Iridex Corp Q2 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the IRIDEX Second Quarter 2022 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. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Leigh Salvo with Investor Relations. Please go ahead.

Thank you, Carmen, and thank you all for participating in today's call. Joining me are David Bruce, Chief Executive Officer; and Fuad Ahmad, Interim Chief Financial Officer. Earlier today, IRIDEX released financial results for the quarter ended July 2, 2022. 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 Federal Securities laws, which are made pursuant to the safe harbor provisions of the 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 intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information and future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 15, 2022. And with that, I'll turn the call over to Dave.

Good afternoon, and thank you all for joining us today. Our business continues to be strong and this year's summer slowdown appears to be short-term and attributable to a combination of factors. Macro headwinds from inflationary pressure and US dollar strength relative to foreign exchange rates have dampened our OUS retina capital system sales during the quarter, and increasing pricing pressure on our international customers from high inflation across many segments has driven up customers' total spending and has led them to assess their capital purchase appetites. In the glaucoma market segment, we experienced relative procedure volume weakness in the second quarter. This is largely due to strong comparable results in the prior year's second quarter. However, we experienced headwinds from continued COVID impacts on surgical center capacity and patient procedure volumes. Surprisingly, vacations by doctors, staff, and patients ran unusually high, and as a result, added to reduced delayed procedures. These combined delivered some procedure softness in late May and June. We believe these headwinds are temporary, and our team has maintained steady focus on expanding our market and building physician adoption of our non-incisional approach to treating glaucoma and retinal disease. Clinicians have proven receptive to our enhanced dosing guidance and our monitoring of patient outcomes over time as they build experience towards expanded usage on a wider indication of patients. While this process is taking longer than we would like, our confidence remains high that we're demonstrating improved outcomes that will lead to broader adoption. Glaucoma probe sales volume increased 2% quarter-over-quarter, but declined 6% versus the prior year. The decline stems from second quarter 2021 OUS probe sales that were particularly strong, as the partnering distributors placed and sold final orders before Topcon took over distribution for over half of our OUS territories. Despite these challenges, we are pleased that second quarter probe sales attained our second highest quarter ever, only behind last year's second quarter. In Japan, we completed the distributor transition at the beginning of the second quarter, marking the last of our large international market transitions. As part of the transition, Topcon received product inventories from the prior distributor and therefore placed minimal orders in the quarter. We anticipate renewed contribution from this region in the latter half of the year and going forward. In June, we were pleased to receive our long-awaited regulatory clearance to market and sell our Cyclo G6 Glaucoma platform in China. This important milestone opens up a significant new market for IRIDEX; an estimated 9.4 million adults in China are afflicted with glaucoma, presenting market scale comparable to that of the US. We sold the initial systems and probes to begin the launch, and together with our distribution partners Topcon and Clinico, we conducted clinical launch meetings with over 70 physicians, significantly exceeding our expectation of 15 to 20 from our initial sites. Together with our partners, we will support pilot sites and patient experience to build a strong initial presence in China that we can then leverage to penetrate the broader market. To support the growing awareness of TLT in our China launch, we expanded our commercial team with the addition of a Vice President of Marketing, as well as new sales team members, two in the US and three internationally. The increase in our sales team enables us to continue broadening the geographic reach and focus of our sales efforts. Lastly, our capital position remains secure, so again this quarter, we deployed some cash to mitigate potential supply chain impacts, and we continue investing in initiatives to secure our long-term growth. Year-to-date cash reduction is approximately $5.9 million, with about $3.1 million of that shifted in current assets and cash to inventories and prepayments to mitigate lingering supply chain challenges. On the clinical front, we had several notable updates that put on the work over the previous quarters; presentations and industry articles supporting the dosing impact on outcomes and the importance of sweep speed techniques are increasing awareness of methods to secure optimal results. The first clinical paper from our TLT consensus committee has been published, and the Group is finalizing the submission for the second half of the guidance paper, which will be published in the same journal. We expect these papers to serve as critical proof points as we continue to drive adoption of TLT and introduce this technology to more and more physicians. Turning to product launches, we're excitedly preparing to launch a new suite of laser systems at the upcoming AAO Conference, beginning September 30. This launch will include new platforms for the three main laser products within our retina treatment portfolio, not only with the platform to deliver modernized architecture and ultimately connectivity capability, but they provide IRIDEX a lower cost of manufacturing, which we can use to drive share gains and improved margins. We expect initial shipments in the US to begin in Q4, followed by OUS approvals over the next several quarters, and we will roll out international market launches as those come. As we assess our performance year-to-date and the impact from the extended prevalence of COVID, plus the macro headwinds affecting our expectations for the second half of the year, we concluded that it's prudent to lower our revenue and probe guidance for the year. Our updated full-year 2022 outlook is as follows: total revenue of $56 million to $58 million, reflecting growth of 4% to 8% year-over-year. We now expect probe sales of 61,000 to 63,000, a growth of 5% to 8% over 2021. Our expectation for Glaucoma system sales remains unchanged at 225 units to 250 units. We'll continue to focus on executing our growth catalysts, and when combined with typically stronger second half of the year sales, we are confident in our ability to build momentum through the remainder of 2022. In summary, we perceive the current challenges as impacting fiscal year 2022, but we're confident that we have an energized commercial team, a high-quality distribution network, an enhanced product portfolio, and a multi-year capital runway that will allow us to succeed in our long-term growth strategy and position IRIDEX as the leading provider of non-incisional laser-based treatments in the ophthalmology market. With that, I'd like to turn the call over to Fuad.

