IRIDEX Corp (IRIX) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the IRIDEX Corporation third-quarter 2010 earnings conference call. (Operator Instructions). This conference is being recorded today, Thursday, November 4, 2010. At this time, I would like to turn the conference over to Ted Boutacoff, President and Chief Executive Officer. Please go ahead, sir.

Welcome to IRIDEX Corporation's third-quarter 2010 conference call. I am Ted Boutacoff, President and CEO. I am joined by Jim Mackaness, our CFO. And before we get started, Susan Bruce, our Executive Administrator, will read the required Safe Harbor statement.

This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended, relating to the Company's scalable business model, operating expense control, product demand, growth strategy and prospects, including the Company's fourth-quarter revenue, gross margins, operating expenses, as well as the impact of tissue-sparing laser photocoagulation and the laser market as a whole.

These statements are not guarantee 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 January 2, 2010, and our Quarterly Report on Form 10-Q for the second quarter ended July 3, 2010, 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. We are pleased to report improved performance in the third quarter. As we predicted during our last earnings call, the effects of European economic crisis during May and June, which had a swift and negative impact on capital equipment sales during the second quarter, were indeed transient.

Our third quarter saw solid results across all elements of our business. We exceeded our Q3 guidance. We reported our seventh consecutive quarter of operating income. We experienced growth both year to year and sequentially and continue to strengthen our balance sheet.

Our growth strategy is based on organic initiatives and strategic acquisitions, and we are beginning to see the benefits of some of the initial steps we have already taken. As we look at our nine-month 2010 performance compared to our nine-month 2009 performance, in ophthalmology, domestic systems sales, our durable systems, have increased 19% to $4.2 million. International system sales have increased 14% to $6.3 million.

Our focus on maintaining our leadership position in laser photocoagulation technology with the introduction of the IQ 577 and IQ 532 laser systems have contributed to these results, as has the recovering economic climate.

Although recurring revenues, consisting of consumables and service, decreased 5% to $12.1 million, the leading indicators suggest that we have turned the corner. We expect this to be accelerated with the introduction of our recently released adjustable and intuitive EndoProbe and the ramp-up of the products we purchased from RetinaLabs.

Growing our consumables through new product introductions and acquisitions is another core piece of the strategy. This week, we were awarded a federal therapeutic research project grant in the amount of $244,000 to accelerate the introduction of another new consumable product. And even with the slowdown in Q2, our diluted earnings per share for the nine months were up -- were $0.22, up from $0.21 for 2009.

Jim Mackaness will now discuss the details of this quarter's results, and then I'll give you an update on the American Academy of Ophthalmology meeting that recently was completed and how the feedback from a number of key opinion leaders supports our plan for growth in 2011. Jim?

Thanks, Ted. I'll start by reviewing our third-quarter revenues. Total revenues for the third quarter of 2010 were $10.8 million, up 4% or $0.4 million compared to $10.4 million reported for the corresponding quarter in 2009 and up 9% on a sequential basis from $9.9 million as reported for Q2 2010.

Ophthalmology revenues for the quarter were $8.0 million, up 4% from $7.7 million for the third quarter of 2009 and similarly up 4% on a sequential basis from $7.7 million reported for Q2 2010.

Looking at these revenues geographically, domestic ophthalmology revenues, excluding OEM revenues, for Q3 2010 were $4.8 million, up 10% or $0.4 million compared to $4.4 million for Q3 2009 and up 26% or $1.0 million compared to $3.8 million for Q2 2010.

Generally, we see business activity recovering. We did suffer some part shortages, which prevented us from shipping all of our backlog. And we did win a large order from the US military for $0.5 million that we have been working on for an extended period of time.

OEM revenues, which we disclose as part of our domestic ophthalmology revenues in our Form 10-Q, were $0.1 million for Q3 2010, down $0.2 million from the $0.3 million reported for Q3 2009 and down $0.1 million from $0.2 million reported for Q2 2010. As we've mentioned previously we anticipate OEM revenues to continue to decline as our OEM partner moves to a new platform.

