Leigh Salvo – IR
Barry Caldwell – President and CEO
Steve Brown – VP and CFO
Robin Hughes – VP, Global R&D, Regulatory and Quality
Chris Cooley – Stephens
Jim Sidoti – Sidoti & Company
Erica Layon – Benchmark
Kayla Crum – William Blair
STAAR Surgical Company (STAA) Q3 2013 Earnings Call October 30, 2013 4:30 PM ET
Good day, ladies and gentlemen and welcome to the Third Quarter 2013 STAAR Surgical Company Earnings Conference Call. My name is Regina and I’ll be your conference operator for today. At this time all participants are in a listen-only mode. Later, we will be a conducting a question and answer session. (Operator Instructions) As a reminder, today’s event is being recorded for replay purposes.
I would now like to turn the conference over to your host for today, Ms. Leigh Salvo, Investor Relations. Please go ahead.
Thank you, operator, and good afternoon, everyone. Thank you for joining the STAAR Surgical conference call and webcast to review the company’s financial results for the third quarter which ended on September 27, 2013.
The news release announcing the third quarter results crossed the wire about half an hour ago and is available on the 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, please go to the Investor Relations section of STAAR’s website again 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 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 today, 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 remarks about the corporation’s projections, expectations, plans, beliefs and prospects. These statements are based on judgment and analysis as of the date of this conference call and are subject to numerous important risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.
These risks and uncertainties associated with the forward-looking statements made in this conference call and webcast are described in the Safe Harbor statement in today’s press release as well as STAAR’s public periodic filings with the SEC including the discussion in the Risk Factors section of our 2012 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 the GAAP numbers, we have provided non-GAAP adjusted net income and diluted net income per share information that excludes manufacturing consolidation expenses, Spain distribution and transition expenses, gains or losses on foreign currency, fair market value adjustments for warrants and stock-based compensation expense.
We believe that these non-GAAP numbers provide meaningful supplemental information and are helpful in assessing our historical and future performance. A table reconciling the GAAP performance to the non-GAAP information is included in our financial release which is available on our website and in our slide presentation.
Now, I would like to turn the call over to Barry Caldwell, President and CEO of STAAR Surgical.
Thanks, Leigh and good afternoon everyone. Thank you for joining us today for a review of our third quarter results, as well as an update on our performance for the first nine months of 2013 and expectations for the remainder of the year.
With me today on the call is Steve Brown, who was named CFO during the quarter. Steve had previously served as Vice President, Global Finance at Bausch & Lomb that he had been there since 2008. Also on the call is Deborah Andrews who continues with the company as Vice President and General Accounting Officer, as well as Robin Hughes our Vice President of Research & Development and Regulatory.
I’ll start our call this afternoon with an overview of the third quarter results against our four key metrics. Steve will then offer a detailed look at key third quarter and nine months financial results as well as an update on our manufacturing consolidation project. In closing, I’ll discuss key operating milestones and new product developments. Then, we’ll open the call for your questions.
Our momentum continued globally through the third quarter and the results of product approvals in new markets and the benefits of our manufacturing consolidation are having a positive impact on our financial performance not just today but as we look out into the foreseeable future. The two significant headwinds we face this year, the value of the yen and IOL supply constraints persist.
Let me start by reviewing our four key metrics which we established at the beginning of the year and updated accordingly throughout the year. These metrics as you can see are focused on our revenue growth, our gross margin expansion, profitability and our manufacturing consolidation progress. As you can see we met all four metrics during the first two quarters. You may recall that we raised our revenue growth metric on the second quarter call to an annual growth rate of 12% to 14%. Now, let’s review our performance during the third quarter stacks up against these one by one.
First revenue, revenue for the third quarter was $17.1 million which represented 8% growth over the prior year U.S. dollars. Year-to-date revenues of $53.3 million reflect a 13% increase year-over-year in U.S. dollars. We believe we’re on track to finish at the upper end of the revised revenue growth rate for the full year. That would put our growth rate at 13% to 14% for the year despite the anticipation of those headwinds continuing. One of our continued headwinds is the negative impact of currency as the value of the yen further weakened during the quarter and throughout the year.