Thank you, Dave, and good afternoon everyone. I will now review our financial performance for the second quarter of fiscal 2022, starting with revenue. Total revenue for the second quarter was $13.8 million, up 2% from $13.4 million in the second quarter of last year. We sold 15,000 Cyclo G6 probes in the second quarter, a decline of 6% from the prior period and a 2% increase quarter-over-quarter. As Dave noted earlier, the year-over-year decline was primarily a result of the prior period including final orders by distributors in advance of our move to Topcon’s exclusive distribution. Moreover, we are also experiencing some headwinds from a stronger dollar as the vast majority of our revenue is priced in USD. We sold 48 Cyclo G6 systems in the quarter compared to 47 in the prior period. Year-to-date, we have sold 104 Cyclo G6 systems, tracking our initial expectations for the full year and validating our worldwide installed base expansion goals for 2022. It also highlights the broadening adoption of TLT for the treatment of glaucoma. Total product revenue from our Cyclo G6 product family was $3.5 million, down 3% compared to the second quarter of 2021. Turning to our retina business, product revenue was $7.5 million, flat compared to the prior year period. Strength in our legacy IRIDEX retina products was offset by relative softness in PASCAL revenue. Recall that last year in Q2 and Q3 we shipped extra units to start building inventory in Japan ahead of a shipment blackout as we registered IRIDEX as the manufacturer of record for PASCAL. Other revenue, which includes royalties, services, and other legacy products increased 22% to $2.7 million in the second quarter of 2022 compared to the same period in 2021. This substantial increase resulted from higher service revenue and higher amortized revenue recognition from the sale of distribution rights to Topcon. We expect to sustain this level for the balance of the year. Gross profit of $6.3 million in the quarter reflected gross margin of 45.6% compared to 45.5% in the second quarter of 2021. We expect that further margin expansion will come from increased probe volumes and sales of our new laser platforms as they take the place of existing systems in the future. Operating expenses for the second quarter were $8.4 million compared to $7.2 million in the same period of the prior year. The increase was the result of higher R&D spend on planned investments in new product developments and additional R&D capability from the acquisition of the PASCAL product line. Additional planned investments in the sales organization, as well as expanded marketing and clinical activities also contributed to the higher operating expense in the period versus the same period last year. Higher R&D and sales and marketing expense was partially offset by lower G&A expense in the period. Net loss in the second quarter of 2022 was $2.2 million or a net loss of $0.14 per share compared to an income of $0.09 per share for the same period in 2021. Please note, the second quarter of 2021 included a one-time gain of $2.5 million from the forgiveness of our PPP loan. We ended the quarter with cash and cash equivalents of $18 million, representing cash usage of $2.7 million during the quarter. Cash usage included approximately $1.1 million investment in inventory and related pre-orders. We believe these investments in materials and inventory are necessary to mitigate potential supply chain bottlenecks in the future. We expect to start bringing down inventory starting in the fourth quarter of fiscal 2022 and into fiscal 2023. We reiterate that these shifts in our current assets are an essential part of the supply chain management strategy in the current environment. In conclusion, I'll provide an update to our guidance for 2022. As Dave mentioned, we now expect total revenue for fiscal year 2022 to be $56 million to $58 million compared to $57 million to $59 million previously. G6 probe sales are now expected to range from 61,000 to 63,000 compared to a range of 67,000 to 70,000 previously. Finally, our expectations for growth for installed base growth for Cyclo G6 Glaucoma Laser systems remains unchanged at 225 to 250 units. With that, Dave and I would like to turn the call back to the operator for questions, operator?

Thank you. Our first question comes from the line of Tom Stephan with Stifel. Please proceed.

