Earnings Call Transcript - IRIX Q3 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q3 2023 IRIDEX Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Trip Taylor, Investor Relations.

Philip Taylor, Investor Relations

Thank you, 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 September 30, 2023. 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 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 the 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, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 14, 2023. And with that, I'll turn the call over to Dave.

David Bruce, CEO

Good afternoon. Thanks, Trip, and thank you all for joining us. Today, I'll discuss recent corporate and Medicare reimbursement developments and our business progress. Then Fuad will provide details on the third quarter financials, and we will open the call for questions. I'll start with the topic I expect people are most interested in learning more about: that's the Medicare coverage policy that was the subject of our recent 8-K and the potential impacts to our business. On October 26, WPS, a Medicare administration contractor or MAC, was the first to issue an LCD, changing its coverage related to minimally invasive glaucoma surgery or MIGS procedures. Last week, as expected, four other MACs released similar LCDs, and all will become effective December 24, 2023. While the clear focus of the five LCDs was MIGS device use, they also changed their coverage criteria for cyclophotocoagulation or CPC, which is the basis for IRIDEX' MicroPulse and continuous-wave glaucoma procedures. While MIGS are incisional surgical procedures predominantly done coincident to a cataract surgery, the CPC procedures done with IRIDEX devices are neither incisional nor are they commonly done coincident to cataract surgery. While the MACs provided little context or explanation for their motive in coverage changes, it's believed they were reacting to the rapid rise in volume and cost of MIGS procedures, particularly driven by multiple MIGS devices deployed during one cataract intervention. This drove an increase in surgeons submitting multiple billing codes and a large increase in reimbursement expense per procedure and in total. The LCDs limit MIGS procedures concomitant with cataract surgery to a single device and specifically call out newer MIGS devices that enable both a canaloplasty and a goniotomy procedure to be performed with a single device. These and several other procedures were labeled as investigational, which means they were made ineligible for Medicare reimbursement until more rigorous clinical work on effectiveness is published. The LCDs confirm that cyclophotocoagulation received continuing payment coverage. Unlike the targeted MIGS procedures, CPC is not labeled as investigational. However, the coverage criteria for CPC was redefined via an extensive list of patient characteristics and symptoms that would effectively limit reimbursement to procedures performed on patients suffering from very advanced-stage glaucoma. For our business, on patients enrolled in these restricted-coverage MACs, this means fewer MicroPulse TLT procedures and stricter limitations for continuous-wave CPC procedures. So how many fewer procedures? Let me run through the numbers to get a sense of what impact the LCDs might have on IRIDEX' glaucoma revenue. And note, there's still a high degree of uncertainty. We believe the following classifications and assumptions represent the situation. First, half of IRIDEX' glaucoma revenue is international and unaffected. Further, two of the seven total MAC payers in the United States have not issued a change to the cyclophotocoagulation coverage. These MACs cover about one-third of our U.S. footprint, including key states like Florida, Texas, and Pennsylvania. To be clear, CPC is still covered in all the MACs; the procedure is just now subject to restrictions, narrowing its coverage in five of the seven MACs. So the American Glaucoma Society estimates that approximately 60% of U.S. glaucoma patients are covered by Medicare. Our procedures are performed on moderate to advanced severity, probably skewing a little bit older, so we estimate about 70% of our volume has Medicare coverage. However, within Medicare, about half of patients are covered by these MACs' network of payers and half are in Medicare Advantage programs, which are administered by traditional insurance companies like Aetna and UnitedHealthcare. Currently, none of the MAC Advantage or Medicare Advantage payers have altered their coverage for CPC even as they've issued new updates for their MIGS coverage criteria. At this time, IRIDEX cannot accurately predict the impact these LCD coverage changes will have on its U.S. glaucoma probe or system business. The math implies about 20% of U.S. procedures fall directly under the MAC