Iridex Corp Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the IRIDEX Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to turn the conference over to your host, Hunter Cabi, Investor Relations. Thank you, and please go ahead.

Thank you, and thank you all for participating in today’s call. Joining me are Dave Bruce, Chief Executive Officer; and Jim MacKaness, Interim Chief Financial Officer. Earlier today, IRIDEX released financial results for the quarter ended September 26, 2020. A copy of the press release is available on the company’s website. Before we begin, I’d like to remind you that management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws, which are made pursuant to the Safe Harbor provisions of this Private Securities Litigation Reform Act of 1995. Any statements made during this call that are not statements of historical fact, including, but not limited to, statements concerning our strategic goals and priorities, product development matters, sales trends and the markets in which we operate. All forward-looking statements are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place reliance on these statements. For a discussion of the risks and uncertainties associated with our business, please see our most recent Form 10-K and Form 10-Q filings with the SEC. IRIDEX disclaims any intentions or obligations, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 9, 2020. And with that, I’ll turn the call over to Dave.

Thank you, Hunter. Good afternoon, and thank you all for joining us. First, let’s acknowledge that these past quarters dealing with COVID-19 have been challenging for everyone, and I appreciate your continued support and interest in IRIDEX. I’d like to start our call with a brief review of our strategic priorities for the year and highlight the recent progress toward those goals. Then Jim MacKaness, our Interim Chief Financial Officer, will provide additional insight into our financial results for the quarter. After that, we’ll open the call for questions. In mid-2019, we identified several key strategies we were confident could lead us to substantial improvement in our business for 2020 and beyond. At that time, no one foresaw the dramatic and widespread impact of the COVID-19 pandemic. And while we necessarily made a number of adjustments to our operations and short-term resource allocation, we have continuously kept an eye on our longer-term growth plan and not wavered from those initial goals. In short, those goals included the implementation of structural changes to reduce operating costs and cash preservation measures to extend our financial runway. Also, adjustments to our sales and marketing processes to expand the adoption of our non-incisional MicroPulse transscleral laser therapy, both with new customers and by reengaging our significant installed base. Lastly, to pursue judicious product development investments that would strengthen our competitiveness and improve gross margins. I’m encouraged by the progress we’ve made on each of these objectives while we reacted to and mitigated the challenges presented by COVID-19. Overall, the positive recovery trends we began to see as we exited Q2 persisted throughout Q3. While we continued to experience some impact from capacity restrictions and reduced throughput of ophthalmic practices and surgery centers, our business substantially improved from the trough we experienced in early second quarter. Top line revenue improved sequentially to $8.8 million from $6.2 million, a 42% increase over Q2 2020. We experienced the strongest rebound in our glaucoma probes to the point that we exceeded sales in last year’s third quarter by 6%, with over 10% outperformance in the U.S. We’re seeing a slower bounce back in capital systems sales, particularly with international customers, as they have largely remained financially conservative throughout the duration of the pandemic. To mitigate the inevitable revenue impacts from deferred or delayed procedures and capital purchases, we made it a top priority to significantly reduce spending with a shift to web-based sales and marketing activities and gradually increased direct customer contact as access opened in the third quarter. This enabled us to limit operating losses to be in line with our third quarter 2019 results, despite the lower revenue this quarter. These shifts, coupled with improved balance sheet management, led to a sequential increase in our cash position at the end of the third quarter by approximately $300,000. And year-to-date, our cash balances declined by only about $700,000. This is a meaningful accomplishment by our team in a volatile environment and positions us well with operating runway as we work toward full recovery of our business to pre-COVID levels and beyond. As you recall, in the second half