Great. Hey guys, thanks for the questions. If I can just start on G6 guidance, you maintain the systems placement guide which I would think would be the impacted portion from inflation in macro, which I think on the retina side you said may be impacted, but then with G6, I think the probe shipments is where guidance came down somewhat meaningfully for the second half. So I guess on the probe side what else are you seeing beyond macro, because I guess, would that least procedure volumes be a bit more resistant to macro, just trying to make sense of this dynamic. Is it competition? Just any color there, Dave, would be helpful.

Sure. Hi, Tom. Yeah, I would say that macro is a factor and then as we shifted distribution, some of the softness in the second quarter was inventory shifts. For example, in Japan, as I mentioned. Going forward, we think we'll recover on those items and reestablish the growth trajectory. Our original guidance was about 18% probe growth through the course of the year, and we've been relatively flat year-to-date versus last year. So as we start to grow again in the second half, we've got that lack of growth in the first half to carry over, and that's why the numbers are down. So we're going to grow at a rate starting from a lower base than we would have expected for the second half of the year. So I think when you do that math, you see it coming lower than you would expect. We're actually pretty pleased with the guidance of system sales that indicates the appetite is there to adapt, and our visibility is such that we're feeling comfortable that there is still demand there. Those price points for capital equipment are not so high in the $20,000 to $25,000 range, so that's the easier capital purchase to continue forward with, compared to retina laser systems which might be between $50,000 and $100,000 depending on the feature set. Does that clarify things for you a bit?

Yeah. That's helpful. Actually, I think that's a really good segue into my second question. Just on kind of the medium term for G6. Not going to ask you to guide for 2023, but I'm curious how we should be thinking about next year at this stage. It sounds like some of the current headwinds are transitory; what is your medium-term outlook? Because I do think guidance implies flattish utilization in 2022 versus 2021, but again, you do think it sounds like you'll get back on the normal growth trajectory of that business. So for 2023, is it fair to think about G6 kind of getting back to the 15% to 20% plus growth rates as we enter next year?

I think so. We thought that was going to be the case this year. And I think COVID persisted longer than I think many of us anticipated. And it kept this in a level as opposed to growth in this first half of the year. We established growth in the second half of the year, and I think that continues. There are a couple of nice catalysts to accelerate that growth. We have high confidence that our newer dosing and sweep speed communication coming from papers, KOLs, and our sales teams calling on our customers is really going to gain traction and start to give consistent and durable results and cause our clinicians to start to broaden the patient base on which they use it. For the longest time, we've talked about expanding to the more moderate stage patients. But before you get that, you've got to get the confidence and the durability, especially the safety profile, and we think we're building that now. I think those things will come out as we move along in the second half of the year. There are also some studies ongoing that will demonstrate the current dosing with the current probe and the outcomes and safety profile from that. So as that emerges, I think it gives greater confidence to existing users to broaden the patient selection and to new users to come on board. So yes, we think 2023 we should be on a higher growth trajectory, barring any unforeseen events that start to affect usage and ability to do procedure volumes and those kinds of things.

Got it. That's helpful. Maybe last one from me, just on the sales force. Can you remind us how large it is now, between each segment? And just talk about the strategy and the rationale here, kind of where these new reps will be focused between the different businesses?

Sure. In the US, we have a team of six territories, plus a support team that adds up to about 10 on the retina side of the business. So that's the capital business. It's primarily a replacement business, although there is some expansion in facilities that want to have a satellite facility and have the same kind of equipment in that facility. But overall, the doctor base is everyone has a laser, and now it's really an opportunity for our new platforms to have some growth as we replace older systems with newer systems. So that's the retina side in the US. On the glaucoma side in the US, we have 14 territories; we just increased that from 12 to 14. We have some clinical support team members, as well as management and inside support. This team totals about 20 people focused exclusively on glaucoma in the US. Internationally, we expanded by three in both Asia Pacific and Europe to provide more support to help Topcon and their distributors drive business in their channels. We added what we call area sales managers as well as clinical specialists to help support cases and train sales reps in the territories. Our international team now totals about seven people covering roughly 60 distributors, including the sub-distributors under Topcon.

Great, that's helpful. And if I can squeeze in one more just going back to glaucoma; obviously, there is a lot of new entrants from a product perspective recently and even more so on the horizon. Dave, can you just talk about your view on the competitive landscape, and to what extent maybe it's factored into the revised guidance? And I guess just more broadly, how are you thinking about ramping competition and the extent that that might affect G6 utilization? Thanks.

