to continue to put some -- use some pricing leverage on MicroPulse to move that up. So I would like to see us move back into the 49%, 51% bracket by the end of this year.

Okay. And then you talked about $0.5 million from an insurance carrier. Can you give us a little bit more? What is that in relation to?

Yes, that was a very beneficial outcome to us. One of our insurance carriers decided to demutualize. And as a result of being a policyholder at the time of that decision, they had to basically do a onetime distribution of all the reserves they have been holding for their mutual owners, if you like, of which we were one. So the consequence of that was they had to return to us about $0.5 million of their reserves. So we've received that money. It's in the bank. And obviously, we'll book that credit in this period.

And that's going to be booked below the OpEx line, right?

A little bit unprinted discussion on that at the moment. We're going through the technical research to understand whether it should be -- the SEC is -- gets a little bit sensitive to putting things in other income.

Well, that's what I'm wondering because your OpEx guidance -- is that included or...

No, no. The OpEx guidance is -- does not presume the credit.

Okay. So should we -- that's what I'm saying. On our end, I mean, how do we go about modeling? I mean, should we put it below? I mean, is that something...

I'd say for modeling purposes where you're saying put it below, because what you're really looking at is our standard OpEx expenditure envelope is more than the $3.8 million to $4.0 million.

Okay, okay.

So that would be more representative of a normal quarterly OpEx expense for us.

Okay. And then, I mean, on the OpEx side of the business, I mean, it seems like you guys got rid of or eliminated 4 VP positions. How do -- how should we look at R&D spend, sales and marketing? I mean, how should we look at that going forward? Are we expecting increased investment in R&D? And you're sitting a lot of cash here. And how do you get to that sales number that you guys are talking about in the first quarter? Is that with increased sales and marketing spend?

Not particularly. I mean, on the OpEx side of the equation is we're looking to manage ourselves at $4 million or below on the OpEx.

A quarter?

A quarter.

Okay.

That does allow us to continue to fund ongoing R&D. Typically, you'd see some random million dollars a quarter goes into R&D. I think what we're particularly seeing on the revenue side is we did put a lot of effort in last year, we continue to, which is more targeting marketing programs and a repositioning of the products and the value proposition to make them more relevant to a larger portion of doctors out there, if you like. And then the last thing is we did launch a delivery device, specifically a TxCell delivery device, in the fourth quarter, which we're quite excited about the opportunities that, that brings to us. We think that rounds out the product portfolio quite nicely. So we think we're...

No, I'm sorry. Go ahead.

So I would say I think we feel we're well positioned to actually be able to see increased revenue growth without necessarily having to right away push up the OpEx.

Okay. And what exactly is TxCell? I mean...

So the typical way that a laser delivers the laser beam is one shot by a foot depression. So it's basically a single shot per, if you like, click of a button. And what we've got here in response to what was initially launched by another company called OptiMedica was an opportunity for the physician to scan or basically put multiple laser dots down with a single depression of the foot switch or the button. The advantage of that, if you like, is the doctor, for example, could perhaps lay down 49 laser spots all at 1 go instead of 1. So the efficiencies to the physician are quite dramatic so that they really appreciate the throughput, the faster time. And we're actually seeing it's also beneficial to the patient because the patient has to spend less time in the chair receiving the laser treatment.

Okay. So can the doctor control the pulse -- the number of pulses per depression of the foot?

Yes. You basically can dial up the grid. And instead of just putting a single dot for each depression, you can go up -- as I said, it's mainly to a 7 x 7 grid that basically allows them to put 49 spots.

Okay. I mean, is this a move-the-needle type of launch that you guys are coming with?

So my -- let me jump in on that one, Jim. It's...

Yes.

Joe, the advantages you've just spoken about are substantial. But another advantage that we have on this is that on the MicroPulse, since it does not burn the tissue, it's hard for the patient -- or, excuse me, hard for the physician to see the spot. And so by having a grid allowing the doctor to set in the density of the spots, the size of the spots, whether it's in a circle, whether it's in a -- just a grid going across the fovea in that example [ph], so the physician can set that up in 1 depression, as Jim said. It's 49 spots. They know exactly where they went, they know exactly how close they are to each other, they know exactly what size. In the earlier stages with MicroPulse, it was one shot, and you could not really tell where it was going because it didn't burn, it didn't leave a mark. This is a major step forward for the physician to be able to use MicroPulse and have confidence they've done something and see the treatment within a few days. They'll start seeing the advantages of it. So for us, we believe it is a major move-the-needle type of an introduction. In fact, one at University of Georgia -- Georgia West University, I watched the first one. And the doctor operating it, took him 12 seconds to do something that was generally substantially longer. And so it is a needle mover.

