STAAR Surgical Company (NASDAQ:STAA)
Q2 2014 Earnings Conference Call
July 31, 2014 5:00 PM ET
Doug Sherk – EVC Group
Barry Caldwell – President & CEO
Steve Brown – CFO
Deborah Andrews – Chief Accounting Officer
Matthew O’Brien – William Blair
Chris Cooley – Stephens
Jason Mills – Canaccord Genuity
Jim Sidoti – Sidoti & Company
Jan Wald – Benchmark Company
Welcome to the STAAR Surgical Second Quarter 2014 Financial Results Conference Call and Webcast. My name is Denise and I will be the operator for today. (Operator Instructions). I would like to turn the conference over to Doug Sherk, EVC Group.
Doug Sherk – EVC Group
Thank you Denise and good afternoon everyone. Thank you for joining us for the STAAR Surgical conference call to review the company’s financial results for the second quarter which ended on July 4th, 2014 as well as recent corporate developments.
The news release detailing the second quarter results was issued just after 4 PM Eastern Time today and it's now available on STAAR’s website at www.staar.com. In addition to the slide presentation will accompanying management’s remarks during today’s call. 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’re listening via telephone to today’s call and would like to review the slides with the company management’s remarks, please navigate to the live webcast which I have just reviewed and choose the no audio slides only option. In addition an archived replay of the event 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 remarks about the corporation’s projections, expectations, plans, beliefs and prospects. These statements are based on judgment and analyses 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 2013 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 consolidated expenses, same distribution transition expenses, gains or losses on foreign currency, fair market value adjustments for warrants, stock-based compensation expense and FDA TICL panel expenses. 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 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 outlay I would like to turn the call over to Barry Caldwell, President and Chief Executive Officer of STAAR Surgical.
Thanks Doug. Good afternoon everyone. Thank you for joining us on the call and webcast this afternoon for review of our second quarter results as well as an update on our performance for the first six months of 2014, an expectations for the remainder of the year. With me today on the call remotely is Steve Brown, our CFO; Deborah Andrews, our Chief Accounting Officer is with me here in Monrovia.
Before we review the agenda I would like apologize for any inconvenience from our delay of this call by one day but we felt that it was important that senior management be in Japan for the funeral services of the Hideo Watanabe, President of STAAR Japan. Hideo joined STAAR three years ago and though he had no previous ophthalmic medical device experience he quickly gained the respect of our customers and our employees. He led the efforts on the manufacturing transfer of IOLs from Japan to the U.S. and the return to growth of IOL sales in the very important Japan market.
Hideo leaves a wife and three sons. He loved his family, he was very proud of them as well as a deep desire and love for fishing. He will be missed. He was a friend to all of us and a strong leader. Hideo reported directly to Don Todd, our President of the Asia-Pacific region. Don and other members of our management team will be present in Japan until we make a final decision on future organizational changes.
With that I will begin our discussion on the business this afternoon with an overview of the second quarter results against the five key metrics we established at the beginning of this year. Steve will then offer a detailed look at the key second quarter and first half financial results. I will then discuss key operating results for the quarter and then open the call for your questions.
So first let’s go to the five key annual metrics we established since the beginning of the year with are our objectives that we set for the business and are as follows. Revenue growth of 8% to 10%, annualized yield growth of 20%, expand our gross margins by 300 basis points for the total year to 72.7, be profitable on a GAAP basis for the entire year and successfully complete our Project Comet which is our manufacturing consolidation by mid-year.
We will review each quarter how our performance tracks to each objective. As we said at the beginning of the year these objectives are not meant to be slam-dunk and that we have to execute well in order to achieve.
Let’s start that review for the second quarter and the first half, with 10% revenue growth for the second quarter and 11% revenue growth for the first half of the year we’re achieving this objective and ahead of our initial expectations. During the second quarter we achieved that growth for the first half of the year we’re achieving this objective and ahead of our initial expectations. During the second quarter we achieved that growth though perhaps a little different way than originally expected.