Revenues in Japan, during the quarter represented 24% of our global revenues. Japan sales increased 18% on a constant currency basis but declined 5% in U.S. dollars based upon the weakened value of the yen. For the quarter, global sales of $17.1 million represented growth on a constant currency basis of 14%. Year-to-date global sales of the $53.3 million represented growth of 18% on a constant currency basis to only 13% in U.S. dollars as the value of the yen has had a $2.7 million negative impact on our revenue line year-to-date.
Now let’s drill down more into our ICL and IOL sales. Total global sales of the Visian ICL product during the quarter represented approximately 63% of total sales at $10.7 million. This reflects an 18% increase in ICL revenues over the same quarter last year. We’ve now added France to our target list making it a total of a 11 I’m sorry 12 now that we will track instead of the previous 11. Visian ICL revenues increased in all three of our regions, Europe, Middle East and Africa EMEA as we call it grew 40%. Asia Pacific grew 10%, while North America grew 9%. So, let’s look at each region quickly.
First of all in EMEA. In Europe, we had 42% growth in ICL revenues primarily due to the gains from the CentraFLOW technology which is been available in Europe now for about 18 months. The CentraFLOW technology may recall takes a step at other procedure making it much more convenient and cost effective for both the surgeon and the patient. Spain, which transitioned from a distributors sales model at the end of second quarter of last year grew 23% representing the first quarter with a true direct to direct distribution model comparison. We also saw strong growth in Germany at a 154%, France at 81% and Italy at 53% year-over-year. All of these markets have the CentraFLOW technology today.
In the Middle East, with the Visian ICL with CentraFLOW was introduced earlier this year, revenues grew 39%. And Latin America where we saw the second quarter approval of CentraFLOW in Argentina we did began to – the CentraFLOW did began to contribute to revenue growth in that market which grew at 30%. In the Asia Pacific region, China grew 22% in revenues as we’re starting to see some of the overhang go away from the heavy negative press on LASIK last year. Korea grew 13% as the distributor prepared for the first sales of the CentraFLOW technology which was approved in late June with an official launch at the end of July. India grew 18% in revenue, the approval of CentraFLOW there was really too late in the quarter to provide much impact during Q3. Japan, now this was our only key market where we saw a decline during the quarter. ICL sales declined 5% in yen during the quarter. According to key customers in Japan, the market has seen significant declines in patients coming in for refractive procedures.
Key market highlights in North America. Visian ICL sales in the U.S. increased by 7% while units for procedures increased by 9%. This is was a – there was a slight decline in price based on a market in which LASIK continues to show weakness and we have a limited product offering. Overall, our results in the U.S. continue to be encouraging.
For the first nine months of the year, Visian ICL revenues grew 24% in these target markets. Visian ICL also grew in each region, EMEA 48%, APAC 16%, North America 10%. Overall, I’m pleased with our year-to-date performance as a result of the momentum generated in the marketplace by our rapid cadence of new product introductions and approvals. The Visian ICL continues to gain market share in the global refractive surgical market. This is illustrated by the approximately 33,000 Visian ICLs with CentraFLOW which have now successfully been implanted since the introduction of the technologies in the markets where approved. It is very easy to see of the positive impact from this product has helped drive growth in the EMEA region.
Remember, we’ve just started our efforts with this technology in Korea, India and Latin America. This should be a key driver for sales in Q4 and 2014. We expect to add China and now Japan approvals of CentraFLOW during the first half of next year which should allow those markets to drive incremental growth during the second half of 2014.
Turning to ICL unit or procedure growth in the first nine months of the year, all 12 of our key markets grew. To-date in 2013, we’ve seen a 20% increase in procedures or units of the ICL and a 3% increase in price. The Visian ICL units increased in all three of our regions as well EMEA 31%, APAC 16%, North America 13%. EMEA also experienced a 13% growth in price which was driven by the CentraFLOW technology.
Now let’s turn to global IOL sales. For the quarter, this represented 31% of our total sales at $5.3 million which was a 12% decline in U.S. dollars but on a year-over-year basis increase of 1% in constant currency. The negative impact of foreign exchange on the IOL line was significant at $809,000 during the quarter. We also ended the quarter with approximately $800,000 in backorders from our European customers. Our supplier of acrylic IOLs continue to be unable to beat the high demand for the new KS-IOL products and this represents the second major headwind that we faced all year. As a result, distribution efforts for the KS-IOLs were again curtailed and further impacted our sales in several regions.