And -- so then, your first quarter revenue include TxCell?

Yes, it will include, yes, the sale of certain -- a number of units of TxCell. It became available to the channel at the beginning of the year, correct.

Okay. And then I guess my final question, then I'll hop out. On the cash and the buyback, I'm just curious as to why -- I mean, the stock is so -- I mean, the float is so low here. Why continue to use the cash to buy back stock? And you had spoken about acquisitions or partnerships. Is that taking away from your ability to really maybe use that cash in another acquisition or partnership? I'm just a little confused.

Sure. Will, do you want to take a first crack at that?

Yes, I think the situation, Joe, is that we will be opportunistic in -- at utilization of the cash. And when we're talking about the buyback, we have -- and we'll have certain levels where we'll buy the shares, and it's not going to be absolute like the tender we did in the fourth quarter. It'll be more like we've done prior to the tender. We'll utilize a little bit of cash. We'll utilize the cash from the standpoint of doing acquisitions when you -- if we need be. But I don't -- your earlier comment about the float. I don't -- we don't have any float anyway. So I'm not sure that, that's a -- by taking a few more shares off the market is going to harm us in any way. And I think, from my standpoint, it enhances our existing shareholders' value, the people who believe in the story. And I believe Jim's comments earlier support the fact that we're going to be generating enough cash to be able to do so and still do acquisitions if we need to. So we're not going to be doing any large acquisitions, that's for certain. So we don't need to have $15 million or $17 million, so.

No, I understand that. It's just from my standpoint, it seems like you guys are trying to slowly take this thing private.

No, the answer is no.

And our next question is from the line of Jason Stankowski with Clayton Partners.

Just curious if you had a final share count at the end of the quarter as opposed to the weighted average.

Yes. So what I had was 8.5 million on the common. You then have to add 1 million for the presumed conversion to preferred. And then there's 1.6 million options outstanding. So I get to a total of 11.1 million.

Okay. And is that a fully diluted number? Or are a lot of the options underwater?

That was presuming all options were above water. That's fully diluted.

Fully diluted, okay. And just can you give us any sense of the MicroPulse adoption into the non-retinal surgeon area, if that's starting to gain any traction and whether any of the sales of MicroPulse machines have come from new customers kind of in this quarter and as you kind of broaden the distribution? Just curious how that, to the comprehensive kind of doctors, is going and whether you're seeing that start to move at all yet.

Yes, Jason, this is Will. The answer to that is yes. I think Jim mentioned earlier about the way the Web page is presenting data today. We are getting orders directly off the Web page from comprehensive doctors. And I think the term we use, comprehensive, these practices are getting substantially large. They also are employing a few retinal people themselves and trying to keep them on in their own house. And what this does for us is we've been calling on about 2,000 retinal in the U.S. And not outside the U.S. but in the U.S., about 2,000 retinal specialist offices -- doctors and offices. With the advent of MicroPulse and the safety as in by the way they're treating and teaching residents today how to use MicroPulse because of the safety, the doctors in the comprehensive offices are saying, "This is -- I can do no harm; therefore, I want to try." And I think what we're seeing is now, you go 2,000 retinal specialists, to maybe another 60,000 doctors that have been employing MicroPulse before the patient would be sent to a retinal specialist for some other severe treatment. So I think it's opening up markets that are substantial for us, and we are beginning to see that, both -- in both trade shows and the way Tim Buckley, our V.P., is setting up these programs where we're doing teaching programs at different trade shows. So we should see more and more going forward.

Good. And for what it's worth, I think Berkshire Hathaway had about 1.8 million shares for the first 29 years of its existence or so and shareholders did just fine. So we're fully supportive of helping people who need liquidity that aren't interested in the story and using some cash to take them out of their positions.

[Operator Instructions] I'm showing there are no further questions. I'll turn the call back to Will Moore for closing comments.

I want to thank everybody for -- that's on the call today for your support and continued interest in IRIDEX, and we will do the best we can to enhance shareholder value going forward. I look forward to talking on the next conference call. Thank you.

Ladies and gentlemen, this concludes our conference for today. If you'd like to listen to a replay of today's call, you can dial (303) 590-3030 or 1 (800) 406-7325 with the access code of 460-3021. We thank you for your participation. You may now disconnect.