Second quarter revenue came in at 20 million or 20.1 million in constant currency which is an 11% growth rate. We were not as impacted by the valuation of the dollar to the Japanese Yen in the second quarter and as a result currency impacted the sales by only about $90,000.
Our growth was driven by increasing Visian ICL and other sales as well as an increased growth rate in IOL product sales.
As you can see ICL revenue declined slightly as an overall percentage of our total business, IOL revenue was basically the same and our lower gross margin other sales grew to 7.2% of total sales driven by the increased IOL injector sales to our third patty supplier acrylic IOLs. As you know these are lower gross margin sales and total sales increased by 39% in this category during the quarter.
For the first half of 2014 our reported revenue growth of 11% or 13% in constant currency is above the annual growth objective we said at the beginning of the year of 8% to 10% based on a number of factors that we will review during this call we believe the second half offers an opportunity to increase the growth rate we saw during the first half.
Turning to our IOLs, during the first quarter we generated 4% revenue growth and our momentum continued to build during the second quarter. Global revenue for the quarter in IOLs grew 10% to 6.4 million and represented 32% of our total sales. Global IOL units increased 17% during the quarter. IOL growth was driven by the increased supply of the KS-IOL acrylic preloaded products which drove sales in the European region.
In addition we experienced a return to growth in China despite not being able to restart the KS-IOL commercialization in this market at this point. We did reduce our backlog for KS-IOLs during the quarter by approximately 1/5. During the first quarter we invested as you will recall KS-IOL supply to rebuild the consigned account levels in Japan which we had to reduce back in early 2013. We started to see the benefits of those consignments as KS-IOL units increased approximately 80% during the final eight weeks of the quarter.
We’re continuing to see a very high rate of KS-IOL growth in Japan through the first three weeks of the third quarter. As our confidence continues to build in the supply of KS-IOL products we now expect the revenue increase greater than anticipated at the beginning of the year for the IOL product line.
Let me drill down in the regions on IOLs for just a minute IOL revenue in Japan, our largest market represented 46% of the global IOL revenues. IOL revenue in local currency decreased 9% from prior year. You may recall that during the first quarter IOL units increased 22% driven by some buy-in by key accounts of silicone IOLs ahead of tax increase in Japan. Total IOLs units have increased 5% during the first half in Japan. Sales in Europe which represented 28% of our total IOL sales increased by 117% and an increase of 99% in units during the quarter due to heavy net increase supply of KS-IOLs.
IOL sales in China increased by 65% again here that despite the fact that we haven't relaunched the KS-IOL products, supply to that market was suspended during the second quarter of last year. IOL sales in the U.S. declined by 11% during the quarter. IOL revenue for the first half was 7% as reported and 11% on a constant currency basis. IOL units increased 17% while overall average selling price had a decline due to the geographic mix of sales.
Now let’s turn to our second annual objective which is ICL revenue growth for the year of 20%. Though our ICL revenue grew only 8% during the quarter our growth rate for the first half is at 12%, we have some key initiatives during the second half which we believe will allow us to achieve this objective for the full year. Those initiatives include new product launches, increasing selling prices and increasing promotional support. We will go into more details later on this call.
ICL revenue in our 12 target markets increased by 9% during the quarter, as you can see our European region grew 22% led by Spain up 26% Middle-East up 37%, France up 47% and Germany up 21%.
Our overall revenue growth in APAC was only 2%, growth in APAC was limited somewhat by higher comparables in the year ago period ordering patterns particularly in China and a continued slowdown in the overall refractory procedures in Japan. In China there were some delay of ICL inventory ordering based upon a potential tax savings for distributors.
Revenue in the Asia-Pacific region was led by a 9% increase in China, a 6% increase in Korea and India increased 9%. Revenue in North America of ICLs declined by 1% during the quarter which was an improvement from the first quarter decline. Second quarter revenues of ICLs with the CentraFLOW technology represented 63% of total ICL revenue. To-date there have been more than 70,000 implants of the ICL with the CentraFLOW technology.