coverage restrictions, with our glaucoma procedures for the most severe patients the least affected and those for more moderate stages being most affected. At this time, it's uncertain how physicians will react to coverage reductions and their decisions to offer our treatment to patients. We've heard many doctors, particularly during the recently held American Academy of Ophthalmology in San Francisco, that CPC is not only a proven and effective but an essential part of their treatment program for controlling the progression of glaucoma for their patients. These physicians communicated their strong intention to continue performing CPC. Several doctors discussed the possibility of offering patients for whom CPC is obviously the best next treatment an option for self-pay if coverage isn't available under their plan. Qualitatively, there are two important competing considerations. First is going to be physician confusion and frustration surrounding these reimbursement changes in the affected MAC states. We expect the coverage restrictions will result in many of our potential prospects deferring adoption, leading to fewer domestic orders for consoles and probes as providers work through the confusion around what has changed and who’s affected and how they will position CPC in their practice. In affected MAC regions, doctors may not be aware of an individual patient's coverage and to whom they can offer our procedures and generally pull back usage to avoid non-reimbursed procedures. On the other hand, there are some potential positives for IRIDEX. MIGS are a big deal in the glaucoma community right now, and the LCDs are receiving a lot of attention. And this includes physicians wrestling with their options going forward in treating the disease. Ironically, with the LCDs falling hardest on MIGS and thereby almost certainly reducing the number of MIGS procedures that will be performed, there should be greater need, recognition, and interest in non-incisional alternatives. This is a marketing opportunity that plays right into IRIDEX' existing positioning in glaucoma. The LCDs' effort to reduce the number of MIGS procedures may ultimately trigger the longer-term effect of significantly improving the market opportunity for our CPC offerings, both in the U.S. and OUS. Ophthalmologists that have long been caught up in the growing assortment and uptake of MIGS may be more open to IRIDEX' non-incisional alternative. Beyond working to appeal the LCD coverage restrictions, IRIDEX will have the opportunity to position itself as a champion for patients, physicians and pursuing the best medicine. Many clinicians have commented to us that it's a mistake to channel patients toward more advanced surgical procedures too early. It's basic disease management to defer more complicated higher-risk surgeries as late as feasible. On top of that, there are many patients where surgery may not be indicated. This includes older, poorer-health candidates and the younger, otherwise healthy individuals for whom a glaucoma surgery in their 40s, 50s, and 60s can be complication-prone and lifestyle-limiting and may also result in decades of more involved and expensive follow-up. We believe we have a strong case to appeal the specifics of the LCDs, and we're gaining and gathering support within the physician community. We've submitted the first phase of our appeal, working with several influential physicians, some of whom plan their own letters and reference studies explaining why overly restricting CPC is a mistake. The final LCDs ultimately set the criteria for CPC patient characteristics by partially adopting conclusions from an AAO technology assessment report that is 22 years old. We believe they erred by setting compounding criteria for coverage, resulting in overly narrow patient qualifications. They also erred by only choosing some of the recommendations from that assessment and ignoring others. The conclusion of that assessment by the AAO presented a list of several patient types for which CPC is indicated as appropriate treatment options. The LCDs quoted this list of symptoms and characteristics but replaced the commas between them with the word 'and'. The resulting effect means that to qualify, a patient must have all of the characteristics of each listed patient type. This appears clearly wrong. We sent a correction request noting the process errors and seeking rapid adjustment to the definition. We believe this appeal is compelling and should, emphasis on the word 'should', lead to a relatively speedy correction of the LCDs to lessen the successive restriction of coverage for CPC. We believe the error of interpretation embodied in the current wording, if uncorrected, will lead to unrecoverable loss of vision in patients who may be denied access because of the erroneous restriction. We urge each MAC administrator to