Sure. We think that our non-incisional approach is relatively unique. We can treat moderate stage to later stage, and we don't need an incision and the clinician doesn't need to make that decision in order to treat, for example, a stand-alone procedure. What we're hearing from clinicians is their preference, if they can avoid it, is to not make an incision and use our technique if they're satisfied that it delivers results and safety. That said, I think there is a lot of interest in understanding and potentially trialing some of the newer entrants and new approvals for stand-alone procedures. I think it's taking some mindshare. I don't know at this point that it is really affecting us demand-wise; we don't hear that our market share is declining because of it. There is just a great deal of interest out there, and our technique is relatively differentiated in that respect. However, we are one of the voices in that space that clinicians are hearing amid all the noise from competitors targeting glaucoma specialists and comprehensive ophthalmologists. I believe our strong product offering allows us to maintain our position in the market. Internationally, there's less competition because the adoption rates for new entrants are not as high. While there are a few competitors attempting to do what we do with our non-incisional probe approach, we feel confident in maintaining a relatively dominant position in actual procedure volumes going on.

Great. Thanks, Dave.

Thank you. One moment for our next question, please. Our next question comes from the line of Scott Henry with ROTH. Please go ahead.

Thank you, and good afternoon. Just a couple of questions. Dave, I guess first, and I know you've talked about it in the prepared remarks and probably in the last question as well. But I wanted to flush it out one more time. So the G6 came in below expectations, and I've heard a lot of different things, capacity constraints. What do you think was the main driver of why it came in below expectation? If you don't want to put it on just one thing, maybe if you could simplify it, what do you think happened in Q2 that made things not turn out as much as you thought they would?

I think it's two straightforward factors. Number one, the persistent impacts of COVID continued to dampen procedure volume at least in our facilities with our procedures. Secondly, it was evident to us that the latter part of May and into June showed significant procedure volume softness. Initially, we were unsure about this, but after canvassing, we found vacations were a common response. So I think that's very short-term, as in one quarter-focused. We saw recovery in July that made us comfortable there was indeed a cyclical nature to this issue. So I believe that the decline is temporary and attributable to that. Additionally, I believe there were timing issues with orders shifting from one quarter to another, especially internationally; I think Japan was a prime example where we saw some inventory and order delays due to the transition to Topcon. We anticipate that those orders will come in the future and recognize that while there is growth potential, the shift in procedure volumes is absolutely disruptive.

Yes. I mean, I guess –

We do not have strong macro visibility on what was happening to cataract procedures and other similar procedures, but we can observe the effects on our own sites. To express it another way, we have noticed a pattern of significant procedural disruption in our own facilities where the capacities were adjusted lower due to staff, clinician, or patient absences – both voluntary and involuntary. That's indicative of the lack of volume. The timing of distributor orders is also another factor, particularly for Japan where we anticipated volume shifts based on the distributor transition. With those factors in mind, you can see how there was an alignment with our expectations.

Okay. I guess what I was trying to uncover is, all of this seems temporary and glaucoma is not going away, barring some sort of contraction from the economic cycle where perhaps people just see the doctor less for a period of time that should reverse at some point. You should expect to see growth return to trend perhaps in 2022. Is that a fair assumption?

Yes, that is a very fair assumption. It's our expectation. We've continued hiring, and we're pushing our marketing programs and clinical programs to get back to that phase. We understand that we can't exceed expectations every quarter; sometimes, you need to take a step back, analyze the data we gather, and correct our approach accordingly. We anticipate a recovery since these specific factors affecting the second quarter were quite clear and, indeed, temporary.

Great. And just another question, no real reason to ask it now, but it seems it was on my mind. On the R&D side, the company spends a good amount, $2 million a quarter on research and development. What products is the company currently working on? Where is the return from that investment? Not that there isn't one, I'm just curious if you want to highlight any of the stuff you are working on?

Yes. Our R&D efforts have significantly focused on developing our new platforms, particularly the PASCAL platform, which represents a significant step up from our previous offerings. This includes higher levels of investment and longer timeframes to bring these innovations to market. We are nearing completion of this process, allowing us to redeploy resources to other areas of opportunity. Connectivity with clinicians and advancing methods for delivering energy for glaucoma and other applications are two main areas we are expanding. This evolution may include developing devices that could create a therapeutic effect while incrementally increasing our revenue as the procedure volumes grow. We are committed to advancing these innovations while also maintaining confidentiality regarding our competitive strategies.

Okay, great. Well, thank you for taking the questions.

Thank you. And with that, we end our Q&A session for today. I will turn the call back to David Bruce for final remarks.

Thank you. And thanks everyone for joining the call. We'll continue to work on behalf of growth and strong management of the assets and look forward to reporting to you next quarter.

And with that, ladies and gentlemen, we thank you for participating in today's program. You may now disconnect. Everyone, have a great day.