International ophthalmology revenues totaled $3.1 million, level with $3.1 million for the third quarter of 2009 and down 16% or $0.5 million compared to $3.6 million for Q2 2010. Sales were lower on a sequential basis, reflecting the traditional international seasonality of the July/September period. Similar to domestic ophthalmology systems, we did end up with some backlog due to part shortages preventing us from shipping all orders.

Looking at the recurring component of our ophthalmology revenues, which consist of consumable products and service, on a worldwide basis, revenues were $4.2 million and represented 53% of total ophthalmology revenues for the third quarter 2010. This represents a $0.1 million increase from $4.1 million reported in the third quarter 2009 and a $0.3 million increase from $3.9 million on a sequential basis. This is the first time in a number of quarters that we've had both year-over-year and sequential-quarter growth. With the recent introduction of the adjustable and intuitive EndoProbe, we are looking for this trend to continue.

Aesthetics revenues for the quarter were $2.8 million, up 5% or $0.1 million from $2.7 million for the third quarter of 2009 and up 27% or $0.6 million on a sequential basis from $2.2 million reported for Q2 2010.

Looking at these revenues geographically, domestic aesthetic revenues totaled $1.6 million, down slightly from $1.7 million for the third quarter of 2009, but level with $1.6 million reported on a sequential basis.

International aesthetics revenue totaled $1.2 million, up $0.2 million compared with $1.0 million for the third quarter of 2009 and up $0.6 million on a sequential basis from $0.6 million in Q2 2010.

We commented on our last earnings call that our Q2 results have been negatively impacted by the economic crisis in Europe, and we thought this was a short-term phenomenon. This turned out to be correct. The bounce-back was all the more rewarding because the July-to-September period is typically a seasonally lower sales period internationally.

Switching attention to gross margins and expenses, gross margins for the third quarter 2010 were 48.5%, lower than 49.2% reported for the third quarter of 2009; however, up from 45.9% on a sequential basis.

Compared to Q3 2009, gross margins decreased due to unfavorable manufacturing variances of 1.5% of revenues compared to favorable manufacturing variances of 0.8% in 2009. Manufacturing variances include inventory and warranty reserve movement and adjustments for overhead absorbed on closing inventories. This decrease was mitigated by a favorable change in product mix, which reduced our direct costs, and volume efficiencies as manufacturing and service costs held steady, while revenues increased.

We have commented before that our near-term target range for gross margin is 45% to 50%, and we have been executing consistently within this range. Operating expenses in the third quarter 2010 were $4.4 million, up $0.2 million from the third quarter 2009, but consistent with $4.4 million on a sequential basis.

Our operating expenses were 40.3% of revenues for the quarter. This is within our stated goal of managing operating expenses to between 40% to 42% of revenues for the year.

We generated $0.9 million in operating income. This was lower than the $1.0 million reported for Q3 2009, but up significantly on the $0.1 million reported in Q2 2010. And it was our seventh sequential quarter of operating income.

Our tax rate for 2010 is currently estimated to be 10%. Our tax rate is benefiting from a forecasted reduction in the valuation allowance we currently have booked against our deferred tax assets. Ultimately, assuming we remain profitable, the entire valuation reserve will need to be released, and our tax rate will return to more normal levels. At the end of 2009, the valuation allowance totaled $12.8 million.

This takes us to the bottom line. The Company recorded a net income of $0.9 million or $0.09 per diluted share for the third quarter of 2010 compared to a net income of $0.6 million or $0.07 per diluted share for the third quarter of 2009. Net income for Q2 2010 was $0.8 million or $0.08 per diluted share.

Our EBITDA for the quarter was $1.0 million. This calculation does not include any FAS 123R stock competition expense. And although our cash generation for the operating activities was only $0.2 million for the quarter, the increase in business activity has led us to invest in more inventory, and our accounts receivable balance has increased as revenues have increased. This is reflected in our working capital increasing from $14.9 million to $16.1 million during the quarter.

Guidance for Q4 2010 -- we are forecasting revenues to be between $11.0 million and $11.2 million, gross margins to be between 45% and 48%, and operating expenses to be between $4.6 million and $4.8 million.

And with that, I'll turn the call back over to Ted.