promptly correct this error before the effective date. We're also preparing a subsequent appeal for reconsideration to further broaden the criteria for reimbursement. First, the coverage change did not appear to take into account patient safety by requiring a patient must have undergone more invasive, higher-complication rate surgeries like trabeculectomy or tube shunts. By pushing patients into earlier invasive surgeries, greater follow-up management is required, later life options will be more limited. Basically, if you use up your IOP control tools too early, it can lead to greater loss of vision later in life. Second, the process for considering study evidence was flawed. We have a large body of peer-reviewed clinical studies to support our procedures in a broad range of patient types and severities. This past summer, we submitted to the MACs over 80 published papers on transscleral cyclophotocoagulation, treating over 2,000 patients. It appears their process criteria rejected most of this evidence. Instead, we will seek them to consider the broader body of evidence that supports the safety and efficacy of cyclophotocoagulation. So this leads straight into updating our ongoing clinical programs. As we've discussed prior, we had planned to enroll the first patient by the end of the year in our new prospective multicenter study that will include key opinion leaders as investigators. This release of new clinical criteria within the LCDs will potentially cause a modest delay in the launch as we assess whether our protocol and method are best aligned. But we're nonetheless fortunate to already be well along the road toward producing the clinical data they have stated as required for future reimbursement decision consideration. Having glaucoma physicians rally in support of IRIDEX CPC, at the same time, we're finalizing preparation for a clinical study on the efficacy of CPC specifically targeted to post-MIGS patients, seems very favorable. We'll try to advance our message and market position by capitalizing on the opportunity and attention created by the LCDs. We have confidence the efficacy and safety of our procedures will prevail, and the increased clinician awareness generated through this process can provide exposure and positive public relations at a scale we could never have afforded. Let me shift to recent announcements that the Board of Directors is engaged in a review and evaluation of strategic alternatives that may be available to IRIDEX to unlock shareholder value. This is an appropriate time for the company to explore options for the future of each of our product lines and the company as a whole. Our retina business has achieved a global leadership position in both sales and installed base in ophthalmic laser treatment systems for retina specialists. Over the past 30 years, the company has developed products and has set the clinical and technical standards in the space. Most recently, we launched the new PASCAL platform with MicroPulse capability. In glaucoma, we've been the leading provider of non-incisional transscleral laser treatment beginning 30 years ago with the G-Probe cyclophotocoagulation treatment for later-stage glaucoma patients and more recently with MicroPulse Transscleral Laser Therapy for moderate- to advanced-stage glaucoma patients. Since launching MP-TLT, we steadily expanded our market presence to over 2,000 glaucoma laser consoles worldwide and delivered over 250,000 single-use probes. Both our revenue and product offerings are the strongest they've ever been. We're progressing through our process but do not plan to provide commentary or updates along the way until the Board of Directors determines that disclosure is appropriate. Before I turn over to Fuad for a review of the third quarter financials, I'd like to add a couple of items of perspective. The quarter was in line sequentially, which is positive given Q3 is generally seasonally softer than the second quarter. This quarter was a tougher year-over-year comparison against the strong third quarter of 2022, especially given the loss from expirations. We expected the announcement of our strategic review might have impacted short-term results. But fortunately, we saw a little of this domestically, and it was primarily our distributors that held back orders concerned about the appropriate levels of inventory to carry going forward. As a result of the Medicare reimbursement changes, we have suspended our guidance due to the high variability of the U.S. glaucoma situation and how our business may unfold in Q4 and going into 2024. We remain very focused on cash management to maintain our operating runway and intend to adjust our glaucoma operations as we evaluate the impact to our business from these reimbursement changes. With that, I'll pass the call over to Fuad to discuss the quarter's financial results.

