Strata Skin Sciences Inc (SSKN) 2018 Q3 法說會逐字稿

Good day, and welcome to the STRATA Skin Sciences Third Quarter 2018 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Jeremy Feffer. Please go ahead, sir.

Thank you, Andra, and good morning. Before we begin, I would like to remind you that management's comments today may include forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. These statements include, but are not limited to, our plans, objectives, expectations and intentions and other statements that contain the words such as expects, contemplates, anticipate, plan, intend, believes, assumes, predict and variations of such words or similar expressions that predict or indicate further events or trends that do not relate to this historic matter. These statements are based on our current beliefs or expectations and are inherently subject to significant known and unknown uncertainties and changes in circumstances, many of which are beyond our control. There can be no assurances that our beliefs or expectations will be achieved. Actual results may differ materially from our beliefs or expectations due to financial, economic, business, competitive, market, regulatory and political factors or conditions affecting the company and the medical device industry in general.

Given the uncertainties affecting companies in the medical device industry, any or all of the company's forward-looking statements may prove to be incorrect. Therefore, you should not rely on any such factors or forward-looking statements. In addition, more specific risks and uncertainties facing the company are set forth in the company's reports on Forms 10-Q and 10-K filed with the Securities and Exchange Commission. STRATA urges you to carefully review and consider the disclosures found in its SEC filings, which are available at www.sec.gov and on the company's website.

With those prepared remarks, it's my pleasure to turn over the call to STRATA's President and Chief Executive Officer, Dr. Dolev Rafaeli. Dolev?

Thank you, Jeremy. Good morning, everyone. Welcome to STRATA Skin Sciences' earnings and corporate update conference call for this -- for the third quarter of 2018. Joining me today is Matthew Hill, STRATA's Chief Financial Officer.

A strong second quarter represented confirmation of our turnaround strategy and we built on that momentum with an even more encouraging third quarter that saw continued sequential revenue growth, strong recurring revenue growth and improved margins, resulting in a cash flow positive quarter. These encouraging results, combined with our strategic agreement with a group of private equity-backed dermatology clinics and the technological advances to our XTRAC excimer laser further validates our commitment to our unique business model and move us closer to realizing our vision of becoming the dermatology clinic partner of choice.

In the second full quarter since I had assumed the role of CEO and we completed a $17 million financing, we continue to see tangible results from our renewed focus and recommitment to investing in our direct-to-consumer or DTC advertising program. We were pleased with our operating results in this quarter, posting revenue growth of 8% over the same period in 2017.

While the China tariff has shifted some of our international business earlier this year, the growth is attributed to increase in both our recurring and equipment revenues. We also saw a meaningful improvement in gross margin, due primarily to an increase in the quarter average revenue per consigned domestic XTRAC system from $6,900 in the second quarter to nearly $7,500 in the third quarter. Accordingly, gross margin expanded by 7.8% sequentially and 6.4% year-over-year. As a key driver of gross margin, further improvement in recurring revenue will lead to further margin expansion.

Scheduled patient appointments with our partner clinics, driven by our DTC awareness campaign, nearly doubled in the third quarter, and we expect that number to continue to improve as we realize greater returns from our advertising program. As we have discussed in the past, there is a certain lag effect in our DTC activities, so we are really only now seeing the results of the investments we made in the spring and summer of this year. The improving return on investment validates our business model and gives us confidence that our platform could support additional clinics and technology -- and technologies.

We announced in August that we have reached a strategic agreement with a private equity-backed group of dermatology clinics to deploy XTRAC excimer lasers and to provide them with clinical training, DTC advertising and patient advocacy. We expect to implement this agreement across the group entire network with the first clinics coming online by year-end. We look forward to executing on this agreement and to explore similar arrangements with other parties in the future.

In addition, the unique model has allowed us to embark on a comeback strategy in which we target existing users of excimer lasers, whether these were acquired from STRATA or otherwise, with an established patient treatment business that allows us to increase or improve the current installed base with devices that have a positive net contribution from day 1, while removing nonproductive units. These comebacks provide evidential support to STRATA's unique value-add proposition in the eyes of partner accounts that have already managed to develop their own excimer business and value the services and additional patient flow offered by STRATA.