Thank you, Jim. With our improving financial performance, we are increasing investments in areas which we believe will accelerate our revenue growth. And we do that in two parts -- internal initiatives and acquisitions. So I'm going to talk about both of those.

With regards to internal initiatives, we are focused on introducing new consumable products at a rapid rate. We are now selling a new family of adjustable and intuitive EndoProbes, which are patent protected. As we received regulatory clearance to be able to offer our complete line of EndoProbe devices in Japan through our local distributor.

For durable products, we received a patent for our tissue-sparing technology, which we call MicroPulse. And I will comment further on that in a minute and the importance of this.

With regards to acquisitions, we are making progress in utilizing the products and intellectual property acquired from RetinaLabs. We received CE certification that will allow us to sell the existing products into a number of overseas markets through our existing distributors. And this week, we were awarded a federal therapeutic research project grant in the amount of $244,000 to accelerate the introduction of another new consumable product based on the acquired IP. And then we are actively looking for new acquisition opportunities.

I would now like to add a few comments on the American Academy of Ophthalmology meeting that was just completed here a couple weeks ago. We definitely saw the business activity level being up from last year. We booked more sales on the floor, and the lead count was up significantly, which we take to be good indicators of improving times ahead.

Probably most significantly on a strategic level was the increased interest and the growing acceptance amongst key opinion leaders in the retinal market of the opportunity afforded by tissue-sparing laser photocoagulation. Our hypothesis is that tissue-sparing-enabled lasers can provide the long-term therapeutic benefits that we have come to expect from standard laser photocoagulation, but without having to damage the retina -- hence, tissue-sparing.

There continues to be growing evidence, both in terms of studies undertaken and advancements in the underlying science, that supports our hypothesis. The interest amongst key opinion leaders was significant. The adoption of tissue-sparing as the new modality to perform laser photocoagulation would most likely generate a significant uptick in equipment replacement cycles and afford us the opportunity to drive increased ASPs for the tissue-sparing laser system sales.

And one final note -- with the progress we have made to date and with the opportunities we see before us, we have engaged Matt Clawson and his team from Allen & Caron to work with us as our Investor Relations team. And we are excited to take our story to a wider audience.

I will now open the line up for questions.

(Operator Instructions)

(Operator Instructions). Stan Mann, Mann Family Investors (sic).

I have several questions. One, we seem to be making progress. Question number one is, the Allen & Company (sic) hiring, how do you -- how have you directed them? Is this to sell a company, to acquire companies or to get institutional coverage? Could you give us a little more color on what their job is?

Their primary focus is to expand the investor interest in the Company.

And how are they going to do that?

Well, standard protocol. They will basically look to work with us on targeting investors who would be interested in our story and companies of our size, looking to get us in front of the right people, and basically taking -- as we've spoken before, Stan, just basically taking our story out to a wider audience to drum up interest in the opportunity we have.

All right. The basic -- one of the basic problems, we've discussed it, is that at the size of the Company we currently have, there really is not a lot of interest in this current marketplace. So, address with me what they really intend to accomplish. I mean, our daily trading is not very high. Our liquidity is not high. So it's nice that we hired them; I think that's a good step. But what are they targeting?

Well, as you probably are aware as we are, there's a lot of money on the sidelines and there's a lot of people looking for potential investments. There's a lot of value invested out there. And so we have spent a lot of time and effort, as you know, on getting our performance to a level where we think it starts to make sense to put our story in front of people. We've spent a lot of time in synthesizing our growth strategies and starting to execute on those. So we think it's appropriate to get in front of people and introduce IRIDEX to them.

Have we added any coverage, institutional coverage, in the last year?

The only thing we had was we picked up Morningstar at the beginning of this year.

And that has been it? And they're not really doing extensive coverage, are they?

Correct.

Okay. My second question is, why is our -- are we going to try and leverage our cost base, especially SG&A? I noticed our G&A moved up 10% from last year's quarter. Can you kind of give us a reason why G&A has gone up disproportionately in this environment?

I think you are talking about G&A being at one-point-one --

-- two-five versus 1.061%, yes. A 10% increase.