Fuad Ahmad, Interim CFO

Thanks, Dave, and good afternoon, everyone, and thank you for joining us today. I would like to begin by reviewing our financial performance for Q3 of fiscal 2023. Let me start by providing a high-level summary. We generated $12.9 million in total revenue in Q3, which was flat sequentially versus Q2, important because it is typically a seasonally lower quarter. However, it was down $1.8 million from the prior period, continuing the overall softness in the capital equipment market in '23. A significant part of the decline, approximately $500,000, was due to loss in royalty revenue, as we previously mentioned. And this will be a drag until we lap it next year. On both the G6 and retina side of the business, the macroeconomic and probe adoption headwinds in 2023 we discussed during the August second quarter results call continued to affect overall sales in Q3. Our retina segment revenue in Q3 was $7.9 million compared to $8.8 million in the prior year period. In the quarter, we continued to see stronger and longer capital sales cycles. The strong dollar made pricing challenging internationally and has persisted throughout 2023. While these dynamics contributed to lower sales in retina systems, we aren't seeing customers cancel their capital purchase plans, and we are maintaining a solid pipeline, and our strong market share in the U.S. looks stable. In glaucoma, system purchases were significantly slowed as capital sales were impacted by higher interest rates and economic uncertainty contributing to elongated sales cycles. This weakness led to system sales of 27 units in the quarter compared to 54 systems in the prior year period. The system sales shortfall accounted for the decline in overall Q3 Cyclo G6 revenue to $3 million from $3.5 million last year. Overall, we saw glaucoma probe revenue increased 3% but suffered a 3% decline in units primarily due to order flow in international markets. International volumes were affected by a loss of sales to Russia due to geopolitical issues and soft China sales as anticorruption initiatives caused a stall in new adoption, similar to what other companies are seeing. We also saw distributors reducing inventory levels in both probes and systems possibly as a result of our strategic announcement in August but also to reduce carrying costs. Now to product-level details. Total revenue from Cyclo G6 product family in Q3 was $3 million, down 12% compared to the same period in '22. We sold 13,250 Cyclo G6 probes in Q3, representing revenue growth of 3% on higher ASPs on a negative 3% unit growth from the prior year period. We also saw 27 Cyclo G6 systems in the quarter compared to 54 in the prior year period. Our retina product revenue in Q3 was $7.9 million, up 15% sequentially but a 10% decline from the prior year period. Other revenue, which includes royalties, services and other legacy products, decreased 20% to $1.9 million in Q3 of '23 compared to the same period in '22, driven primarily by reduced royalty revenue of approximately $500,000 from the expiration of license patents and lower-than-anticipated service and repair volume. Gross profit for Q3 of '23 was $5.6 million compared to $6.5 million in the prior year period. Gross margin was 43.7% compared to 44.1% in Q3 of '22. The decline in gross margin was a result of lower overhead absorption in the current period and a more favorable product mix in Q3 of '22. Operating expenses in Q3 of '23 were $7.3 million, a significant decrease compared to $8.2 million in the same period last year. The decrease in operating expenses is a result of cost reduction initiatives the company began in Q2 of '23. Our net loss in Q3 of '23 was $1.8 million, or net loss of $0.11 per share, compared to a net loss of $1.8 million and a net loss of $0.11 per share for the same period in '22. I will now discuss our cash position and cash flows. The net cash reduction in the quarter was $1.8 million to finish with $8 million at quarter end. We were successful with inventory reduction of $1.1 million, but we also reduced accounts payable by $1.7 million. Over the summer months, we significantly reduced our operating expense run rate by more than $3 million annualized. As a result, we are positioned for a significantly lower cash usage in Q4 and a substantially lower run rate in 2024. We will remain focused on expense management and operating efficiencies in the coming quarters as we continue to unwind inventory-related investments and manage cost to mitigate U.S. drop in probe revenue from reimbursement limitations. Finally, as we previously reported, in light of the ongoing ambiguity related to the Medicare reimbursement picture for our glaucoma procedures, we are withdrawing our fiscal 2023 guidance. We will provide a comprehensive update when we have more clarity on the matter. With that, Dave and I would like to turn the call over to the operator for questions.

Operator, Operator

Our first question comes from Tom Stephan with Stifel.

Thomas Stephan, Analyst

I'll start with the LCDs. I mean just a couple here. Dave, what's the mix of moderate versus severe patients for Cyclo G6 today? I think in the past, you've talked about moderate being a very large opportunity for G6 as it was maybe no more than 25% of volume today. So I guess if the majority of your volume is that refractory patient, I'm just curious why the coverage criteria would be such a headwind. And then I have a follow-up.