As you can see the overall procedure growth at 5% or with the growth at 5%, our average selling price did increase and that increase was 3%, in more than 60 markets where our Toric ICL is available, second quarter revenues grew 19% and represented 49% of total ICL sales.
Global ICL revenue for the first half was at 12% with our target markets also at the same rate. Revenue growth in the European region was 24%, Asia-PAC 9%, and revenues declined by 8% in North America. In the more than 60 markets in which the Toric is available first half revenue grew 17% and represented 47% of total ICL revenue.
Now back to our third annual objective which is gross margin expansion and that objective was to grow a minimum of 300 basis points for the year. Gross profit margin for the quarter was 68.2% compared to 69.5% in the second quarter of 2013. Our gross margin expansion continued to face headwinds during the quarter primarily due to geographic mix of our IOL sales, manufacturing startup cost for ICLs in the U.S. and a higher mix of low margin IOL injector part sales. We do expect to see improvement during the second half but unless something currently not in our plan occurs we will not be able to make up for the short fall during the first half. Steve will go into more detail in a moment.
Our fourth annual objective is being GAAP profitable for the full year, we were not profitable in the second quarter. Our net loss was basically driven by the increased investments in R&D and sales and marketing as well as additional cost in general and administrative. We remained focused on this objective and we continue to believe we will achieve despite the unexpected hurdles we have faced during the first half.
Our expectation is based upon the stronger sales growth during the second half with lower operating expenses as compared to the first half. Steve will also go into more detail on this.
Manufacturing consolidation, that was our fifth objective and have that complete by mid-year, we can check it off the box that has been done, that has been achieved. Our team has successfully completed the transfer of the ICL products to the U.S. We anticipate the tax benefits of gross margin enhancement and tax expense will start to be realized in the second half of this year and for the full year in 2015.
As we take a closer look at our manufacturing consolidation yields of the ICL and Toric ICL in the U.S. continued to improve during the quarter though not yet at the level we experienced in Switzerland. During the second quarter approximately 77% of ICLs we’re manufacturing in the U.S. Now that number excludes the over than 6500 Toric ICLs that we manufactured in Switzerland and put into inventory for a potential launch of the Toric ICL in the U.S.
The last production of product in Switzerland was completed before the end of June. We have invested in a 33% increase in inventory levels in ICL since the end of the year to help assure that the quantity and quality demand for the ICL is achieved and while we’re no longer manufacturing product at our Swiss facility, we have maintained enough equipment onsite so that the market demand and operating conditions were to warrant, restarting the manufacturing there could be done very quickly.
The manufacturing consolidation project was completed in about 3.5 years and at a cost of about $6.3 million. Our hard working and dedicated employees in Japan, Switzerland and the U.S. have done an outstanding job on this project. Many of those employees in Japan and Switzerland have lost their positions as result of this transition. That did not stop them from total dedication to a successful transition. We salute their efforts and wish them well in the future. Since the beginning of 2012 we have hired total of 130 new employees which represents over 35% of our total workforce. During the same period we released 96 employees.
The first half of the year has been quite successful on the top line and we’re positioned to increase our growth as the year progresses. We continue to successfully execute on our plans and I’m encouraged by the sales momentum our products are gaining globally. We expect customer adoption of the new technologies like the ICL with CentraFLOW and the KS-IOL products should continue to expand growth. The preloaded ICL offers additional opportunities in Europe during the second half.
Finally, with the completion of manufacturing consolidation project we expect to see margin improvement and expense reduction during the second half of the year.
Now I would like to turn the call over to Steve for more thorough review of the second quarter and year-to-date financial highlight. Steve?
Thanks Barry. Good afternoon everyone. There are several other areas on which I will focus my comments, GAAP and non-GAAP P&L results, gross margins, operating expenses and our tax provisions. First let’s look at the P&L results, as Barry said revenue increased by 10% as reported and 11% in constant currency. Gross profit increased by 8%. I will review the gross profit profile and operating expenses in a moment. The GAAP net loss for the second quarter of 2014 was $1.8 million or $0.05 on a per diluted share basis, compared with a net income of $278,000, or $0.01 on a per diluted share basis, in the second quarter of 2013.