Yes, I think we're really sort of by and large getting down to -- on the G&A side, we're talking 1.12% versus 1.061%, correct?

Yes.

So we're really talking about $60,000 in a quarter?

The size that we are, the size that we are and the pennies we have watched is significant. I would like an explanation.

well, I think that $60,000, that is just predominantly attributable to timing differences. I'm not sure that -- as you've said, we've taken a lot of expense out to get down to a pretty steady state. We were at comparable levels to the preceding quarter.

But we are going to leverage our cost base as our sales increase. That's what I'm getting to.

Well, yes.

We are?

Yes.

My last question is, Ted mentioned RetinaLabs, the acquisition. Can you give us an idea of what dollar contribution their products have made thus far?

No, we are not commenting today.

No comment.

No comment.

Okay. Is there a reason why no comment? I --

No, we just don't break our revenues down to that level of granularity. We provide guidance on systems. We provide guidance on consumer --

I'll give you a simple approach. Have they made a significant contribution to our sales?

I'm going to stick with the no comment.

I'm not asking for dollars. I'm asking if they have made a contribution to our sales.

We've -- they have made a contribution.

They have?

Correct.

And we expect a larger contribution going forward, from Ted's comments?

Correct.

Okay. And the last thing is, we are looking at acquisitions of bolt-on product lines?

Correct.

Are we close to any?

Again, we're not going to start getting into comments about where we are in the pipeline.

Okay. Thank you.

Larry Haimovitch, HMTC.

Congrats on a nice quarter.

Thanks, Larry.

Thank you, Larry.

Jim, you mentioned -- I don't think it's significant, but I just wanted to clarify -- you mentioned there were some orders which weren't shipped because of a manufacturing problem. Was that at all significant? What are we talking about, small potatoes or bigger potatoes?

It was just a couple of hundred thousand. It was just due to -- it wasn't manufacturing difficulties per se. It was supplying of parts through our supply chain.

Right, right. So sales would have been a couple thousand higher, a couple hundred thousand higher, if you hadn't had that issue?

Correct.

Has that problem been corrected for Q4?

Well, yes, in the sense that what we were looking for has come in. But as we move through the quarter, one of the things driving our inventories down, as we've commented, is we know we've got ourselves down to bare bones in certain areas. So now we have to just balance that and make sure that -- what we want to try and avoid is letting inventories creep up too much, but on the other hand, we also want to avoid shortages where at all possible.

Right. I guess this would be for you also, Jim. The aesthetics seems to have bottom based on the numbers you share. Is that -- did I understand those numbers correctly, number one? And number two, is that your sense, that maybe we have kind of bottomed out with the aesthetics business?

I would say that in the US, for the first time, I think we started to see a return to more normal buying behavior. We were better able to track and capitalize on opportunities. So I think that is indicative of this bottoming out. Internationally, we have done very well in certain markets, but Europe was caught a little bit short in Q2, and that came back.

So I think overall, yes, we feel there is a lot more stability there than there has been. We're obviously sensitive to the fact that we have relatively high ASPs and low unit volumes, but the market itself we think has definitely bottomed out a bit.

So based on your guidance, you're looking for roughly $42 million to $43 million in revenue for the full year. How much of that would be aesthetics approximately?

I'm going to say between 25% and 30%, I think, doing the sums in my head.

It's as high as $10 million or more?

25%, yes.

Okay. I didn't realize it was that high, because I know it had declined so much. I hadn't realized it was still accounting for that much of sales. So 25% or 30%, so roughly $10 million to $12 million, somewhere in there?

Yes, exactly.

Okay. Ted, on the acquisition front, we were all very encouraged by the RetinaLabs deal. That was many months ago. I would like an update on what the process is internally, what your pipeline looks like. I mean, one of the companies that I'm very close to, for example, the guy that's mainly in charge of acquisitions, he'll tell me that he's got a pipeline of 50.

Now, obviously, he's not close to closing deals on 50, but he maintains a long list of potential candidates that he talks to from time to time. I would like to know what your pipeline looks like, how active you are personally, and what the process is internally to vet all these opportunities out.

Well, we don't have 50.