of 2019, we redirected our sales and marketing focus to drive adoption of our unique non-incisional glaucoma therapy, both with new customers and by reengaging our significant installed base of Cyclo G6 System owners. Prior to the onset of the pandemic, we saw renewed customer engagement with improving top line results in the fourth quarter of 2019 and the first two months of 2020. In March, as I noted, our team responded quickly to the challenges that emerged as a result of the pandemic. Since then, we’ve continued to maintain full organizational capacity through a combination of work-from-home capabilities and, wherever possible, daily on-site operations for those groups that work from our facilities and the use of virtual online tools to facilitate sales, marketing initiatives, and provide clinical support and training to our customers. Our teams have adapted well to the new environment, and we’ve been able to support our operations and our customers while keeping everyone safe. We’re proud of what’s been accomplished by IRIDEX under these extraordinary circumstances. We experienced favorable improvement month-to-month in the third quarter as our surge in customers and hospitals continued to reopen with patients scheduled for procedures. In terms of geography, sequentially, U.S. sales improved 66% and outside the U.S. increased 16%. On a year-over-year quarter basis, our U.S. business recovered to within 10% of 2019, and our outside the U.S. business within 27%, reflecting the impact of slower recovery and COVID resurgence in some regions around the world. Throughout this new business landscape, the biggest beneficiary has been U.S. glaucoma probe adoption, with growth driven by increased recognition of our non-incisional effective intraocular pressure reduction benefits and conversion to our revised MicroPulse P3 probe. Feedback continues to be very supportive, with customers praising its improved ease of use, which we believe will continue as a catalyst for increasing utilization. I’d like to shift now to highlight the continued progress of our product development program. This quarter, we launched a new Laser Indirect Ophthalmoscope, or LIO, for the retina market. Feedback from our newest users indicates it's a major improvement over our prior offering. In October, we received FDA clearance for our new 810-nanometer laser, the first from a new platform we’ve been co-developing with our partner in China. Though this platform development suffered delays due to COVID impacts, we continue to make progress toward launches in 2021. One key benefit of the new laser platform will be a reduction in manufacturing costs. Once we have completely rolled out the anticipated three lasers on this platform, we expect gross margin improvement north of $1.5 million in the capital equipment side of our business, leading to several percentage points of improvement in our overall gross margin. I’m encouraged by the business we’ve seen so far in the fourth quarter and anticipate that trajectory will continue through the remainder of the year as we shift our focus from reacting to the pandemic to executing our longer-term growth strategy, with adjustments as needed due to the ongoing uncertainty given the recent surges in COVID infection rates. In summary, we continue to make meaningful progress on the strategic objectives we established coming into this year, despite the significant short-term operational adjustments needed in the wake of COVID-19. The third quarter showed strong improvement from the second quarter, enabling us to exit the quarter at better than 80% of pre-COVID levels. We were able to drive quarterly probe sales that exceeded the previous year amidst a partial recovery. Our revised probe and virtual sales and training processes have driven renewed interest from dormant customers as well as attractive new customers. Back in March, we reacted quickly to manage our costs and balance sheet closely. As a result, our cash position has declined by only $700,000 since the start of the year. I’m proud of our team’s success in weathering and recovering in a tough year for the ophthalmology market, but even more so in setting us up to succeed once the impact of the COVID-19 pandemic diminishes. Before I turn it over to Jim MacKaness, I’d like to thank Jim for his service with us as he transitions to another assignment and particularly for his help in managing through a very turbulent situation over the past eight months. I’d also like to introduce and welcome Fuad Ahmad, another partner from the FLG team who is taking over the interim CFO role. Fuad’s broad CFO experience and recent assignments with an aesthetic laser and disposables company will provide seamless and strong financial leadership for IRIDEX. With that, I’d like to turn the call over to Jim.