On a non-GAAP basis adjusted net income for the quarter was 291,000 or $0.01 per diluted share SG&A compared to the adjusted net income of $1.8 million or $0.05 per diluted share reported in the second quarter of 2013.
On a GAAP basis for the first half we lost $0.08 a share as compared with net income of $0.02 a share in the first half of 2013. This has been mainly driven mainly by additional investments in R&D and sales and marketing as well as increased costs in general administration.
On a non-GAAP basis we were in $0.05 and the adjusted income is compared to $0.13 during the first half of 2013. We continue to see improvements in our cost to manufacture of ICLs in the United States. It is not however yet at the level we experienced our facility in Switzerland. As this improvement continues we will begin to see the consolidation benefits in our cost of goods. There were three key headwinds to our gross margin during the quarter which had a total negative impact of 450 basis points.
First the geographic mix of IOL sales during the quarter drove a 230 basis point negative impact, toward the end of the quarter we saw more positive trend as a higher percentage of our KS-IOL sales were in Japan, which carriers a higher gross margin sales. We expect to see an improvement during the second half. Also the negative impact of increased sales of the IOL injectors was 80 basis during the quarter.
We do expect to see this negative trend continue during the second half as an increase amount of injector sales is expected.
Third, the startup increased cost of the ICLs drove a 140 basis points negative impact and we expect to see improvement during the second half as we lower our cost of ICLs manufactured in the United States.
Overall with an increased rate of growth in ICL products and new product introductions combined with cost savings expected from consolidation and higher selling prices we expect to see some gross margin improvement in the second half.
I would also like to provide a bit more color on the second quarter operating expenses. Our spending increased has primarily been in areas of investment for future growth. R&D spending increased by approximately $800,000 which was primarily driven by cost to complete the preloaded ICL project, regulatory costs for the CentraFLOW in China and Toric ICL in the United States and approximately $200,000 for remediation activities in response to the warning letter. Sales and marketing investment spending increased by approximately $1.4 million primarily for cost associated with the expected launch of the Toric ICL in the United States and an increased presence at key (indiscernible) meetings throughout the world.
Incremental cost and G&A spending were driven by compensation related to increased stock compensation expense which was driven by a higher stock price, higher accrual for bonus as targets are being met and tax consulting expenses.
The income tax provision was $367,000 during the second quarter of 2014 compared to a provision of a $599,000 during the second quarter of 2013. Tax benefits from manufacturing consolidations are being partially realized during the year. We will see increased realization for the full year in 2015. The effective tax rate for the second quarter was 26% while the rate for the first half was 23%.
Though we had negative income before taxes we did show a profit in Switzerland which drove the tax liability. As we show profitability in the United States our tax provision is expected to be reduced.
Now let me provide some outlook for key financials for the remainder of the year. As we said we expect to see a recovery in our gross margin results in the second half. Our startup cost of goods sold in the United States should continue to improve as all manufacturing is now in our U.S. facility. With increased supply of the KS-IOLs we expect to drive sales into the higher gross margin markets particularly Japan. With increased customer adoption and commercialization of new products we expect to see higher selling prices.
The lower gross margin injector sales though we will continue to expand during the second half of the year and this will be a drag on gross margin expansion.
We expect to see a decrease in our operating expenses in the second half. We will not have the first half at the A-Panel [ph] costs but we will have activities and expenses associated with the response to the warning letter which we estimate will be approximately $500,000 in the second half.
Basically the manufacturing consolidation expenses are now complete as well and will not repeat. Our tax provision during the second quarter was 26% and for the first half is 23%.
This concludes my comments and now I would like to turn the call back to Barry.
I would like to update several activities in the operational area, we will review the process of correcting the observations cited in the FDA warning letter. We will go through the preloaded ICL European approval and opportunity there. The development progress on the version 6A ICL, the regulatory approvals that are in various stages of progress and our plans for our largest participation ever at the upcoming ESCRS Meeting in London during September.