Yes, that would be a lot. I understand that.

We're probably -- our pipeline is about 10 that we're looking at. And as you know, we're looking at both therapeutic and diagnostic in retina and glaucoma. Those are our targets. And the numbers of those prospects are increasing as opposed to decreasing as more people become aware of our interest and the more we are involved in engaging people in the broader market.

We have them at different levels. We have some that are -- that we have quite far down the pipeline that we've engaged in some pretty good discussions, and others that we're just beginning to have discussions with.

Okay. So if I called you and said, hey, Ted, I've just come across a very interesting retinal or glaucoma deal, what would be the process internally to work that through to a yes or no decision? You don't need to give me all the gory detail, but just kind of to get a sense of what the process might be in a general sense, who the people involved might be, etc.

Well, I would be involved. Jim Mackaness would be involved. Then we'd get some other folks. If it's an earlier technology, we would definitely get our R&D folks involved. If it's something that's a product already in the marketplace, we would have marketing and sales involved. If it's international, obviously the international folks involved. If there's regulatory issues, we have the regulatory guys involved.

Okay. I'm very pleased that you've hired an investor relations firm, but I do share some of the concerns of the earlier caller that your stock trades very poorly and the market cap is very tiny. I'm just wondering how much you really can accomplish. We would love to get some coverage, obviously, love to get some more institutional interest. Do you anticipate, Ted, actually going out, going out on roadshows and stuff like that, or just waiting for them to bring you people to talk to?

No, we plan to be proactive in this, Larry.

What was the name of the firm again that you hired?

Allen & Caron.

Oh, Allen & Caron. Sure, sure. Yes, I know them. They're good, actually, and they know the medtech space well.

And we are aware, and hence why it has taken us to this stage before we thought it was sensible pulling the trigger. We are definitely aware of the fact that we want to invest all our money wisely, but felt at this time now, with what we had, it made sense to start to make some steps in this direction.

Well, good. No, I know that firm, and they're very fluent in medical technology, and they will probably be very, very helpful. So that's good. I am pleased to hear that. Thank you.

Sam Bergman, Bayberry Asset Management.

A couple questions. In regards to the RetinaLabs acquisition, how many products did that bring to the Company?

There were three commercially shipping products at the time, and then there was IP on ranging between perhaps three to five others.

Is there any product up at this point for FDA review or not?

With the tax grant we just received, we will be accelerating one of those for FDA approval.

Okay. And on the MicroPulse technology or the tissue-sparing product, is there any opportunity to license that particular product?

Again, by whom? For us to license to others, or others to license from us?

Yes, you to license to others.

We haven't considered that, and we have not been approached. I think it depends on the situation.

Are there any competitors in that particular field with that type of product or not?

We have a competitor in -- overseas, there are some competitors.

But nobody in this country?

Nobody in this country.

Is anybody close to this country, or are they several years away from FDA approval?

I don't know what their technology pipeline is in other companies.

So how would you try to accelerate the promotion of this product going forward? Is it going to be through direct sales, or is it more for the US than overseas, or a combination of both?

Well, we sell -- revenues are 50-50 for us worldwide, both international and domestically, and with higher unit volumes shipped overseas. So we rely a lot on international sales. This is a technology that will be well appreciated by both patients and physicians globally.

So I think this will be adopted around the world. It does require either direct sales or knowledgeable salespeople. It wouldn't be something that would be easily sold through distribution.

So when you sell this to ophthalmologists, do you have to train the ophthalmologists?

We go through in-services, and there is a certain amount of training is associated with that, yes.

So are you putting any particular program together where you will invite a group of them in so you can get more people involved in using the product? Or you don't have any of those type of seminars?

We, obviously, we do have a medical education group here that provides information to physicians. And then of course, we encourage and support any training sessions that are performed in the university settings.

Ted, you had mentioned one part of the growth going forward. You're going to have some internal initiatives. What internal initiatives -- or what would be the cost for those internal initiatives on a yearly basis? Do you have any guesstimate?

The internal initiatives are budgeted through our normal budget process. So we don't differentiate what they would be. So what you see in spending right now in sales and marketing R&D are part of our internal initiative efforts.