With the renewed push of DTC starting in the second quarter this year, during the first half of 2018, we had 4 comebacks, where, in 2017, we saw 4 comebacks for the entire year. I'm happy to report that the second half of 2018, we have already delivered and installed 8 comebacks and have 5 additional comebacks planned by the end of this year, expecting the 2018 comeback program to exceed 17 accounts. The other highlights from the quarter and subsequent to the quarter were focused on technological improvement to the XTRAC system and its components.

In August, the Food and Drug Administration granted STRATA a 510(k) clearance for our Multi-Micro Dose tip for the 308-nanometer excimer laser. In a multicenter study investigating the efficiency and efficacy of the MMD diagnostic tip accessory, it was shown that high doses of the XTRAC treatment achieved meaningful clearance in as little as 2 to 4 weekly treatments as compared to an average of 6.2 biweekly treatments in previous studies utilizing lower doses. Compared to the current clinical practice average of 16 to 20 biweekly treatments delivered with Narrow Band-UVB devices, the MMD tip produced statistically significant results by the second treatment.

Additionally, the MMD tip took an average of 4 weekly treatments to achieve a reduction in psoriatic plaque of 50% or more relative to baseline. These outcomes, when using the patented OTD technology, are expected to increase patient satisfaction, retention and partner clinic economic performance. First commercial application of the MMD tip will roll out by the end of 2018 and we expect the full study results to be published by the beginning of 2019.

Last month, at the American Society for Dermatologic Surgery meeting in Phoenix, we announced the launch of our new XTRAC S3 308-nanometer laser. The new generation S3 carries a smaller footprint to save valuable space in the dermatology office, deliver faster treatments to enable physicians to treat more patients each day and is equipped with a new user interface that includes support for Optimal Therapeutic Dose as well as other patient and provider user experience.

Taking all of these factors into consideration, both improving recurring revenue growth and enhancements of the technology, we expect revenue growth to accelerate to double digits in 2019. We will have more to say on our broader 2019 outlook when we report our fourth quarter results. Finally, we were happy to participate in several investor conferences in recent months, and we look forward to additional presentations and other outreach events in coming months to maintain a high level of engagement with the analyst and investor community.

With that, I'm going to turn the call over to Matthew Hill to provide a more detailed view on this past quarter financial results. Matt, please?

Thanks, Dolev. Good morning, everyone. I will provide basic financial metrics for the quarter and additional color during the upcoming Q&A.

In the third quarter of 2018, STRATA generated revenue of $7.9 million, representing an increase of 8% as compared to the third quarter of 2017. Recurring revenue during the quarter was $5.6 million, an increase of 1% as compared to the third quarter of 2017. Equipment sales for the third quarter of 2018 were $2.3 million, representing an increase of 33% as compared to the third quarter of 2017.

Internationally, we sold 31 systems as compared to 19 systems for the third quarter of 2017. As we mentioned in the second quarter conference call, customers in Asia accelerated purchases, primarily in anticipation of tariffs, which were implemented in August. Near-term international revenue may be impacted by these advance purchases.

We note that the Nordlys product line license agreement signed in 2017 was strategically discontinued in 2018 following the financing. The comparability of our year-over-year quarterly sales were impacted by this change. Excluding sales of the Nordlys product line, sales for the 3 months ended September 30, 2018, and 2017 would have been $7.8 million and $7.2 million, respectively, representing a 9% increase.

Our U.S. installed base of XTRAC recurring revenue systems remained the same as the second quarter of 2018 at 746 units as we continue to offload nonperforming accounts to be replaced with more -- new more committed accounts. We continue to realize meaningful operational efficiencies during the quarter as we achieved nearly $7,500 in average quarterly treatment revenue per consigned domestic XTRAC system, an increase of 5% compared to the third quarter of 2017.