Thank you, Dave, and good afternoon, everyone. Our total revenue was $8.8 million, down 17% from $10.7 million in the third quarter of last year, but up 42% from $6.2 million last quarter Q2 2020. Our glaucoma product line is recovering nicely. We sold 11,400 Cyclo G6 probes in the quarter, an increase of 6% from the 10,800 probes sold in the third quarter of last year and up 44% over the 7,900 probes sold in Q2. The increase in probes sold in Q3 of this year compared to Q3 of last year resulted in an increase of $0.1 million in glaucoma probe revenue. We sold 37 Cyclo G6 Systems in the quarter compared to 82 in the prior year period and 42 units sold in Q2 of this year. The reduction compared to last year’s quarter was primarily due to our change in sales approach in the U.S. and ongoing capital purchase deferrals resulting from COVID. The prior selling approach involved bundling the laser with probes and offering a deep discount on the laser. The new sales strategy does away with this practice, and we have seen a significant uptick in the average selling prices for the laser. Overall revenues for the Cyclo G6 product family were $2.8 million, although down 6% compared to the third quarter of 2019. This was a 31% improvement from $2.1 million in Q2 2020. Our retina product line continues to be the most impacted with revenues down 23%. Our retina products include lasers and various delivery devices, which we define as “capital equipment” and which are single-use per procedure products. Sales of capital equipment tend to be backend loaded in a quarter and are subject to being delayed at the last minute in any particular quarter. The impact of COVID-19 increases this volatility. Other revenues, which include royalties, services, and other legacy products, decreased 17% to $1.6 million in the third quarter of 2020 compared to 2019. Gross margins in the third quarter of 2020 were 41.5% compared to 40.2% in the third quarter of 2019. Gross margin percentage improved despite the lower sales volume as a result of a shift in product mix towards the higher margin per procedure products and improved pricing of Cyclo G6 Laser consoles. Both were derived from continued execution of the sales strategy we introduced in the second half of 2019. An increased weighting of U.S. sales, sold with a higher gross margin through our direct sales force compared to international sales sold with a lower gross margin through distribution, contributed to the improvement. Operating expenses for the third quarter of 2020 decreased by 10% to $5.5 million compared to $6.1 million in the same period of the prior year. The decrease was the result of cost-saving measures implemented in the second half of 2019 and a reduction in variable expenses as COVID-19 resulted in continued reduced business activity in the third quarter. Consequently, despite the revenue reduction in the third quarter, we saw a loss of $1.7 million or a net loss of $0.12 per share, an improvement over the loss of $1.8 million or a net loss of $0.30 per share in the prior year. For the first nine months of 2020, although revenues were down 24% compared to 2019, due to the impact of a focused expense management strategy, we were able to reduce our net loss by $1.1 million to $6.2 million from $7.3 million. Our cash balance ended at $11.9 million for the quarter, up approximately $300,000 from Q2 2020 and down only $700,000 from the year-end 2019, as Dave noted earlier. We’re very pleased with the management of our capital resources during these tough times and believe this, along with our expense management, puts us on a firm footing to weather the existing COVID headwinds and execute our business strategy for the long term, which brings us to guidance. We continue to find that the COVID-19 outbreak and related uncertainties create a broadly variable business environment for us. As a result, we remain unable to provide a meaningful guidance range for 2020. And with that, Dave and I would like to turn the call over to the operator for questions.

Our first question comes from the line of Jon Block with Stifel. Your line is open.

Hey guys, this is Tom on for Jon. Thanks for taking my questions. I want to begin with trends. Just for a clarification to start off, I think you noted in the prepared remarks that you exited the quarter at better than 80% of pre-COVID levels. Was that for total company sales or G6 probe shipments? And if it was total company sales, could you maybe talk about G6 trends in the quarter?

Sure, Tom. This is Dave. Yes, so the overall number was down 17% compared to last year. And I think we just summarized it as within 80% of pre-COVID. The trends are more reflected in the comments around improvement in the G6 glaucoma probes. Those were actually up against the third quarter last year and up significantly against the trough in the second quarter. So we’re seeing that disposable probe business recovering quicker than the capital equipment business, with the strongest recovery in the U.S. and secondly, outside the U.S. Capital equipment was hit harder in both segments. So that brought the overall average recovery closer to the 80% level of pre-COVID. We see this continuing here as we’re partly through the fourth quarter and seeing some resurgence in COVID around the world, which is affecting certain areas in terms of their access. We’ll see at the end of the quarter, but it may affect their appetite as well. So we’re a little more cautious in forecasting that recovery.