Let me drill down into the regions on IOLs a bit. Our IOL sales in Japan represented 52% of our global IOL revenues in U.S. dollars. And in U.S. dollars this reflects a decrease of 11% compared to the prior year. However on a constant currency basis, we grew 15% in the Japanese market with the IOL. In the third quarter, we continued in Japan with reduction of accounts where we offer a consignment of the KS-IOL due to this lack of supply. It was also necessary to continue the suspension of product allocations in China during the third quarter. This resulted in an overall decline of $500,000 in the third quarter as compared to the prior year third quarter.
Europe, Middle East and Africa, EMEA was the only region where we saw IOL growth in U.S. dollars. The region grew 52% year-over-year demonstrating the ability of the new KS-IOL line to drive market share in the European markets as well. We now believe that our supplier will be able to provide some level in increased units during the fourth quarter if the supplier can meet our expected demand for 2014, we should be able to increase the number of consigned accounts in Japan and expand to additional markets in Europe in addition perhaps reenter the China market.
Overall, IOL revenue was down 9% in U.S. dollars for the first nine months of this year but in constant currency we shown a 3% gain with the supply issues we faced. Despite the challenges in foreign exchange and supply, I’m pleased overall with our performance in the IOL product line. We’ve been saying that we expect single-digit growth in the IOL products and we are achieving just that in 2013.
Now to our second metric, gross margin expansion. Gross margin expansion, we did not meet our metric during the quarter. Gross margin for the quarter was 70.5%, once again the weakened value of the yen in Japan our largest IOL market had a negative impact on gross margins. The increased sales of low margin injectors to our third party manufacturer for the KS-IOL lens without the supply of lens to offset the margin provided a negative impact to gross margin as well. This combination had a negative impact of approximately 270 basis points on our gross margins as a result. We did not meet the metric for the quarter.
Without the impact of these negative factors, gross margins would have been 73.2% during the quarter. As long as the value of the yen is weak compared to the dollar this will negatively impact our gross margins. We now expect this trend to continue into the fourth quarter as well. Given the extended or expected continued trend, we will not meet our gross margin metric for the year. This is a disappointment, yes but I’m really not sure we could have done anything else to combat the yen value and the supply issues from a third party. However, if these factors turn positive in 2014, I expect we’ll be able to regain our gross margin expansion momentum and perhaps catch up to our previous expectations were for 2014.
Our next metric was to be profitable on a GAAP basis each quarter. This was achieved with GAAP net income of $525,000 or $0.01 a share compared to a loss previous third quarter of $90,000. Our final metric is to make progress with our manufacturing consolidation project or project Comet where product quality and supply are maintained throughout. Our team continue to execute successfully to this metric during the third quarter and made progress toward completing the manufacturing consolidation by mid-2014.
At the end of the quarter, we’ve increased our ICL inventory and finished goods. We had a 11,400 ICLs at the end of the quarter. This compare to only 5000 in Switzerland or a total of 7500 at the end of second quarter, so over a 50% increase during the third quarter. Our target is to have about 50% more ICLs in finished goods inventory from where we are today when we finally complete the manufacturing consolidation in Switzerland. This inventory build is consistent with our plan to assure adequate supply and quality of product throughout this consolidation project. Manufacturing yields with the ICL in the U.S. continue to increase and we’re hiring additional personnel to the U.S. and transferring others from Switzerland to maintain the continuity here in the U.S.
Finally, I’d like to comment on our current outlook for the remainder of the year. We have executed to a solid nine months start to the year and I’m confident that the remaining quarter of this year will continue to demonstrate the momentum we have experienced despite the two continued headwinds that we continue to face. The fourth quarter is shaping up to be our largest revenue generating quarter of the year enabling us to achieve our growth rate target at the high end of our revenue growth range for the year. We expect the revenue growth for the year to finish at or near 14%.
Now I’d like to turn the call over to Steve and welcome him for a more thorough review of our third quarter financial highlights. Steve?