Our gross margin percent increased to 61.4% in the third quarter of 2018, up from 55% in the third quarter of 2017. Our recurring revenue gross margins increased to 68.4% in the third quarter of 2018 from 62.3% in the third quarter of 2017. Net loss during the quarter on a GAAP basis was $0.3 million or $0.01 per basic and diluted common share as compared to the net loss of $13.7 million or $3.32 per basic and diluted common share for the third quarter of 2017.

As of today, the company has 29,843,086 shares of common stock outstanding. There are approximately an additional 3.7 million shares to be issued upon further conversions of our Series C preferred stock to a total of approximately 33.6 million shares on an as-converted basis. For the third quarter of 2018, we also reported a non-GAAP adjusted EBITDA for the quarter of $1.6 million, a 43% increase over the third quarter of 2017.

Finally, we are happy to report that we were cash flow positive during the quarter, adding $1.5 million to our cash balance to bring our total to $15.9 million as of September 30. It should be noted that a portion of this increase relates to our increase in international sales. We will continue to manage our cash carefully and to drive efficiencies through the organization, but we are encouraged to see that our increased DTC advertising spend continues to be effective in creating patient awareness of available treatments and growth in new appointments for our dermatology partner clinics. We plan to continue in investing in DTC advertising prudently and make investments in sales, marketing and research and development for we believe we will see significant returns.

Before we go to questions, our financial statements will be filed on our Form 10-Q tomorrow. With that, we will now open the call for questions. Operator?

(Operator Instructions) And at this time, there are no questions. I'll turn the conference back over to management for any additional -- I'm sorry, we do have someone that just queued up. We'll go to Shawn Boyd at Next Mark Capital.

Just a couple, if I may. The pull in of sales with the tariffs being announced, I'm assuming that's primarily or maybe entirely on the equipment revenue line. Can you just speak to if that's true, if I'm looking at that the right way and then also what you -- what we should think about in forward quarters then, what that might hold? So can we think of something normalized for December and kind of into early next year?

Great question. So first of all, you're correct. It's only on the equipment sales line. We run our business in 2 segments and it only affects that segment. We have discussed the pull in, in the previous earnings call. That was expected when the tariffs were announced and scheduled for -- to kick in, in August and it affected our second and third quarter this year. I will turn this over to Matt to provide you some perspective on the comparability of 2018 and 2017, but what you will see from that comparability is that our 2018 numbers by now are higher than 2017. And since we don't provide guidance, the -- our assumption is that there is an increase in our OUS business, but we point out that there is a shift in the timing between the quarters just because of China. China represents 1 of our 4 larger OUS markets and that is affecting our results. Matt, please.

Thank you, Dolev. In the 3 months ended September 30, 2018, we recorded dermatology procedure equipment revenue of $2.3 million as compared to the 3 months ended September 30, 2017, of $1.8 million. And when you look at the 9 months, we recorded revenue for the 9 months ended September 30, 2018, of $6.7 million as compared to $5.8 million from the comparable period in last year.

So if that helps, not all this came from China, but some of it came from China and there's a shift in the timing.

Got it, okay. So maybe another way to kind of come at this then would also be to think about if we -- if I can see here. Growth this year in equipment revenues, pulling out the Nordlys product line, looks to be double digits. It depends, obviously, on what we do on the December quarter. But if you reduce a couple of million in the December quarter, my number show us at 10% growth. Would you anticipate being -- I know that -- I'm sorry for even having this kind of discussion because I know the real key to the story is the recurring revenues, but I just want to sort of move this out of the way, if we can. And so I'm wondering, if the company does 10% growth this year, is it 10% again next year? Or is it more of a flat business? How do you want us to think about the equipment revenues going forward?

If you look at the history of this non-U. S. business over the years, that business has been growing steadily over the years and it has a meaningful effect on the company's results because it represents about 25% of the company's business. However, the recurring revenue, which is probably the focus of this story, represents about 75% of the company's revenue and business. And in order to achieve what we characterized as an expectation of revenue growth to accelerate to double digit in 2019, mathematically, that means that the 75% is going to have to grow as much as well.