Got it. Okay. That was super helpful. And maybe just sticking with trends, you did note international has been impacted by some of the recent surges in COVID. Any pauses in the recovery recently in specific U.S. markets that maybe experienced second waves?

It’s always hard to draw conclusions in the short term on order flow in any given week or even a month. There have been times, for example, in the third quarter, Texas had some restrictions in place in the major metropolitan areas and several other sections of the country. While examining that, you might see some effects. In general, however, it was transient, and we haven’t seen anything significant in the short term given the new highs that are being experienced in daily cases. Our customers have told us they intend to try to continue to provide services safely unless instructed otherwise that capacity will not be restricted significantly.

Got it. Okay. And then shifting gears a bit. Congrats on receiving clearance of the new laser platform. I think the press release noted and you said in the prepared remarks that the family would be introduced next year. Any additional color around the timing there? And maybe when we could expect more meaningful contributions to the top line and margins? And perhaps I can tack on a follow-on there. Gross margins were solid, a bit above our estimate. I think you have a good amount of tailwinds in the near term from a mix perspective and also from the benefits of the new laser family. So how should we be thinking about potential gross margin expansion throughout 2021, following this latest quarter’s 42% figure? Thanks, guys.

Sure. I’ll talk about the newer products for 2021, and then maybe Jim can comment on how gross margins ultimately can impact us and potentially roll out next year. We’ve been developing and discussing a platform that will be the basis for three different laser frequency products for use in both glaucoma and retina. This common platform has modifications specific to the applications that the different frequencies are used for. That gives us a nice commonality and higher volume on the platform, plus working with our partner in a lower cost production environment like China gives us the opportunity to improve the cost position and realize it in gross margin or in pricing that drives higher potential volumes. We’re encouraged by that. We’re not being specific about when we’re going to roll out or exactly what the feature set is primarily for competitive reasons. New versions of products can lead to customers deferring decisions until they see the new product. We want to avoid freezing up the marketplace in those situations. We see the three rolling out over the course of 2021 and expect the full impact of those gross margin improvements by 2022.

Yes. I think, Tom, you identified it. We feel there are a number of things working in our favor. I think as you identified, obviously, the G6 probes continue to become a bigger part of the product portfolio. Increased volumes will also help rebound the margins because we’ll have better overhead absorption. There’s an irony in the sense that we look forward to the international capital bounce back, although that will increase in absolute gross margin dollars; it may come with some gross margin compression. So we just have to be sensitive to that. Ultimately, as you said, I think we’ll transition, as Dave described, towards those margin-increasing projects that will start rolling out at the end of 2021 and begin to come forward in 2022. We’re currently normalizing around our existing gross margin levels, but we expect some uptick over time.

Okay. Thanks, guys.

And our next question comes from the line of Scott Henry with ROTH Capital. Your line is open.

Thank you, and good afternoon. Strong results given challenging times, Dave. A couple of questions. First, I know you’re not looking to give guidance, but would you say you’re comfortable that current trends indicate a sequential increase from Q3 to Q4 in revenues?

Well, seasonally, Q3 is weaker than Q4. So all things being equal, the answer to that is an easy yes. We were pleased with the bounce back and recovery in Q3. However, the idea is that, for example, capital equipment—the all clear has not been sounded. We’re a little hesitant to forecast how the end-of-year capital equipment deal cycle will go. We’ll certainly be ready to ship product. A good portion of capital equipment is back-end loaded, and it’s easy to defer it in these circumstances. So we’re slightly cautious about that, but generally, yes, we feel the fourth quarter should be sequentially better than the third quarter.