David Bruce, CEO

Thanks for the question. Yes, for very late-stage patients, the criteria includes factors like very limited visual potential and pain, among others. It also requires having had a prior trabeculectomy or tube-shunt procedure. These restrictions likely exclude many later-stage procedures. We estimate that around 25% of patients would qualify under these strict criteria, while about 75% would fall under advanced stages but not meet these specific criteria. In areas where MACs are the insurers, we find the coverage is quite restrictive. However, if clinicians are aware of their patients' coverage, typically about two-thirds maintain coverage. Therefore, it's essential to collaborate with clinicians to ensure they understand their patients' coverage, and if they aren't currently aware, it might be beneficial for them to become informed.

Thomas Stephan, Analyst

That makes sense. And then with the LCDs, just regarding the timing of the 8-K, the proposed LCDs obviously came out starting in June, and CPC wasn't even determined to be covered at that time. So why is it now expected to be a 2023 headwind or issue? And maybe why wasn't that the case or the thought, I guess, it was 4 or 5 months ago?

David Bruce, CEO

The proposed LCDs were released in June, and we submitted an appeal along with clinical evidence and various arguments to maintain coverage. We had some success because the original LCDs labeled all cyclophotocoagulation as investigational, but now there is coverage with several restrictions. We believe that incorrect assumptions influenced the creation of that list. Two years ago, one of the MACs classified cyclophotocoagulation as investigational, and we successfully challenged that with our responses, but there were no updates in the final determination. When this year’s proposed LCDs came out and we responded, we thought it unlikely that there would be significant additional restrictions, which is why we did not issue an 8-K at that time. Many clinicians are now learning about the new final determinations and are reacting to them in real-time, showing some outrage and then trying to figure out their next steps. The actual determination has now introduced significant restrictions, which we believe will lead to two potential short-term impacts for Q4. First, in areas with restricted MAC coverage, clinicians may take longer to decide whether to adopt new systems and probes, likely postponing purchases until next year. Second, in cases where only partial coverage is available, clinicians may refrain from offering the procedure to patients, depleting their existing inventory without reordering. We’ve spoken to many clinicians, and their responses vary widely about their future actions. Consequently, instead of providing a broad range of potential outcomes for the quarter, we've opted to withhold guidance.

Thomas Stephan, Analyst

Got it. That's great color. And then last question, just pivoting to retina, modest upside in the quarter relative to our estimates, and sequential growth was very strong. I guess, Dave, can you talk about how you're executing in that business and you're now lapping, I think, some tougher comps. So what do you believe is a sustainable growth rate for that segment kind of as we, I guess, sit here today?

David Bruce, CEO

The retina business is performing well. Early in the year, macroeconomic factors led clinicians to defer their purchasing decisions rather than canceling them. The strong performance in the third quarter may reflect some of these deferrals from the second quarter. We believe we are moving past this uncertain period. Additionally, we launched our new IRIDEX PASCAL platform, which has received positive feedback, encouraging evaluations and purchases. We are optimistic about the capital equipment market in the U.S. However, internationally, we haven't seen the same recovery in purchasing mindset, and we've experienced fluctuations in distributor inventory. This can lead to variability in quarterly performance. Overall, we are confident in the strength of the retina business and anticipate solid growth ahead. This segment of the industry is mature, with a long-term growth rate averaging in the mid- to lower single digits, which we believe we can meet or exceed. We expect to experience some quarter-to-quarter volatility, but the moving average will give a clearer indication of our performance. We are comfortable and assured in the retina business.

Operator, Operator

Our next question comes from Scott Henry with ROTH Capital.

Scott Henry, Analyst

Dave, I wanted to clarify regarding the retina business. When discussing organic growth, is the mid-single digits what you're targeting for that category? I just wanted to ensure I understood correctly.