Okay, okay. Moving over to the recurring revenues. The scheduled patient appointments, I really apologize on that, I didn't quite catch the number. Would you mind just repeating that?

We did not provide the number. We said that the number was approximately double what it was last quarter. In the last earnings call, we've disclosed that the number of appointments for the second quarter was just under 900, it was 870, and the number of appointments for this quarter is approximately double that.

Got it. And as I recall, you were trying to hit roughly 2,000 by the end of the year? Is that still...

Correct. And as I said, I was expecting to hit approximately 2,000 by the fourth quarter of this year, which represents the run rate that this company was producing at the highest quarterly run rate in 2015 when it was producing the highest number -- the highest recurring revenue numbers and the highest growth in recurring revenue. Correct.

Got it, okay. Fantastic. So -- that -- on that point, is there anything -- and this is just kind of more of an update question. Is there anything -- as you continue to kind of revamp the advertising and continue to try to push the consumer awareness, any sort of lessons learned this year or anything that we can speak to that you're sort of tweaking as we go into next year? Kind of a fairly catch-all question but I know that seems to be what's pushing these patient appointments, so that's the reason for the question.

Good question. I think it's an open-ended question, so I'll start by answering a few things and you'll guide me if this answers your question. As we've updated through the year, we've turned the advertisement back on at the beginning of April when I stepped back into the company. That brought us to a few learnings. First, we are doing today almost entirely online and digital approach through online advertisement and social media versus an almost entirely offline approach back in 2015. That gives us a more efficient advertisement in the sense of cost per lead, cost per appointment. Also, it helps us be very targeted on the end patients because we know who they are, we have a very sizable database of past patients and we know what they -- what's their lookalike in terms of a social persona and online persona. So we know who they are and that makes it way more efficient. So as I have updated in previous calls, our acquisition cost is significantly less than it was in 2015. Our last update was that this is less. Our acquisition cost per appointment is less than $200, where it used to be approximately $500 in 2015. So that's the first learning.

Second learning is we are advertising to more than one indication. In 2015, we were only advertising to psoriasis patients and we were only advertising in English. Today, we advertise to more than one indication and we advertise in English and Spanish. That allows us to deliver a more diverse patient base in a more diverse indication base to the partner clinics. That also allows us because of the focus on online and social media advertisement to advertise instead of by DMA, by a region or a media market, we now advertise by ZIP code. So we can target a specific clinic that we want to enhance and we target them directly. So that, starting in April, we started advertising. We ramped it up, and now we're actually focusing on the more successful partners, those that would take the patients, make sure they show up, make sure they convert, make sure they get the treatment and give them an amazing patient experience.

The next thing I can comment on this is that by doing that, we also know which clinics are not productive because if until the beginning of this year one could blame STRATA for not providing patient flow to these clinics, now we offered the opportunity of getting a patient flow across the market. And we know which ones are going to be productive and which ones are not going to be productive, and we can focus specifically on those that are going to be productive.

And maybe, lastly, and I'm going to tie this into the comment I made in the prepared remarks, by bringing back comebacks, those accounts that have experienced and have built their own excimer laser patient treatment portfolio and are coming back to work with us as partners, we are able to drive patients directly to them, knowing what the results are going to be because we know and they know what it means to take a patient, diagnose, see that they're fit for the treatment, treat them and then get them into a recurrence mode. So we know this is going to happen faster.

And if you incorporate all of that with the technology and clinical improvements, we expect 2019 to move even faster just because these targeted accounts, those that we can target the ZIP codes, we can get them the patients, are capable of getting more patient capacity. So pointing back to your -- to the number 2,000 appointments, which was the highest number we achieved in a quarter in 2015, that number was mostly driven by clinic capacity and I will define clinic capacity as the ability of the clinic to take patients now versus schedule them 2, 3, 4 months out. So we're getting more and more clinics to accept these patients now, as in the next couple of weeks, versus get them way out there.

And that provides a more efficient advertising because the patient that is being scheduled for an appointment that happens in the next couple of weeks has a higher probability of showing up, has a higher probability of being converted because we send them to the right clinics and has a higher probability of getting the right clinical procedure because these clinics are open in listening to us and improving the way they work. We have seen that in the past. We've seen this when this business was ramping up between 2013 and 2015. We see it today. We believe that we're running ahead of the curve in terms of the turnaround only because we see the results coming in faster than we anticipated. I hope I answered the question. But if not, let me know.

No, you did. That's fantastic and it's great color. And just to make sure I'm on the right page, the comebacks are what you quantified as potentially 17 devices this year versus I think you said you had 4 in all of 2017?

Correct. And I'll define that as -- the comebacks has been something that we have done. Again, in the previous time that this company was ramping up, there is a base of excimer lasers, whether these were sold by STRATA, its predecessor PhotoMedex or otherwise that are out there, they have their own patient bases that is treated by excimer laser. They are prescribing. They are producing revenue. And by them coming back, not only they vet the notion that we provide value add to them and there's a reason why they come back, but also they know that we can push their business and increase it while still paying us a portion of that revenue stream. Between 2012 and 2015, this business had approximately 250 comebacks. This was the -- this was approximately half of the growth and it represented, at that time, the most productive growth engine.

Why? Because to launch a new account from fresh means we need to train the physicians. We need to train the providers. We need to help them get their own patient base set up. We need to help them with their reimbursement practices. We need to help them with getting them up and running. Versus getting a comeback, we start seeing a net contribution coming from that business from day 1. 17 is definitely -- 17 in 2018 is definitely more than 4 in the whole year of -- sorry, 17 comebacks in 2018 is definitely more than 4 units coming back in 2017. And it represents a meaningful uptake to our installed base, but it also represents the beginning of what's going to happen in 2019.

Got it, okay. Very helpful. The -- switch gears for 1 second here. The private equity-backed clinics, so I guess, what -- I'm trying to quantify. I'm trying to put that in perspective and I'm saying, okay, they've got roughly 750 systems in the field. Maybe the way to think about it is how many of those are already at clinics that are backed by private equity firms or maybe we can just kind of quantify the new agreement that you've got in terms of what the potential is there. And then also if you could just elaborate a little bit more on who else we're talking to. Or is this -- are we talking about 2 other PE-backed entities? Are we talking about 10? How big is this kind of opportunity there?

Thank you, Shawn. Good question. So in our investor presentation, we outline the size of the opportunity and I'll do this now over the call since you asked. We have mapped out approximately 40 different private equity groups that have acquired or own dermatology clinics. These 40 different private equity groups -- and that's a growing number, so I assume that next time you ask me, it's going to be a higher number because we keep mapping them. We have mapped out 1,200 clinics that are owned by them. There are groups that are as small as 10 and there are groups that have hundreds of clinics. And these are either characterized by being national or some of them are regional or even local. They're operated differently than the individual physician clinic, where the decisions are not made by an individual physician owner that makes these decisions based on his own clinical perception and his own capabilities of management of the clinic.

They're made by a private equity-backed management team, many times private equity or, I would call them, MBA-type management decisions where the decisions are business oriented and they're targeted towards growth and margins and expansion. Out of these 1,200 clinics that we've mapped out, we have XTRAC devices in 86 of them. That represents approximately 7% penetration. The company previously related to this -- previous to 2017, related to this as a structural change in the market where the market is changing and there's more and more acquisitions. However, the company did not relate to it directly and did not have specific action items.