Okay. Great. And looking through the numbers, it looks like probes per system jumped strongly off the Q2 low and almost reached normalized levels. Would you expect probes per system to continue toward that steady state that if I think back to the second half of last year? I know you’re shooting to have an even higher level; just trying to get a sense of the trend in utilization.

Yes. As we shifted from pushing systems to more locations and possibly going back to figure out usage later, we’re now focusing on those customers—whether they have a system or are looking to buy a new one—to adopt the procedure and treat more patients, particularly late-stage glaucoma patients. The combination of our safety profile and significant reductions in intraocular pressure should make it a preferred procedure—safe, non-incisional, with good results. So as we engage customers and educate them on the papers supporting this and peers practicing it, we’re driving usage first and system placements second—leading to increased average per site or new sites having higher averages. We still have a portion of our installed base that aren’t users right now. Once we bring them back online and increase their volumes, it will help the overall average usage. We view ourselves as having a very small penetration into the significant pool of moderate to severe glaucoma patients. Thus, we believe there’s substantial upside for adoption, revenue, and disposable probes for us. That’s the strategy we’re pursuing.

Okay. Thank you for that information. And then retina, while down, was still a good number higher than Q1 and well off the lows of Q2. Do you think you can maintain that level of sales? Or was there anything unique that happened in Q3?

We believe we’re improving our competitiveness. The launch of the LIO product was significant, and we’ve enhanced some delivery devices that attach to the laser system and deliver the laser energy into the eye, whether through a scanner-type product or a headset for the ophthalmologist. As we boost our competitiveness, we expect those sales numbers to improve—that's our intent. Historically, however, we’ve seen a slow decline in that segment, a combination of capital equipment and increasing global competitiveness. Maintaining share often leads to price compression, resulting in a decline. We believe we're improving our competitive position, and we’ll enhance our gross margins with the new systems in the retina space—whether we choose to focus purely on profit or to use some cost improvements for more aggressive pricing and greater share. We believe we can be well-positioned to compete more strongly in the future. That’s why we have invested in developing that space.

Okay. A final question. In the prepared remarks, there were comments about the ASP going up in the G6. If I recall, the system ASP increased in Q2 versus Q1 this year. Did it increase from Q2 to Q3 as well? Or was that just a comparison against Q3 last year? And how is ASP in probes trending? Thank you.

Yes, Tom, this is Jim. So we definitely saw a significant uptick year-over-year, for sure. We also saw a bit of pricing increase between Q2 and Q3 of this year—so both are positive trends. In general, pricing has held very well with minimal fluctuation in probe pricing over the last couple of quarters.

Thank you. And our next question comes from the line of Paul Nouri with Noble Equity. Your line is open.

Hi. I was wondering if you could talk about capital equipment sales, whether it’s the G6 on its own or the company as a whole. What was the trend this quarter? Should we expect in Q4 to see something similar to this quarter in capital equipment sales, or might it have been accelerating in the later months of the quarter?

Hi, Paul, it’s Dave. It’s just difficult to forecast. We’re seeing a nice recovery in Q3 from Q2, and the trough of Q2 was solid when comparing to Q1, which was affected by COVID toward the end of the quarter. A significant percentage of sales in any quarter for capital equipment tends to be back-end loaded. The industry has conditioned buyers to wait for the best deal. That said, going into Q4, we’re currently comfortable with the flow of business that could occur. However, we remain mindful that restrictions are increasing in countries worldwide. You never know how long that will last or whether it will broaden to a larger percentage of the world market or possibly even the U.S. It’s challenging to forecast the quarter, but where we stand today, capital sales appear consistent with the recovery we’ve seen in the third quarter in terms of activity and potential demand.

That was my only question. Thank you.

Sure.

Thank you. I’m not showing any further questions. I’ll now turn the call back over to you for closing remarks.

All right. Thank you, Bridget. I’d like to thank everyone for joining the call and for your continued interest in IRIDEX. We look forward to talking with you in future quarters. Thanks, everyone. Goodbye.

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.