Thanks, Barry. And good afternoon everyone. It’s pleasure to join the STAAR team at this exciting time and the company’s growth. There are five areas in which I will focus my comments, the impact of foreign currency, the manufacturing consolidation, tax impact, gross margin expansion, GAAP and non-GAAP adjusted net income results and key financial results year-to-date. As Barry discussed, the continuing decline in the value of the yen resulted in a negative impact to our revenue of $1 million for the quarter. Most of this $809,000 negatively impacted IOL sales a $155,000 was a negative impact to our other product categories.
For the nine month period the negative impact of foreign currency was $2.7 million primarily in IOLs by $2.2 million and other sales by $364,000. There was also a $110,000 impact on ICLs in the first nine months of this year. The value of the yen to the U.S. dollar for the first nine months has been 96.7 compared to 79.3 in 2012. There has also been a negative impact on gross profit for the year of $533,000 and a positive impact on our operating expenses of $624,000.
Our manufacturing consolidation project is progressing as expected under our revised plan with positive results. Manufacturing consolidation expenses for the quarter were $490,000 a decline from $728,000 during the third quarter of 2012. Expenses for the first nine months of the year were $2 million as compared to $2 million during the same period of 2012. We expect to spend about $260,000 in the fourth quarter as these expenses wind down. Our manufacturing consolidation is already demonstrating a positive impact on our income taxes. In the third quarter, we recorded an income tax benefit of $433,000.
Now that the manufacturing consolidation process – project is complete in Japan. We were able to release the valuation allowance against its tax assets. This resulted in our income tax line being recorded as a net benefit of $25,000 during the third quarter of 2013 compared to a $219,000 tax provision during the third quarter of 2012. Excluding the tax benefit from the Japan, the effective tax rate for the quarter was approximately 82%. We did generate a profit in the United States for the first time in 14 years. This is a positive sign going forward as the profit generation in the U.S. will allow us to begin using our $122 million of net operating losses. For a few quarters, we mainly back and forth on profitability in the U.S. until the manufacturing project is complete.
Our effective tax rate was 61% for the first nine months of the year excluding the tax benefit in the third quarter. Our effective tax rate for the year is now expected to be approximately 45% based on the decision to continue manufacturing in Switzerland through the first half of 2014.
Now I’d like to talk about expanding gross margins. Gross profit margin for the quarter was 70.5%. The product mix during the quarter was approximately 63% ICL and 31% IOLs. The continued weakness of the yen combined with Japan sourcing of the preloaded silicon IOL from the U.S. had a negative impact on the gross margin percentage in the quarter. In addition, we had a higher mix of lower margin IOL injector sales in Japan. Due to the supply constraints of the KS-IOL units the gross margin impact of the lower margin injector sales would not offset. Without the impact of these negative factors, gross margins would have been 72.7% versus the reported 70.1% for the first nine months. With an increased supply of KS-IOL units to sell and a return of the yen exchange rate to more recent levels. We would expect to be able to return to our gross margin expansion targets in 2014.
Our GAAP results for the third quarter and year-to-date are quite positive. Here, you’ll look at a few key factors around our nine months GAAP results. Revenue has increased 13%, while gross profit has increased the same. Operating expenses have grown 7% and remember the $2 million of this spend is from manufacturing consolidation. This cost will be a minor expense in 2014 and occur only during the first six months of next year. Also, we’ve invested $490,000 for facility improvements and expanding the U.S. facility. The medical device tax was $149,000 during the nine months.
Our income tax – our income before taxes is five times greater than the results from 2012, well our tax is 14% higher. Net income is $0.03 per diluted share versus a loss of $0.01 per diluted share in 2012.
Now I’d like to talk about non-GAAP. To provide investors with a better basis on which to compare results and understand our business we’re also reporting net income on an adjusted basis, which excludes manufacturing and consolidation expense, Spain distribution transition expense, gains or losses on foreign currency transactions, fair value adjustment of warrants and non-cash stock-based compensation expense. Excluding these items, adjusted net income for the quarter was $1.7 million or $0.04 per diluted share as compared to the adjusted net income of $1.7 million or $0.05 per diluted share reported in the third quarter of 2012.
As the one-time expenses start to diminish, the non-GAAP results will look more and more like our GAAP results. The results from this quarter are driven by an increase of approximately $600,000 on the net income line offset by a lower add back of approximately $600,000 in manufacturing consolidation and Spain distribution costs. Non-GAAP adjusted net income for the first nine months was $6.7 million or $0.17 per diluted share, 55% higher than the adjusted net income of $4.3 million or $0.12 per diluted share reported in the first nine months of 2012.