So I know there was no guidance given, of course, for 2011, but should we expect the revenue line to grow faster than the R&D and the G&A that you have to add, assuming the ramp-up and everything else goes well?

We definitely expect revenues to grow faster than any corresponding G&A investment, for sure. R&D is -- how can I put it? -- we're a little more open to finding good things to invest in, let's put it that way. So we can get [more of what we see] and keep it prorated, but there may be times where we want to actually try and step it up a bit.

Okay. On the earnings report, I read two earnings reports. One had an $800,000 settlement amount in the earnings, and another one showed that as zero. Is there an $800,000 settlement amount that carried over quarter after quarter this quarter also or not?

There was a settlement from a legal issue back in 2007, and the outcome of it is, every second quarter, we have received $800,000. That has two more annual payments to go. So you will see that in the next two years in Q2 for $800,000.

For $800,000, so this quarter there was no $800,000.

Correct.

It was all internal profit margins.

That is correct.

Okay. And the last question I wanted to ask you, in terms of Allen & Caron coming on board, when do you expect to first start your IR program, after the first of the year or before that?

No, we are expecting to start it before that.

Before that?

Yes.

Okay, thank you very much.

(Operator Instructions). Stan Mann.

I have a couple more questions. One, Ted and Jim, do you expect to leverage gross margin as you are growing? In other words, can we expect down the road to see over the 50% gross margin, which I think used to be traditional?

Yes, that is definitely one of our goals. We think two elements to that -- obviously, volume efficiencies, and also continuing to grow the consumable line should both be able to contribute to that. So we would definitely like to get our margins up to 50% and then north of 50% from there.

Okay. Second question, Ted, do you have any feel at all for the dollar potential of the MicroPulse, the new technology, worldwide, any feel at all?

Well, there's one way of looking at it very, very top-down, Stan, if you bear with me on this.

Okay.

There's about 25,000 laser systems around the world. If, indeed, all of them are required to be replaced, then you would have a significant amount of opportunity.

So unit sales for each MicroPulse --

Probably $30,000.

Oh, that's big-time.

Yes.

Okay, but that's unlikely. So, realistically, from your experience --

No, you would have a ramp, you'd have a ramp. But you'd have some normal sales activities every year. And then I think that would be accelerated because when you're looking at replacing an asset, you say, what is new on the market out there that can provide me, the new offerings? And that accelerates the replacements. That's why our model shows an acceleration of replacement as opposed to some wholesale flip-flop into the new technology.

Of the 25,000, how many of the systems does IRIDEX -- what kind of a market share do you currently have?

We have about 10,000.

Oh, wow. That's terrific. I noticed in my visit to University of Illinois Ophthalmology hospital last week, I noticed that they're dramatically increasing the size of the department, and that's a US major hospital. Are you finding that worldwide?

We are finding that all governments are appreciating the value of good vision. And there is investment from healthcare dollars going into vision.

So you are seeing interest, growth in that sector?

Yes.

Okay. My last question, which you're not going to answer, really, at our size, either we've got to double in size to the $100 million area to get any interest -- is there any interest in the Company being acquired or consolidating?

Well again, I think the answer to that is we recognize that to become attractive, we have to do more than just grow our organic revenues by 10%, which is why we're looking for acquisitions. We also recognize that the more momentum and the more attractive that we become, obviously, to interested investors, there's also the opportunity that we start to become interesting to other companies.

So our biggest goal is to continue to make sure that we make progress, execute on our plan and grow both through our own efforts and through the acquisitions. And then we will consider the other alternatives if and when they show up.

Okay, so you are constructively open?

Yes.

Okay. Thank you. Good job, gentlemen.

Thank you. Mr. Boutacoff, there are no further questions, sir. Please continue.

Then I would like to thank everyone for participating in this call and for your interest in IRIDEX. And we look forward to sharing our progress with you at our next call. Good night.

Thank you, sir. Ladies and gentlemen, if you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030, using the access code of 4380709, followed by the pound key.

This does conclude the IRIDEX Corporation third-quarter 2010 earnings conference call. Thank you for your participation. You may now disconnect.