Let’s first address the warning letter. We thought it would be helpful for our investors to understand the history of our FDA, GMP facility inspection results over the past eight years.
We have had a total of nine FDA inspections at the three facilities in which we have manufactured products for the U.S. market during that period. Off those nine inspections six resulted in no observations. The other three inspections resulted in a total of seven observations all of which were successfully addressed with the agency.
As you can see two of the three GMP inspections at our Monrovia facility resulted in no observations. The last inspection prior to the one in the first quarter was in January of 2012 at which time there were no observations.
First we have taken and continue to take very seriously each observation in the warning letter and the corrective actions required. We believe our actions illustrate this approach. As you can see in the time line we have made four (indiscernible) responses to the FDA compliance branch.
On April 11th, our initial response to the 483 observations. On May 12th, our first monthly progress report to the agency. By the way this was a proactive commitment we made to the agency that we would provide an update on our progress each month at this stage. On June 13, we had our monthly update but along with that there were additional responses to the 483 observations and our initial response to the warning letter. On July 18th, our monthly updated and additional responses to the 483 observations and warning letter were included in that monthly updated July 18th.
In addition the FDA did approve the Monrovia site location for the manufacturing of the myopic ICL back in August of this year. Most of the ICL product shipped to U.S. customers this year has been manufactured here in our Monrovia facility. The majority of the warning letter observations identified four general or key areas of remedial action, one is design controlled documents from the Dow [ph] manufacturing facility that were unavailable upon demand during the February inspection.
Two, software validation of an online ICL calculator. Three, data collection and trending on ICL bolt [ph] complaints and finally shelf life data on the currently approved myopic ICL product. We have put a significant amount of resources both internal with employees and external with expert quality consultants into addressing the agencies concern and are committed to continuing to do so until we have satisfied their requirements.
So to preload, we announced on July 1st, the CE Mark approval for our new Visian ICL preloaded system. We see this product as a significant enhancement for our customers, the preloaded ICL provides a number of benefits to both surgeons and patients during the preparation and delivery of the ICL into eye. The preloaded system simplifies the process for the surgeon by reducing the number of steps to prepare and delivery the ICL into the eye. The current loading process that you can see by the pictures illustrated here is burdensome and many surgeons believe it to be the most challenging part of the ICL procedure today.
Additional benefits though include that the learning curve is shorter for surgeons and this new enhancement to the Visian ICL should allow surgeons who perform a limited amount of refractive procedures to add the ICL to their refractive offering. It also saves procedure time, makes a good delivery of the ICL and the eye more consistent, the larger optical zone can result in better quality vision at night when the pupil enlarges.
There are new intellectual property rights around the product in both design and the new nanoCOAT technology which helps to assure the integrity of the ICL delivery.
We plant to initially focus on key surgeon evaluation so they can speak to the benefits of the preloaded ICL product during the upcoming ESCRS meeting in about six weeks. The ESCRS will be the official launch of the product for Europe and we expect to see full commercialization during the fourth quarter.
The next generation Visian ICL underdeveloped by our team is the V6A which has designed would allow us to enter the large myopic vision correction market which is estimated at over 3 billion eyes. The V6 ICL differentiates the ICL for myopic patients nearing age 40 who will soon near or soon need near and intermediate vision correction.
The goal of V6A ICL is to add a near vision enhancement feature to the ICL platform to treat the early onset and progression of presbyopia. This new optic on the ICL platform should allow up to two diopters of near vision correction while providing some intermediate correction as well.
The patient recruitment process for the initial conformity study is currently underway as well as the manufacturing of product for these evaluations. Our hope is to have some initial clinical experiences to present at the ESCRS. That’s a tight timeline, if we’re unable to meet that we would expect to present both clinical and scientific data at the American Academy of Ophthalmology in Chicago during October. We expect to be able to gain approval and begin commercialization of the V6 ICL in Europe during the first half of 2015.
Turning to regulatory approvals in process, we completed what we believe to have been a successful experts panel meeting in China on May 15th regarding the CentraFLOW technology. Since that meeting we have received follow-up questions and have prepared the response. We expect the decision within the next 105 working days.