Finally, I’d like to take a look at our key financial results year-to-date. Revenue growth during the first nine months was 13%, an 18% on a constant currency basis. Visian ICLs grew 24% during the first nine months both at actual and in constant currency. This was driven by the success of our CentraFLOW technology. Gross margin was 70.1% including the negative impact of 260 basis points as noted on the slide. Without these factors, gross margins would have been 72.7%. We finished the quarter with $23.4 million in cash the highest total in the history of the company. This compares to $19.7 million at the end of the second quarter. Even with the investments we are making in the business, we generated $3.1 million in cash from operations during the quarter.
GAAP net income was $1.3 million which was $1.6 million improvement over the same period in the prior year. Non-GAAP net adjusted income was $0.17 per share as compared to $0.12 per share.
This concludes my comments. And I’d like to turn the call back to Barry. Barry?
Thank you Steve and it’s great to have you on the team.
I believe three key topics I’d like to turn to quickly. We’re seeing some very positive progress in our regulatory submissions on the ICL product line. First, let’s look to the Toric ICL Submission in the U.S. We did have an inspection visit both in Switzerland and U.S. from the FDA during the third quarter. Key reviewers of the Toric ICL Submission were present for two days in Switzerland and four days here in the U.S. The latest news is, we responded to a technical question not a clinical question on October 24. This morning, we received another technical not clinical question to which we need to respond by early next week. We’re waiting to hear from the agency for a Panel Day on the Toric ICL Submission.
During the quarter, we received regulatory approval of the CentraFLOW technology in India, Korea and Argentina – I’m sorry third quarter was India, second quarter was Korea and Argentina. And you can see the success that we’ve had in Europe, we think that, that will help in these markets from this point forward. Three additional key submissions for the CentraFLOW technology are underway, China, Japan and the U.S. During the quarter, we visited directly with our consultants and the CFDA in China. We believe those discussions resulted in avoiding the need for additional testing and we remain on track for approval during the second quarter of 2014.
In Japan, we also made very good progress during the quarter and now expect to have CentraFLOW approved during the first half of 2014. Previously, this was not on our schedule for next year. In the U.S. we submitted a revised clinical protocol for CentraFLOW to the FDA on October 5th. This revised protocol was a response to suggestions made by the FDA to our earlier submission. A face to face meeting with the FDA is now scheduled for December 12th in Washington. We would like to establish the sites and provide the protocol before year end.
The recent ESCRS Meeting in Amsterdam was exceptionally successful and productive for STAAR, a lot of really good things happened at this meeting including our largest ever Visian ICL experts meeting. One other things that sorted throughout the event was a common theme that there are escalating awareness’s now of the limitations of LASIK.
During the quarter or during the past few years, we’ve introduced at a rather rapid pace new technology utilizing the ICL as the platform. 2011 was a V4d which expanded the range to virtually any myopic patient. In 2011 it was the V4c with the CentraFLOW technology which we’ve been discussing. This year, during the ESCRS, we introduced the Visian ICL Preloaded System which includes an enhanced optic design with the CentraFLOW technology and of course Preloaded. This technology is designed to reduce the procedure time, shorten the learning curve on the ICL technology as well as make the delivery of the ICL even more consistent during the procedure.
We expect to gain CE Mark approval in Q4 and begin the full launch of commercialization during the first quarter of next year. So, what’s next? The Visian ICL V6 that’s next in line of our rapid cadence of new products and we believe it will offer some significant new opportunities for the ICL platform. Our R&D department has been working on the research side of the V6 ICL for sometime. Now they’ve completed their work on the V5 preloaded we can move the V6 ICL to the top of the development list. We believe the technology is exciting and can add significant value to our customers and the company. The technology is designed to treat Presbyopia. Presbyopia is a progressive loss of the ability for the natural lens to focus on objects near.