David Bruce, CEO

We believe the long-term outlook in that area is stable. It's a mature market with a replacement cycle, particularly as group practices or universities in urban areas open satellite locations in the suburbs that require similar equipment. At this point, while we have leading technologies, there's not a significant new cycle emerging to replace older equipment due to groundbreaking new features. We are positioned for a replacement cycle, especially since many systems older than five years, including numerous PASCAL systems nearing the end of their service life, cannot be repaired if they fail. We anticipate opportunities for above-trend growth, especially if the capital equipment environment improves, although we expect ongoing quarter-to-quarter volatility. Strong quarters, like last year's third quarter, may lead to weaker comparisons in the following periods. Overall, the long-term trend is upward, with short-term moving averages also trending in the mid-single digits or better.

Scott Henry, Analyst

Okay. The other line decreased sequentially from the second to the third quarter. Regarding the $1.9 million figure, do you think that's the base? Or should we anticipate further declines? I'm trying to gauge the lowest point for that category. I understand some factors have changed and will annualize, but I'm looking to clarify what the base level is.

David Bruce, CEO

Yes. The two drivers of volatility in that number are the change in elimination of a long royalty contract that we had. So the patent expired and so the contract expired, and that was about $500,000 a quarter. And that's why the comparison to last year was a dip of about $500,000. Also in that other category is service revenue. We have a strong service business where most of it is depot service. They ship a system back to us, we repair it, and ship it back, and we sell extended warranty contracts. So we're booking revenue accruing it quarterly for those extended service warranty contracts. And then we're also doing individual service on a nonfunctioning system as well as preventive maintenance. So there are regular preventive maintenance cycles, and certain states are stricter than others, but we have a steady flow of systems that need to be checked, calibrated and recertified and sent back. So that business goes up and down, and that can vary by $100,000 or more in any one quarter. And so that can contribute to that number.

Scott Henry, Analyst

Okay. Regarding the G6 business, I'm not seeking guidance since I know you won't provide it. As we think about Q4, which we're currently in the middle of, what should we consider from that view? Have systems been sold, or has everything kind of collapsed? I'm just trying to get an idea of the kind of response you initially observed in the next month.

David Bruce, CEO

Well, I mean frankly, so are we. It's all across the board, and you feel like a play-by-play announcer because you have one conversation with someone who is from a state where there is no change to coverage. What's the issue here? And then others that just fear this is very restrictive, that it could extend to additional payers and are very seriously considering eliminating or at least very significantly restricting their offering of CPC. And those are the factors that make it very difficult. And so as much as we tried to really put together scenarios and identify a range, it's a little bit difficult here. I mean this news is two weeks old. So that's the problem with trying to do guidance. Clearly, people have said, I got to wait. Let's see what happens in terms of system purchases and adoption if a significant chunk of their intended procedure volume isn't going to be available because it's restricted on reimbursement. So we will obviously stay very focused on it. And as we can develop a picture, we'll take a look at when it's appropriate to reinstate guidance.

Scott Henry, Analyst

Okay. Fair enough. Final question. With regards to the appeals process, what would be our next data point?

David Bruce, CEO

Well, as I said in the comments, we submitted an appeal on the grounds of misinterpretation of the actual study that they quoted to set the definition of the criteria. And that's in the hands of the various MAC administrators, and there is no defined schedules that they must act under and respond under. So it's difficult to know whether they will respond immediately. That's what we seek. We think it's compelling that they do. It's very unusual. I can't say I've seen it in any other types of situations where the specific paper that you quote, you change the criteria that was written in that paper. And it just seems highly unusual to us and to everyone that we've discussed this with and seems like an error in interpretation that should be corrected. And we hope they see it that way.

Operator, Operator

I would now like to turn the call back over to Dave Bruce for any closing remarks.

David Bruce, CEO

Thank you. And thank you all for attending. I know it's a bit of a turbulent time. There was a lot of information that came our way, and we tried to share with you. And we'll stay focused on managing through this situation and look forward to updating you in the future. Thank you.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect.