STAAR Surgical Co (STAA) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, thank you for standing by. Welcome to the STAAR Surgical Second Quarter 2012 Financial Results Conference Call. (Operator Instructions) This conference is being recorded today, Wednesday, August 1, 2012. I would now like to turn the conference over to Doug Sherk. Please go ahead, sir.

Thank you, Operator, and good afternoon, everyone. Thank you for joining us for STAAR Surgical conference call and webcast to review the Company's financial results for the second quarter, which ended on June 29, 2012. The news release announced the second quarter results across the wire about half an hour ago and it's available at STAAR's website at www.staar.com. Today's call is also being broadcast live via webcast. In addition, a slide presentation will accompany remarks by management. To access both the webcast and the presentation slides, go to the Investor Relations section of STAAR's website at www.staar.com. If you are listening via telephone to today's call and would like to review the slides that accompany management's remarks, please navigate to the live webcast, as I've just reviewed, and choose the no audio/slides only option. In addition, an archived replay and slides will be available on the STAAR website.

Before we get started, during the course of this conference call the Company will make forward-looking statements. We caution you that any statement that is not a statement of historical fact is a forward-looking statement. This includes any projections of earnings, revenues, sales, profit margin, cash, or other financial statements; any statements about plans, strategies or objectives of management for future operations or prospects for achieving such plans; any statements concerning proposed new products, including expectations for success of the ICL or other products in the US or international markets; government approval of new products or developments, or other future actions of the FDA or other regulators; the outcome of product research and development or any clinical study; any statements regarding future economic conditions or performance; the size of market opportunities; statements of belief and any statements of assumptions underlying any of the foregoing. These statements are based on expectations and assumptions as of the date of this conference call and are subject to numerous risk and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

These risks are described in the Safe Harbor statement in today's press release and in the Risk Factors section of our annual report on Form 10-K. Investors or potential investors should read these risks. STAAR assumes no obligation to update these forward-looking statements to reflect future events or actual outcomes and does not intend to do so.

In addition, to supplement to GAAP numbers we have provided non-GAAP adjusted net income and basic and diluted net income per share information that excludes manufacturing consolidation expenses, gains on foreign currency, or losses on foreign currency, fair market value adjustments for warrants and stock-based compensation. We believe these non-GAAP numbers provide meaningful supplemental information and are helpful in assessing our historical and future performance. A table reconciling the GAAP information to the non-GAAP information is included in our financial release, which is available on our website and in our slide presentation. Now, with that out of the way, let me turn the call over to Barry Caldwell, President and Chief Executive Officer of STAAR Surgical.

Thank you, Doug, and good afternoon, everyone. Thank you for joining us today for our review of the second quarter 2012 results. With me today on the call is Deborah Andrews, our CFO. Also on the call are our three commercial regional heads who are in town to present our five-year strategic plan to STAAR's board of directors tomorrow. So, via phone I'd like to introduce to you Don Todd, who is President of our Asia Pacific region; Hans Blickensdoerfer, who is President of Europe, Middle East, Africa and Latin America; and Don Fagen, who is Vice President of North America.

I'll start with an overview of the quarter and ask our commercial heads to weigh in at times. I will also review our 2012 key metrics in light of the results for the quarter. Deborah will provide a detailed look at our second quarter financial results and discuss progress with our manufacturing consolidation project. Before we take your questions, I'll review with the three commercial heads anticipated progress and key drivers during the second half of the year and our expected performance.

As we announced a couple of weeks ago, our second quarter revenue growth was not what we had expected. There was an unusual combination of three dynamics which limited our sales. Let's look at the results.

ICL revenues increased by 4%, IOL revenues decreased by 4%, and as we have planned, the other defocused category of products continued to decline at a rate of 38% during the quarter that resulted in an overall 2% decline in total revenue for the quarter.

This slide shows the quarterly growth rate for the ICL over the last several quarters. There were three key challenges during the second quarter which constrained our growth rate. We basically had a $2 million shortfall to expectations and the resulting negative impact we believe was attributable to three key markets -- 25% from Spain, 25% from Korea, and 50% from China.

The first dynamic was that our ICL growth in China was flat during the quarter. You can see on this slide the excellent growth that we have experienced in China over the past 2.5 years. The average year-over-year growth rate has been 95%, or basically doubling over the previous quarters over a 9-quarter period. So, let's look to see what we believe happened to interrupt our growth rate and trend.

There was a lot of media coverage in a China market on complications associated with LASIK. According to our research, this coverage resulted in a significant slowdown in all refractive procedures in the market. Don Todd, who is our president of Asia Pacific, would you add a little more color to the challenge we face?

Yes, Barry. The media coverage commenced in response to comments by an influential Taiwanese doctor and generated widespread negative attention regarding LASIK throughout China beginning in February and going through April time frame. One Chinese online media outlet cited an alarming statistic that 1 in every 5 LASIK patients will suffer complications.

Then in mid-April there was another round of media coverage focused on a group of Chinese doctors recommending again LASIK for military personnel. Our customers in China reported a sharp decline in appointments regardless of the procedure and the results was a flattening of ICL procedures that created a $1 million decline in our expected second quarter revenue performance.

In addition to the China development, there was also a second dynamic that impacted our second quarter growth in APAC. We received a smaller than anticipated stocking order from our Korean distributor. Specifically, we were expecting the timing of an order that was approximately $500,000 more than the one we received during the quarter. This has happened occasionally in this market over the years, and we should gain these orders during the second half. The ICL sales from our distributor to end customers did increase during the first half.

Thank you, Don. Now let's turn to the other key ICL markets. This chart shows some very good growth rates for the ICL and other evolving markets outside of the three we're talking about. Those markets, however, are just not big enough yet to overcome shortfalls from the three major markets we're speaking of. We did execute on a distribution model change in Spain during the quarter, and I'll ask Hans, would you comment on this?

Sure, yes, Barry. In Spain we transitioned from a distributor model to a direct sales model through a combination of a distributor not reordering product to inventory as we would normally have done. Also, our responsibility to buy back his inventory during June, the market generated about $500,000 less in sales than what you would have expected for the quarter. This resulted in ICL sales in Spain declining by 28% during the quarter compared to prior year.

Now we have meaningful revenue upside for the second half of the year as we will be enjoying end customer pricing [with] distributor price.

Thank you, Hans. Now let's turn to a couple of additional views of ICL results in other markets in Europe and the US. First, let me turn to you, Hans, and then we'll go to Don Fagen.

Well, I know there has been a lot of concern about the economy in Europe and negative impacts of business. We have seen a nice rebound in overall European ICL sales from the first quarter, including the results from Spain. ICL sales in Europe increased 28% over prior year. You could also see from the prior slide the ICL growth in Latin America up 28%, and Italy more than doubling. So, these are still markets today. We did hire new employees to manage these markets late last year, and this shows they are already having a quite positive impact.

I would also like to add that we have now implanted over 5,000 V4c ICLs with the AquaFlow technology, and the results have been excellent. 56% of the ICL volume in Europe during the quarter was V4c model, and 61% in all the markets in which the V4c is approved.

Great, Hans, thank you. Don, how about the US market?

Well, Barry, in the US, civilian sales of ICL continued to increase as revenues grew 6%, while on the military side there was an increase of 1%. Overall, growth for the quarter was 5%. Now, I will say, though, we have only completed one month of the third quarter. There was a nice strengthening military ICL sales in July. We do not have -- excuse me -- we do have some surgeons back on these bases doing ICL procedures now, and some newly trained surgeons are about to begin implanting ICL.

Good. It is nice, Don, to see a return of the military after we have had several quarters of decline. So, now let's review the 2012 key metrics in relation to the results. From the second quarter the red arrows reflect a disappointing quarter, and also how tough we are on grading our results, and I'll go over that.

As we have reviewed, revenues actually declined 2% during the quarter, and ICLs only increased 4%. Obviously, both misses on the first two lines. The third line on our gross margin, it was 69.3% for the quarter, which was a 250 basis point improvement over prior year. Still, it lagged behind the 70.3% margin for first quarter. So, as a result of that we did mark it as not achieved, though we do believe we are still on track to achieve our annual target of 71% in this metric. Deborah will discuss this in more detail in a few moments.

On the fourth line, though we were not profitable on a GAAP basis, you can easily see that the $700,000 investment in manufacturing consolidation flipped our bottom line to a loss. We were also profitable on a non-GAAP basis, as you will see. Nevertheless, we graded it as a miss, though we do not see this interfering with our ability to be GAAP-profitable for the full year.

Deborah will discuss manufacturing consolidation in more detail, but overall we're on schedule, even ahead of schedule on the regulatory approval side, while experiencing no disruption to our customers in supply or quality. After Deborah goes into the financial details, we'll return to discuss second half key drivers and expected results, with a quick glimpse into what we've seen during the first five -- or four weeks, I should say, of the third quarter. Now I'd like to turn the call over to Deborah for a more thorough review of the second quarter financial highlights. Deborah?

Thanks, Barry. Good afternoon, everyone. Since Barry and the sales team have already discussed revenue highlights, I'll be focusing my comments on other key financial highlights, including operating expenses, our gross margin expansion, GAAP net loss and adjusted net income, and cash. I'll close with an update on our manufacturing consolidation project, and then with a view of our P&L post consolidation.

First, let's skip over to operating expenses. Our total operating expenses including manufacturing consolidation expenses increased 15.7% to $11.2 million. Manufacturing consolidation expenses increased $500,000 to nearly $700,000, when compared to prior year. Our operating expenses before manufacturing consolidation expenses were $10.5 million, up 10.7%. This increase was primarily due to an increase in global marketing and selling expenses, including the addition of 13 out of the planned 16 headcount additions, the timing of the ASCRS trade show, which was in the first quarter of 2011 and in the second quarter of 2012, and $175,000 amount related to the change in distribution in Spain to a direct model.

Operating expenses also increased due to a $342,000 increase in stock-based compensation. We estimate the annualized cost of the headcount addition will be approximately $2 million, and the expense associated with the transition in Spain will continue through February 2013, at which time the normal logistics cost of being direct in a market will begin.

In terms of gross profit margin, our gross profit margin increased year-over-year reaching 69.3%, a 250 basis point improvement over Q2 2011, and despite the 2% decrease in our sales, our gross profit dollars actually increased 1.7%. This improvement in gross profit and gross profit margin is primarily due to improved ICL mix, but also due to improved ICL and IOL manufacturing costs, and higher average selling prices. ICL revenue represented 54% of total sales compared with 51% in the second quarter last year.

We continue to expand IOL gross margin in all five categories of IOLs we offered despite a decrease in sales. Overall, IOL gross margins were 60%, which was a 300 basis point improvement over the 57% in Q2 of 2011.

Our overall margin of 69.3% was down from the record 70.1% we reported in Q1, primarily due to a lower mix of ICL sales, 54% in Q2 versus 56% in Q1, and a higher mix of lower gross margin IOLs to China ,which had a significant increase over prior year.

In terms of our non-GAAP measures, to provide investors with a better basis on which to compare results and understand our business, we also report net income on an adjusted basis, which excludes manufacturing consolidation expense, gain or loss on foreign currency transactions, fair value adjustment of warrants, and noncash stock-based compensation expense. Excluding these items, the adjusted net income for the quarter was $1 million, or $0.03 a share, compared to adjusted net income of $1.4 million, or $0.04 a share in Q2 2011.

Our adjusted net income for the first half of the year was $2.4 million, or $0.06 per share, compared to adjusted net income last year in the same period of $1.7 million, or $0.05 per share. A more detailed review of the GAAP to non-GAAP reconciliation is available in the tables issued in the release today.

We ended the second quarter with $17.5 million in cash and cash equivalents on the balance sheet. This compares to $16.4 million of cash at the end of Q1 2012, and $16.7 million at the end of Q4 2011. We generated $1.7 million in cash from operating expenses in the second quarter despite the increase in expenses associated with the manufacturing consolidation projects.

Moving on, our manufacturing consolidation project is progressing on schedule. Expenses during the quarter, as I said, were about $700,000, and the year-to-date total is $1.3 million. We expect to spend about $2.3 million in total during the year.

We began shipping the first of our IOLs to Japan during July, and expect to be shipping all IOLs for Japan from the US during the fourth quarter. We're on schedule to start shipping the first Visian ICLs from the US during the first quarter of 2013.

We believe that the transition will be significantly beneficial, specifically improving our cost of goods and creating a more favorable tax structure. Once the manufacturing consolidation is fully implemented, we believe we can improve gross margins nearly 80%, and we believe that it will drive our tax rates from 50% to 10% beginning in 2014.

We estimate the consolidation project, including the impact of our tax strategies, will result in an anticipated savings exceeding $100 million for the aggregate period of 2014 to 2021.

And based on the expected revenue growth and financial benefits from the manufacturing consolidation, we expect our results in 2014 to look something like this. Revenues over $100 million. Our gross margin should be at or near 80%. And even if we have higher than expected expenses of $50 million, our earnings before tax would be $30 million. With a tax rate of 10%, we should drive 27% to the net income line. This concludes my comments. I'd like to turn the call back over to Barry.

Thanks, Deborah. So, that shows a shortfall in second quarter. It doesn't impact our expectations for 2014 after consolidation. Okay, now let's review our expectations for the remainder of the year and key events which will help drive our results. I'd like to provide you with the metrics we are striving to achieve during the second half of 2012. They are, one, to generate solid double-digit total revenue growth versus the second half of 2011.

Second would be to grow our Visian ICL revenue at the rate of 25% versus what we achieved in the second half of 2011. And I might add, this assumes a little rebound to growth in China, not much. So, any additional growth from that market should be an upside.

Three, continuous improvements from our second quarter results quarter-by-quarter of our gross margin so that we achieved 71% for the full year. Our gross margin at the turn here through the first half is 69.8% as a reference.

Fourth, be profitable in the third and fourth quarters. And five, continue to manage our consolidation project so we don't sacrifice supply or quality.

So, now let's look at our full year 2012 metrics and the changes with these two metrics overall to revenue, total revenue and ICL growth. As you can see, the first two, they're okay, there's our growth drivers. Here's some of the key events and activities which will help drive our results during the second half.

We have two users meetings coming up -- one during August in the United States, and the other during September in Europe. These meetings have been very successful in the past as leading ICL surgeons share their experiences with the technology in an educational way, which helps to generate better outcomes and more interest in the ICL technology.

We also have the ESCRS meeting upcoming during the first half of September. We will be highlighting the V4c success and our two new IOLs -- KSSP and the NanoFLEX Toric. Later in September we had planned a STAAR symposium highlighting our direct presence in the market during the Spanish Society of Ophthalmologists Annual Meeting. We expect that all of these events will lead to increased awareness of the benefits of the ICL technology and a greater adoption rate.

Let's discuss the IOL business for a few minutes. Don and Hans, how do you see the impact of these two new IOLs in your region, and I'll turn to Hans first?

Well, Barry, as you know, we have a three-piece, preloaded, acrylic IOL in Europe. Some surgeons prefer a single piece model. It is about 50/50 in terms of surgeon preference. This is particularly important to the German, the French and the Italian markets. IOL sales in these markets during Q2 declined by about 21%, and we believe this product will help in all three of these markets.

Now, with the NanoFLEX Toric IOL, this is a new product for us and it is a market with good pricing and the segment is growing. This will have a positive impact the second have and rolling into 2013.

Okay, Don Todd?

The Japan sales team has been eagerly expecting the KS-SP to sell. Now, remember, we received regulatory approval in Japan over nine months ago for this product. This fills a void in their bag and should be very helpful going forward. The situation is about the same as Hans has described in Europe.

Okay. Thanks, Don and Hans. Our IOL business during the quarter declined by 4% over prior year, though this was a 6% increase over the first quarter of this year. By comparison, two of the big competitors here -- Novartis, which is or was Alcon, reported that global IOL sales were flat during the second quarter. And Abbott, which used to be AMO, ha reported their cataract business actually declined by 2.1% during the quarter.

During the second quarter we had a decline in US IOL sales as well as Europe. Don Fagen, can you give us some insight on this segment?

Sure. First, we had planned a decrease in some of our lower priced silicone IOL business (inaudible). You will recall that over one year ago the NTIOL status ,which provided an additional $50 reimbursement, expired. We have maintained our NanoFLEX IOL pricing very well. It has actually gone up since last year. The major competitors are all getting very aggressive on their pricing for standard IOLs.

With the expected cost reduction from our manufacturing projects we have given the sales team more flexibility in their pricing guideline to customers for the remainder of the year. We have also adjusted their commission plan for the second half of the year to help drive NanoFLEX and silicone Toric IOL sales. We think it will have a positive impact during the second half.

Good, great. Thanks, Don. As mentioned, we added 13 new direct employees during the first half of the year, which we believe will help bring additional value during the second half. And you can see from the slide there is a focus on consumer awareness or online marketing, and actually we have extended the offer and it's been accepted for the 14th add, which would come in Japan.

We are rapidly expanding our consumer awareness campaigns around the Visian ICL. Our focus is online marketing and advertising, consumer-driven websites, moving interested -- trying to move interested patients on the technology directly to ICL surgeons, practice development, and even more traditional direct-to-consumer testing.

Finally, a member of the famous Black Eyed Peas band, Apl.de.ap., recently had ICLs implanted. His story was presented on "Good Morning America" last week, and the link here is attached, if you'd like to view it. Also is the link to the Visian ICL blog site on his ICL procedure, which appeared the very same day. Obviously, Apl. is a huge star with the ICL target market, and we're looking for ways to potentially partner with him to expand consumer awareness of the ICL technology and the great results it can offer to patients like himself.

Bottom line is that we had a disappointing first half of the year, but we're also very encouraged about our opportunities to rebound very quickly during the second half. We believe we are gaining market share with the ICL in most, if not all, major markets. Our July revenues, though only one month of a three-month period and not yet audited, gives us solid confidence in this rebound.

During July, for example, ICL revenues increased 25% globally, and that was with minimal growth in China. There is no guarantee that this will be the trend for the remainder of the quarter, but it does give us a very good start overall to the third quarter.

We will be presenting at the Canaccord Genuity Conference in Boston on August 15, so if you'd like to see us, you can contact that group and get a slot. And with that, I think we're ready to take your questions. So, Operator, could we please open the line for questions and answers? Operator?

Yes. (Operator Instructions) The first question is from the line of Chris Cooley with Stephens Inc. Please go ahead.

I guess my first question and then I'll have a follow-up. I just want to make sure I fully understand what's giving you confidence here in the second half of the year relative to the first half performance. And you've held out a couple different items, and so maybe you could help us, I guess, two parts to this and the follow-up. When I think about the growth targets, help us understand the unit volume growth versus pricing and how that compared versus the prior year to get to these numbers.

And then, secondly, I'm a little confused. You cite a couple different users meetings as being potential catalysts in the back half of the year. In prior calls you called out meetings like the World Congress and ESCRS as being a detriment to your performance in that quarter because surgeons were out of the market attending these conferences. Should we take from that, or infer from that that you're basically saying there is a big fourth quarter as opposed to more metered growth through the third and fourth quarter? Thanks.

Okay, multiple things in there, so let me first take the top one in terms of confidence, I think that you asked. One points to the start we had in July. I think we've seen several things turn around in July that, though we can't guarantee, we think will continue throughout the quarter. And I think that has happened in all three markets. So, maybe I'll just throw the ball over and let all three of the commercial heads just quickly, on confidence, throw anything out to Chris that you see that does help your confidence. Hans, I'll start with you and we'll just go around the table.

Well, our Q1 was a bit weak, as we just illustrated here in the call. Q2 already was much stronger than Q1. And, as Barry was saying, we've seen the continuation of the growth just leading into the startup of Q3. We have the Spanish project, which was very exciting, and we are gaining here on the pricing level, but more importantly I think we are gaining control in this market, taking over the management of the business and much rather than just relying on the third-party, our distributor there. So, from my point of view, I am very confident that the second half of the year is going to be better than the first half.

Hi, Chris, this is Don Todd. In Asia we kind of have the exact opposite from Hans. We had a great first quarter and then second quarter we had what we've noted in the presentation, some issues related to bad public relations stuff. Not about ICL, but about LASIK, which pulled down the whole refractive market a little bit. But as time is passing we're starting to see that those sales are starting to come back. So, I'm feeling very comfortable with our second half growth targets, and I think it will be -- the second quarter will be water under the bridge moving ahead. We see all indications growth is moving forward in all my major markets in APAC.

Hey, Chris, Don Fagen here. With regards to North America, I see us coming to a tipping point to a degree. That tipping point being it's time for some of these things we've bee working on for half of a year to a year to really click in. As Barry said, in July we were starting to see evidence of that. Some of those elements would be the social media. A lot of work has been done behind the scenes here over the past six months, as well as increasing the size of the department. So, I see that as starting to kick in.

Three or four months ago I'd go in and talk to doctors and one of the first things I'd say, hey, are people calling in asking about the ICL? And 9 times out of 10 they'd say no. Now when I go in and talk I'd say half of them are saying yeah, you know what, we're actually getting some phone calls. So, some unique activity taking place there.

The other thing is the practice development, business development some might call it. This all falls under our STAAR University Program. The practice development, that's the hand-to-hand combat, out there with our key accounts, getting everyone from the person answering the phone to the coordinator to the doctor to integrate ICL as part of their overall refractive service. We're starting to see that get some traction.

Also, we just finished up training four new sales representatives. I add those to the rest of my direct reps and that's about a 25% increase in the coverage I'm going to have from a direct side. So, very anxious about the horsepower, the talent that we've got out there on the streets advocating our message.

And last but not least here, I'm seeing an uptick in both a civilian as well as the military number of units year-over-year, so, again, I see this all as a tipping point. It's coming to fruition. I don't know if it's going to be huge but I do see it leaning in a very positive direction as of the end of July.

Great. Thanks all three of you. And, Chris, I'll add one other thing onto the consumer awareness. We're seeing some pretty interesting data here in term of website hits, concerning the ICL name. For example, one of the data points that we just recently looked at here on ad names and the ICL name in the US has shown that for every three hits that LASIK received over a monthly period, the ICL received one hit. We thought that was pretty doggone good. So, we continue to track that and monitor that. We have invested in consumer awareness both here and the US. We have a three-person department here now and in the markets with several individuals.

Let me go to the next part of your question, it was pricing and units. Both of them are up for the second half. I can't tell you what the split is overall. I tend to look at the revenue number more than I look at units, and watch our gross margin go up. Third is your users' meeting comment. I think a little bit out of context. The only meeting I think we've ever referred to as being detrimental was the meeting in the Middle East, and it did seem to bring a lot of folks in and they spent a lot of time there. So, we did see that impact. I believe that was first quarter of this year. Yes, Hans is shaking his head. Other than that, our other meetings, our user meetings are just outstanding and gives opportunities for folks to share. So, is that it, Chris?

If I could just squeeze one other in just briefly. I think end of your last call you mentioned that you had 58% penetration with the V4c at the end of the quarter, and I believe -- maybe I was confused. I think you said it was 56% exiting this quarter. Was that just for Europe and worldwide was higher, or can you help me reconcile that?

Yes, yes. 56% was just in the European markets when Hans was specifically speaking to that about the European economy. 61% is the rate now for all approved markets. Now, of course, we're adding markets, so it's hard to compare quarter-over-quarter as we add markets.

Thank you so much.

Operator, next question?

Thank you. The next question is from the line of Matthew O'Brien with William Blair. Please go ahead.

Good afternoon. This is [Kayla Crum] in for Matt O'Brien. I just had a quick question. I know you mentioned the new headline influence in China and your initiatives in spreading the ICL awareness. We were just curious as to how you plan to distinguish your procedure from the LASIK surgery for surgeons specifically in China and adjust the behavior in that market to be more open to the ICL surgery?

Great. Thank you for the question. First of all, I normally -- and I thought this is where you're going -- I get the question that, hey, if there's bad news about LASIK, this should be really good news for the ICL. The answer is no and yes, at least initially. What it does is it just chills the market, puts the market to a halt in the decision-making process for patients. Further down it does help us as patients start to look at an alternative for LASIK, which they might have considered before.

Now, we already had planned the consumer awareness that I spoke of earlier, and we've added an individual in the China market, so that makes us with five employees in China working with our distributors there. And her focus is just on that, on online marketing, website, consumer awareness. So, we'll be using that vehicle for the most part in the China market, which coincidentally, we already had those plans in place. It wasn't something new that came up after this event happened. Anything else, Don, you'd like to add?

Yes, I think that, just to comment, that the physicians have not chilled at all on ICL. In fact they are very bullish on ICL, and we're gaining more and more confidence by surgeons all the time. It is really based in the patient level. And to Barry's point, the consumer awareness will help in educating patients to know that there is an alternative, and I see that helping us in the mid to long term.

Thank you. The next question is from the line of Raymond Myers with The Benchmark Company. Please go ahead.

Yes, thank you. I want to ask more about the manufacturing consolidation. One point in particular, Deborah, you mentioned that the first US Visian ICLs will be rolling off your manufacturing in first quarter 2013 from the new consolidated manufacturing. Can you discuss how that impacts the gross margin?

Well, what happens is, because we're selling from the US, that drives more profit into the US business and enables us to start utilizing our NOLs. So, right now we have operating losses, or pre-tax losses and we can't take -- record a tax benefit on those losses; whereas, in Europe, where we're profitable, we're recording income, so that the losses in the US are offsetting the income in Europe. But there is no equal offset to the tax side of things.

There is no impact on gross margin, though.

No impact on gross margin.

Right.

Once you shift from four manufacturing plants globally to one, won't that impact your cost of sales?

Oh, absolutely, yes. Once that's fully completed, it will reduce our overhead costs and improve our cost of goods.

And when will that be?

2014.

Is it an all or nothing type thing?

We are beginning this year, obviously we're transitioning the Japan IOL manufacturing. But you're really not going to see measurable improvements until the consolidation project is complete.

I'll just add, and I've said this in the past, I really don't want to put any measures on third quarter in terms of anticipating greater gross margins, because it just puts more leverage on the team. And we've got to keep in mind supplying quality as we go through this consolidation project, so that is primary. I don't want to put anymore pressure on the group.

Thank you. The next question is from the line of Jason Mills with Canaccord Genuity. Please go ahead.

Hi. This is Christine for Jason. Thanks for taking the call. I have a couple of questions for you. First, Deborah, I missed in my note-taking, could you go over the margins by ICL and IOL? I missed that in my notes.

Well, the IOL gross margin was 60%.

60%, okay.

And that's versus 57% a year ago. The ICL we didn't quote, but I'm just assuming it was in the 85% range. It's been 85% quite consistent with --

Right.

Great. And then for Don Fagen, I am wondering if now that we have some military personnel who have returned to the states, are you expecting the mix in the US to return to more -- a greater percentage coming from military sales?

A greater percentage of overall business from military?

In the US for ICL.

I would guess, Don, based upon what we're seeing and what we're hearing, our military the second half is going to grow greater than our civilian the second half. Probably a fair statement.

Fair statement, correct.

So, that would mean, yes, the second half, I believe it was 11% overall military sales made up the component during the second quarter. That likely is going to increase the second half.

True. Right, Christine.

Thank you. The next question is from the line of Rick D'Auteuil with Columbia Management. Please go ahead.

My question is on Spain. Can you discuss what the model will look like on a direct sales basis with the distributor not in the mix going forward? Talk about -- I think Spain was about 5% of your overall sales last year, around $3 million. That, and I believe there was a pretty substantial markup from the distributor, so what does that mean for your margins and then ultimately, even if you don't sell anymore units there, what do you expect the revenue impact to be?

Good. Let me answer it first and then I'll let Hans add more to it. Though we don't report Spain alone, you do a pretty good job of guesstimating what percent it was of our business last year, and you're fairly close. It will positively impact our margins because the revenues we'll get will be 2X of what we previously had been getting. So, if sales are flat the third and fourth quarter of this year versus last year, we'll show 2X in terms of our revenue result. That revenue result on the same cost of goods obviously will raise our gross margin and it will help contribute to our drive to get to 71% overall.

But one of the things that I should also point out is that we will have a little bit heavier operating expenses the rest of the year because there are some additional costs incurred with the distributor. Because, remember, we moved him out earlier. We transitioned earlier. He had until the end of February, I believe, next year, so he's still going to get his margin between now and then. That will show up in our operating expense line, and I think we pointed out it was about $175,000 expense during the second quarter that would be just associated with that. Those kinds of costs will continue through first quarter of next year.

Then we will go to what the cost basis would normally be for being direct in a market, and we're actually going to partner with the same distributor. He's going to be our logistics partner and we will continue to pay him for those efforts. But that would go back to a more normal rate. Hans, anything -- what would you like to add?

Well, I just want to add that Spain is now our largest refractive market in Europe and it is very important to have management under well control. To your question on how sizable the Spanish business is, it's somewhere in the range of 20% to 25% on the total European value, and obviously we are not there today. We are going to be there with the end user (inaudible), so we are looking forward to that.

Well, theoretically it will actually go up as a percent of Europe, then, because of the dynamics that Barry talked about.

Exactly.

Thank you.

Thank you. The next question is from the line of Joe Mondillo with Sidoti & Company. Please go ahead.

Good afternoon, guys. Thanks for taking my questions. Real quick, a lot of my questions were answered, but, Barry, I'd like to focus a little bit on the US and what you guys are doing with the military. I believe, if I'm correct, didn't you lose a surgeon in the military? One was retiring and you were waiting for one to get trained; is that correct?

Yes, let me kind of paint the picture a little bit for everybody. You may recall probably around two years ago, military represented about 25%. Is that right, Don?

Correct.

Yes, of our US sales. You can see it was 11% in the quarter. So, let's drop down, and what happened was two of our largest implanters in the US -- one retired from the military and the second one was shipped off to Afghanistan. Now, good news for us now and it's just started to kick in, and that's why I think Don's got a smile on his face about the second half of the year with ICLs, Dr. Scott Barnes is now back in the battle at Fort Bragg. So, we got him. He was a very large implanter of ICLs. And then down at Fort Hood, Greg Parker, who had retired, is actually back on base in a civilian surgeon for one or two days a week, Don?

At least one day a week.

Okay. So, we are going to see upside the second half from those two events. Plus, we had been training the replacements, as you point out, Joe, and some of those will also be taking on ICL procedures for the first time the second half of this year. Don (inaudible) --

Absolutely, and we just got a text yesterday. We were sitting here at a meeting and Dr. Barnes said, hey, I just want to let you know I'm doing 27 ICLs next week; is that a record? Very positive.

We told him no, of course.

And, Barry, I know you're doing it at these two bases. Is there plans to -- I mean, is it just getting docs to perform it and training? Is there other base opportunities? I mean --

Yes, yes. We have been training docs to some of the smaller volume bases. These are two very large bases, so that's where higher volumes would come from. But some of the smaller bases are starting to pick up well, too, from the training we've done the past six months or so.

Like any bases in Europe that the US has? Any possibilities there? I know Germany has a big --

Yeah. No, not really. It's very rare. Now, Scott Barnes has gone to Germany before to put in some Toric ICLs, because he can't do that in the US, but, no, not a whole lot of volume there. They usually bring a surgeon -- I'm sorry, a soldier back to the US when he has an eye problem.

And how do you get that to translate that over into the US? I know you spoke about the guy from the Black Eyed Peas, you talked about social media. Can you give us a little bit more color? I mean, it seems like you're having the success in the military and then it kind of is dropping off once it gets to the civilian side.

I think Don pointed out our civilian sales were up 6% first quarter in the US -- I'm sorry, second quarter. They were also up first quarter, I don't remember the number off the top of my head. So, our civilian business has been helping to make up for the lag in military over the last six quarters or plus. So, I think we'll see growth second half in both segments, but the military will grow faster than the civilian second half.

Thank you. The next question is from the line of Bruce Jackson with Northland Capital Markets. Please go ahead.

Good afternoon. So, just a couple of questions about Japan. Japan was up this quarter. I wanted to know the status of the Shinagawa contract and how the trend is going with them. And also if you could talk a little bit about where the sales strength came from this quarter in terms of the ICLs versus the IOLs.

Okay. First let's talk about Japan and talk about Shinagawa. They're very sensitive about talking about their volumes, but I will say this overall, both Shinagawa and Optical Express are doing quite well in Japan. They're growing nicely quarter-over-quarter, and Don Todd has heard me say this before. Would I like to see them grow quicker? Absolutely. And we're trying to help them and support them in every way we can. Don has spent a lot of his time there. Our Japan organization, we've got folks who are dedicated to these two large centers and we see progress. We see more progress to come in the future. Don, is there anything else you would add?

Yes, I think we still have a lot of untapped potential at Shinagawa, and moving a very large LASIK center like -- you know, it's interesting. They do as many LASIK procedures as some countries do, and so it's kind of nice to have that much volume in one account, but you also have a lot of inertia that we're fighting. And without getting into specifics, there's operational things we're working through with them to try and make them more efficient and be able to bring on more ICL patients and effectively move them through their centers. But it is improving. It's not as fast as I'd like it to go, but we have frequent meetings with them. They're very strong on the results of their ICL patient outcomes. In fact they brag about how well the patient sees. So, I think over time they're gaining more and more confidence in the outcomes and also the procedure itself. But it's moving and it's showing some good growth, but we have plenty of opportunity to increase that momentum in the second half of the year.

On the second part of your question, Bruce, I would say refer to slide 8. There is a pretty good chart on several markets there. You can see that Japan, as you pointed out, they were up 74% in the quarter, Germany up 83%. Italy, though a much smaller market, more than doubled. Latin America, which is a new market, new sales rep for us there, up 28%. India continues to be strong, up 22%. So, there's some of the markets. Though they're not big enough yet to make up for the hits we had in China and Korea, they will grow up and get to that point.

Okay I guess my question was in terms of the sales growth in Japan this quarter, was it mostly driven by the ICLs or the IOLs?

Well, the Japan number here is ICL growth only. So, it was up 74%.

74%, okay. And then once you do get the new one piece acrylic IOL launched in Japan, is that something where you're going to have incremental uptick and it should show some acceleration?

Yes, that's the KSSP, the single piece preloaded acrylic. We do offer a three-piece acrylic preloaded in Japan, but about half the market prefers the one-piece versus half the market preferring a three-piece. And our sales reps have been telling our docs in Japan that the single piece is going to be coming any time, because we had approval for over nine months, as Don painfully points out to me. So, this will help them in terms of maintaining accounts and also expanding in new accounts that wouldn't even try the three-piece because they prefer the single piece lenses.

Thank you. The next question is a follow-up from the line of Jason Mills with Canaccord Genuity. Please go ahead.

Hi, thanks. I just wonder if you can give us an update on the FDA and the Toric?

FDA and the Toric. Yes, we're continuing to pursue that. It's still a week-to-week, back-and-forth response, and Q&A on specific events. The event that has been the topic really of the year, I'd say, the last six months that we've been working on with them is this patients in the window and out of the window issue. So, we are still working with that. We're hoping to drive to a conclusion here shortly. I will tell you we have engaged an additional consultant who has prior experience with the FDA, and we're working with that group as well. So, we're hoping to see some progress, but it's still -- I'd say the first six months of this year it has been on that same singular issue back and forth with them.

Okay, great. Thanks so much.

Thank you. The next question is from the line of Larry Haimovitch with HMTC. Please go ahead.

Good afternoon. Hey, Deborah, I know you don't have enough to be thinking about so I thought I'd give you something else to think about.

Great. Thanks, Larry.

The beloved, beloved medical device tax looks like it's going to start January 1. Do you have any kind of estimate on what that's going to cost STAAR a this point? And, Barry, do you have any response to the cost that it will impose? Some companies are talking about price increases, other people are talking about reducing employee headcount. Just wondering what your thoughts are.

Yes, good question, Larry. Let me dive in first. First of all, just make sure we're all on the same page. It's a 2.3% tax. It's for US sales only, so that helps us today, in that 80% of our sales are outside the --

Yes, yes.

-- United States. On the ICL side, which is about half of our US sales, we will pass that on to the end consumer. We'll raise our price in the US for that. On the IOL side, we won't have the opportunity to do that, so we will have to -- we'll have to pay the tax on that ourselves. And if you look at half of the US sales, 2.3%, you're taking $200,000 or less in 2013.

Yes, I didn't think your impact was -- so, for you it's a relatively modest impact then.

Correct. And if anything we are adding employees as we bring manufacturing here. So, we may be one of the few US companies that are increasing headcount in the US.

Yes, okay. Thanks, Barry.

Thank you, Larry.

Thank you. The next question is from the line of Patrick Smith with Jackson & Smith. Please go ahead.

Hi. Most of my questions have already been answered, but I just wanted to make a comment with regard to your announcement of the individual with the Black Eyed Peas. I think that's a great route to go to get awareness, to build awareness around the product. I'm glad you finally got around to it, as I suggested it a number of years ago. But bottom line is I think that gets the awareness out there, and I would suggest looking for someone in the sporting world.

Yes. You know, I must admit that until this story came out last week, I thought black-eyed pea was a vegetable and I thought apple was a fruit. But I've embraced it very quickly. I've come to learn that Apl.de.ap is kind of like Tiger Woods would be to me. And some of you may know that Tiger Woods is by many in the US to be considered to be the turning point behind LASIK.

Well, yes, exactly, and that's the exact point I made several years ago, that if you could find somebody -- and not necessarily that high profile, but just somebody to drive consumer awareness. Because if people do the research, the ICL will sell itself.

We're hoping to have the Apl. ICL rap soon.

Sounds good. Thank you very much.

Thank you, Patrick.

Thank you. And the next question is a follow-up from the line of Bruce Jackson with Northland Capital Markets. Please go ahead.

Hi, thanks. Just one more follow-up question. Are we still on track for a preloaded NanoFLEX in Europe during 2013?

First of all, the preload comes with the V5 ICL first, and then we'll transfer that same technology to the NanoFLEX, and that should be later in 2013, yes, and we should still be on target for that.

Okay, great. Thank you.

Thank you.

Thank you. There are no further questions at this time. I will turn it back over to management.

Thank you, Operator, and thank all of you for your participation on our call today. I will remind you again, August 15 we'll be in the Boston area with the Canaccord conference, and I hope we've answered all your questions today. But please feel free to give us a call. We look forward to providing you an update on our progress on our third quarter call during October. Thank you. Goodnight.

Ladies and gentlemen, this does conclude the conference call.