Like the development of cataract, Presbyopia is a natural part of the aging process and will all get it as long as we live. The first sign it usually start around age 40. This is the reason I wear glasses, not because of around the age 40 but because I can’t read or see the computer screen without some assistance. The version 6 is actually already evolved to two platforms, the V6A and the V6B, let me explain. The V6A, this is a product for the myopic patients who are nearing the age of 40 when the first need for enhanced near and intermediate vision starts to become apparent. The optic design anticipated would provide one to two diopters of near vision enhancement as well as provide intermediate or laptop vision enhancement. This should delay for several years, the need for reading glasses for these patients.
The patient here is actually making a decision between LASIK ICL or doing nothing. This would provide this feature of the V6A an additional competitive advantage to the ICL over LASIK since it would be delaying the full impact of Presbyopia. We believe this enhanced feature on the ICL would drive usage down the myopic diopter curve where a greater opportunity exist for the ICL technology today. We’ve targeted availability of the V6A in Europe for either late next year or early 2015. In parallel, we’re working on the V6B ICL. This would provide a permanent solution to Presbyopia until the patient becomes of cataract age. The objective to find a permanent solution to Presbyopia has been called the Holy Grail of Ophthalmology for years.
According to market scope, a 100% of those at age 51 have Presbyopia. Today, the potential for a clear lens [indiscernible] procedure or refractive lens exchange has not gained but momentum. This is basically a cataract procedure for a patient with a clear or a good lens. This procedure removes the natural lens of the patient and replaces it with a premium type IOL like a Multifocal or accommodating. We believe it’s a combination of not having the right technology available and the requirement that the patient prematurely give up their natural lens which is dampened any enthusiasm for these procedures.
The V6B ICL would allow the patient to enjoy good near and intermediate vision while maintaining their natural lens until it becomes a cataract. We believe clinical trials will be needed for this product as we will be looking to increase the improved age range for the technology.
Before I open it up for questions, let me review some investor visits and meetings we have scheduled. November 6th and 7th will be in Milwaukee and Minneapolis. During the second week of November, we’ll be in New York City on the 12th with analyst and investors on the 13th at the Stephens Fall Conference and on the 14th the Canaccord Genuity Medical Technology Forum. The AAO Meeting is been held this year in New Orleans and we’ll be hosting an Investor Breakfast on Saturday Morning November 16. On December 3rd we’ll be back in New York City for the Piper Jaffray Annual Healthcare Conference. On December 16th and 17th we’ll be traveling with Benchmark to San Francisco and the Pacific Northwest. On Monday January 13th we planned to have an Investor Dinner Meeting in San Francisco with Stephens in association with the J.P. Morgan Healthcare Conference. We hope to see many of you at these events. If you like to set up a time, please welcome me or Doug now. As a reminder, we also have Deborah Andrews and Robin Hughes on the room as well today.
With that, we’re ready to take your questions. Operator, would you please open the line.
(Operator Instructions) And your first question today comes from the line of Chris Cooley with Stephens.
Chris Cooley – Stephens
Hey, good afternoon everyone. Can you hear me okay?
Hi, Chris. Yes.
Chris Cooley – Stephens
Great. Congratulations on another good quarter. Just a couple of housekeeping items and then maybe one forward looking item. Just in listening to your talk about the guidance for the full year and your confidence in the upper end of the revenue range, it seems pretty clear that you’re not going to be picking up much momentum just to the supply constraints and currency on the cataract side. So, am I doing the math right, are you implying fairly sizeable step up in terms of the growth rate for the Visian closer to 30 plus percent. And if so, can you help us pass out how much of that you think is an acceleration in underlying demand versus stocking as you go into these new countries with a new CentraFLOW technology. And then I’ve got a quick follow-up. Thanks.
Sure. First of all, let me say on the cataract side, if we do get increased KS-IOLs which we anticipate one of the things we would like to do is to eliminate the majority if not all of the backorders in Europe and finish the year clean. So, we would anticipate if we can get that supply the IOL line to be stronger. On the ICL side, we have been signaling I think even on the second quarter call that sales in China and Korea would be good third quarter but we expect there will be an quite strong fourth quarter. So, I think in those two markets in particular, we’re going to see very strong results during the fourth quarter and we do anticipate that Europe which has been running – I don’t have it in top of my head but close to 50% year-to-date growth in Europe we expect that to continue run at that kind of rate.