What we have done is we have looked at these as national accounts. We've started a national accounts business approach. We are approaching them in I would characterize this as 3 different levels. We approach the owners, so the private equity teams and their management. We approach the regional management of these teams as well as approaching them from the clinic up, so kind of the voice of the public coming up to them. The benefit we have by approaching them is that we already have a certain installed base with them and I would characterize this as that 7% penetration. And we can tell them it's not a single clinic outcome. It's a -- it's an average. We can show them their few clinics and what their few clinics are delivering. And let me remind you that from their perspective, from a business perspective, there is no balance sheet impact for them. They don't need to invest in getting capital equipment. There is no investment in training because we do that for them. There is no investment in patient advocacy because we do that for them. And in many cases, we can provide them with the patient flow from day 1, depends on the location and so on.

So the agreement we announced in August was with the first group. They have dozens of clinics on -- specifically, we did not identify them. They asked not to be identified. Obviously, they look at this as a strategic advantage for them as well. We have been approached by others. We are moving forward with others. I am sure that when we have an announcement to make, it will be made public and you will be able to see it. But you might assume that we're moving forward with others as well and we anticipate to have a significant growth engine within these over 1,000 clinics.

To complete the picture, let me provide another perspective. We have invested in some market studies and there are approximately 1,200 physicians that are prescribing our procedures in the country. That is out of 14,000 derms. We believe that, that number can go up to anywhere between 4,000 and 5,000 derms. These are the clinical derms. So if you look at these as the 3 growth engines, comebacks is one. Those that already prescribe but are not doing this with us are a huge comeback -- are a huge growth engine. The second one is those that are within groups that are controlled by private equity groups that already have our installed base. They understand what the growth can mean for them and there is, give or take, 1,100 of these today. And then there is an additional anywhere between 1,000 and 1,500 physicians that are additional targets.

And we -- the way we look at them is a good business target for us is a physician that has his own Rolodex of patients in our indication. How do we know that? Because we see who prescribes topicals. We see who prescribes biologics. And we see which markets we have the advertisements going and we don't have enough coverage and we approach them. And at the same time, we also see which markets we have accounts and we need more patient flow to go to. So that -- it's kind of managing the map as we grow. I hope I answered your question in full.

Yes. No, again, good color. And just forgive my ignorance on this but your existing base is 746 systems. That's across how many clinics right now?

That's across 746 clinics.

Okay, so it's one per clinic, okay. And then last thing for me. The gross margin on the recurring revenues, up sequentially 500 basis points, 68.4%. Wow, we're getting there quick here. So is that the kind of gross margin that we can expect to hold? You're kind of -- you're ahead of what I was thinking and it's wonderful. But I'm just wondering, can we hold the high 60s? Is there anything that I should think about that was sort of an outlier that drove Q3? What kind of forward look should we think about on that gross margin?

Good question. In 2015, when this business was generating in the range -- it depends on the quarter but in the range between $10,000 and $11,000 per quarter per device, right now it's $7,500, the gross margin was 72%, 73%. We've discussed this in previous earnings calls. At that time, if you look at that number, 72%, 73%, there were some cost of goods expenses that are higher than today. So we were less efficient in the field service and we were less efficient in some other forms. So when I discuss this with investors, I point out to the fact that we were at around 50% earlier -- or sorry, at the end of 2017. You have the table at the bottom of the earnings release. We are now coming close to 70%, and I would expect it to continue to go higher, only because this marginal or additional treatment provides more than 90% contribution margin. So as we grow the number of procedures per clinic, that margin can further expand.

However, when we bring new clinics to the game, so when we expand the number from 746 up, if these clinics are not as productive as the average, that number will not expand. So we're managing this so that we -- in the past 3 quarters since Q1, we have maintained the installed base where the company previously was shrinking installed base. And I discussed this in a previous earning call. I said we're going to start growing installed base during 2019, and by growing installed base, we anticipate that we will be able to maintain or expand the average revenue per device and, by that, maintain or expand the gross margins for that business.

And that does conclude the question-and-answer session. At this time, I will turn the conference back over to management for any closing remarks.

Thank you, operator, and thanks, everyone, for joining us this morning. We appreciate your participation on today's call and for your interest in STRATA. We look forward to updating you again in the near future. Have a great day. Thank you.

And that does conclude today's conference. Again, thank you for your participation.