Chris Cooley – Stephens
Okay. And then maybe just – I’m actually squeezed two and if I may and I promise to get back in queue. When I look at gross margin I understand the impact of FX which you guys are clearly building incremental inventory right now. Help us think about that, is that additive or is that a headwind right now in terms of running plants, I’m just trying to think about the cost structure as you wind down outside of the U.S. and ramp up in the states. And then similarly, we think about an inventory slipping out in the coming year 2014. Help me to think about the potential step up in margin. And then the last question that I had was just to get on the Toric, maybe if you could provide some clarity over ground what a technical question may or may not be and if we should expect further ones. Thanks so much.
Okay. So, first of all on the ICL inventory. It’s been our plan all along to build that inventory level. And I think one of the slide shows that our inventory level at the end of last year was about 13,000 ICLs in inventory. We aren’t even back to that level yet. We were at the end of second quarter 11,400. We want to be at least 20,000 lenses in inventory before we shut down the manufacturing in Switzerland. We think we’re on pace to do that but we also know we have an increasing number of ICL sales that increases the target.
So, we’re challenging ourselves right now whether the 20,000 would be an adequate number or we actually need to be higher than that. And also it’s rolling on top of that what if the Toric ICL were approved early next year as the inventory requirements there. So, we’re trying to balance all of these factors to make sure that we have adequate supply and quality of our products before we make the plan and move it closing the Swiss facility. Then on your Toric ICL technical question, I’ll let Robin comment in minute but it’s basically around the conversion rate of the power of the ICL from the sailing solution to be assessed. Robin is that?
There was that question in the question that we got this morning is really about the measurement of power. So, it has nothing to do with the clinical submission, it’s a very simple question that we’ll as Barry mentioned we will answer in the early part of the next week. There is zero risk with answering that question.
Chris Cooley – Stephens
Understood. Thank you, so much.
Your next question comes from the line of Jason Mills with Canaccord Genuity. (Operator Instructions) And Jason, your line is open now.
Great. This is actually [indiscernible] for Jason. My first question would be – just kind of thinking about next year and not really looking for guidance but perhaps looking at the U.S. how should we think about the growth trajectory given the upcoming or potential for product approvals?
Well the key product approval [Jeff] in the U.S. would be getting the Toric approved. And kind of a measure that we’ve used is in all the other 60 markets where we sell both the Toric and the standard myopic lens the Toric lens is about 50% of the sales. So, that’s the kind of increase we would expect to see in the U.S. now. Now, I’ve also caution that there is some pent-up demand out there and the early adoption might be higher than that and then it could level off.
Okay, great. Very helpful. My second question would be in regard to your cash balance. If you mind update us on your thoughts on the use of this cash?
Sure. First of all we think we’re in a good spot now in terms of cash and as those who on the calls they’ve watched company for a while, there has been periods of time, we’ve not going to be in a situation where we’ve been happy with our cash position. This gives us flexibility at this point. We are looking at some outside technologies that could enhance some of our products. So, we may do some licensing or purchasing of some of that technology. We also know that next year as you look at our business I mean we can really start to see it this year but next year with the consolidation complete, this business can generate lot of cash, that’s a kind of problem we’d like to deal with versus not having any. But as of today, we’re happy with the amount of cash we have. We are looking to license additional technologies that would help our product line and enhance our growth going forward.
Great. Thanks for taking the questions.
Thank you, Jeff.
Your next question is from the line of Jim Sidoti with Sidoti & Company.
Jim Sidoti – Sidoti & Company
Good afternoon. Can you hear me?
Hi, Jim. Yes we can.
Jim Sidoti – Sidoti & Company
Great. It sounds like capacities initially you need to build up inventory, you’re expecting an increase in the over next few quarters as those new products get approved. Are you confident that you have enough capacity in the U.S. once you shut down the Swiss plan and if not what are you doing about it?
Really good question Jim. And actually we were going over that earlier this morning. And we are debating the inventory level by ICLs needed. But overall, yes we’re very confident with the start-up here in the U.S. But the reason we are is because we’ve had such a great assistance from our employees in Switzerland that they’ve been very active here both in coming for one, two, three or four weeks at a time. Others who have made commitments over the next 12 months, 18 months to either stay here in the U.S. for come back over a periodic basis. We are adding individuals here in the U.S. and we are transferring those – we are transferring some from Switzerland here. We began our second shift during the third quarter and we do have the capacity here within the loss we currently have to triple of cloud drupal the ICL production.
Jim Sidoti – Sidoti & Company
All right. And then my follow-up another Toric question. Are there more panels or I assume that it would probably done with panels for 2013. Do you know when the next panel would be in 2014?
I don’t believe there has been an announcement of the next panel date but as I would anticipate we’d be the next panel and we’re waiting to get that dates any day.
Jim Sidoti – Sidoti & Company
Your next question is from the line of Jan Wald with Benchmark.
Erica Layon – Benchmark
Hi, this is actually Erica in for Jan. I have a quick question on your gross margin targets. Can you extend on into 2014 is that what you’re looking for. Does that mainly be looking for 250 basis point improvement next year doing that FX and the surprise suppliers visit aren’t causing you problems?
Well, really good question I mean if things were to turn around, with the value once again and also our IOL supply issues, what I’m trying to say is I think there is a possibility that we can catch up on what we lost in 2013 and get back on where we thought 2014 would be. And that if Toric is approved in the U.S. it should add more than 250 basis points. But we haven’t evaluated next year a plan and as we develop our key metrics for 2014, we’ll keep you informed.
Erica Layon – Benchmark
Okay. Thank you. And I’d like to ask a quick question on this backlog, you have no – could you provide some idea on your confidence level that it could get this cleared up this year versus your expectations that it might roll into next year.
Yeah, it’s really good question now. Just to remind everyone the lens is made by a third-party vendor in Japan. We make the injector systems, they are marred together into a preloaded single piece and three piece acrylic IOL. And the results clean results have been great, the demand for the product has been high. I did visit Mongolia just a few weeks ago, our supplier which is Nidek has built a new facility for the enhanced capacity. They also sell the same product so they are just as motivated to get the supply up as we are. And we’ve offered to work with them in any way possible, I think our communications between the two companies has been very strong. And I’m more encouraged now than I was six months ago.
Erica Layon – Benchmark
Okay. And if I could just follow-up with one small thing. Instead of selling the same product as well is there some sort of allocation strategy between and signing those deal and you think internally?
Well, yes they make the IOL, we make the injector system. So, we both pretty much please each other.
Erica Layon – Benchmark
Okay. So, they’re not selling their component separately through lens.
They’re selling without our injectors.
Erica Layon – Benchmark
And so allocation between selling it with your injectors are not as that point in said is 50-50 will be – I’m just worried about the rest could they to be selling it to their customers for where they supply your backlog.
They tell us it’s about 50-50, they will trust us.
Erica Layon – Benchmark
Okay, thanks. Thank you, very much.
(Operator Instructions) Your next question comes from the line of Matt O’Brien with William Blair.
Kayla Crum – William Blair
Hi, guys, this is Kayla in for Matt. Thanks for taking our questions. Just looking at Japan, I’m curious about the commentary about declines in LASIK procedures and whether or not your guidance assumes that there is going to be continued softness in that market in Q4 or as you’re seeing some sort of a recovery there?
Yeah, usually when these things happen they don’t quickly turn around. So, I think as we look at Japan for fourth quarter, we’re not looking for huge increases but we are looking for the trends to turn around, we are looking for ways to put the ICL in front of mind to patients and maybe even help to draw more patients into some of the key accounts.
Kayla Crum – William Blair
Okay. And then with respect to Korea, what sort of growth are you seeing from CentraFLOW compared to the base business at this point?
Well, I think Korea grew about 7% the first half of the year during the third quarter that grew 13% and that’s just the early days of CentraFLOW because it was approved kind of during the middle of the third quarter but we would expect to see a larger improvement or increase during the fourth quarter.
Kayla Crum – William Blair
Okay. All right. Thank you.
There are no further questions in queue at this time. So, I’d like to turn the call back over to management for any closing remarks you’d like to make.
Great. Thank you, very much operator. And we appreciate everyone on the call today. If you have additional questions, please feel free to contact us or if one of the staffs along our Investor Meetings if you’d like the schedule, visit with us, please contact EVC, through me or Doug. Thank you and have a good evening.
Ladies and gentlemen, thank you so much for your participation in today’s presentation. You may now disconnect. Have a great day.
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