In addition we continue to interface with the FDA to finalize the process for the commercialization of the Toric ICL in the U.S. after the favorable panel vote on March 14. Since the advisory panel meeting we have provided additional data to the agency on the sensitivity analysis of protocol deviations which was reviewed by the panel. The FDA has not provided us with the timeline for decision on the PMA supplement for the Toric ICL which has been under U.S. review for over eight years.
We do know the agency continues to review our approval submissions as they have asked questions this month in regard to the PMA supplement on the ICL calculator software for the U.S.
We will be conducting our annual Visian ICL experts meeting prior to the ESCRS meeting and our goal is to attract 300 ICL surgeons that would basically double last year’s attendants. Presentations are planned by ICL key opinion leaders on the CentraFLOW technology early surgeon experience with the preloaded ICL and potentially as I said some initial clinical results with the V6A ICL.
In addition we plan on hosting a dedicated session for Chinese surgeons on the CentraFLOW technology. We’re preparing for our largest exhibit presence at the ESCRS in our company’s history. In addition to the preloaded ICL will be featuring the nanoFLEX Toric IOL and potentially early clinical experience with the V6A ICL.
We’re hosting the lunch symposium on the Visian ICL at which we’re preparing for an attendance of 250 to 300 surgeons.
We mentioned earlier we believe our growth during the second half of the year should be higher than the first half, and there are several catalyst driving that growth on the near horizon. On the revenue side the preloaded ICL for European launch during the second half. The increased supply of KS-IOLs to meet demand, our primary focus on this supply will be to expand sales at our highest gross margin markets and we’re starting to see that.
Increased IOL injector sales this second half will drive the revenue side higher. Potential new product approvals for which we cannot predict the timing at this point. Additionally the interest in the initial clinical experience of the V6A ICL should be high and should potentially drive incremental interest in the Visian ICL product offerings.
On the gross margin line we expect contributions from the consolidation project should positively impact our second half results.
Before we open the call for questions let me review our investor meetings as you can see on this slide and if you happen to be at these conferences we would be glad to see you or if any of these cities we would be glad to stop by.
In addition at the ICL Experts Meeting in London which is September 11th and 12th, any investors or analysts are interested in attending we can provide you an invitation. On Saturday October 18th at the American Academy of Ophthalmology on Saturday morning we will host an investor breakfast at that time and we expect to report our third quarter earnings on October 29th.
With that operator we’re ready to take the questions. Could you please open the line?
(Operator Instructions) Our first question comes from Matthew O’Brien with William Blair. Please proceed.
Matthew O’Brien – William Blair
I was hoping just for a clarification on the guidance for the year, Barry, it sounds like the top line number in aggregate is going to be around that 8% to 10% level? But the other metrics most likely will fall a little bit shorter. What you’ve outlined is that the right way to think about it?
First of all and one of the reasons that we try to change the language here at annual objective is that a lot of folks interpret our metrics to be guidance. We don’t intend them to be guidance, we set them up every year as key objectives for our business and as I said they are not always meant to be slam-dunk. On the revenue side though we will continue to measure ourselves against the 8% to 10% growth I think what we have tried to say is that we see the opportunity in the second half for growth at a higher level than what we see in the first half and the first half was 11% as we reported and 13% in constant currency.
I think the only one that we’re saying that we think we can’t get to at this point unless something happens that we currently don’t see is hitting that gross margin metric of 300 basis points of improvement but we will continue to measure ourselves against that same measure each quarter.
Matthew O’Brien – William Blair
Okay, I mean that’s one where it's a little confusing when I look at your ICL number and again I know it's just a target but just to get to the 20% for the year you would assume something caused you 25% growth in the back half I’m just not sure how to reconcile that versus what we have seen in the first half.
I think couple of things that you’ve to look at is that we’re expecting a higher growth in the APAC region, you saw during the second quarter that growth was not as high as it normally has been. A couple of key reasons there, one is in the China market and actually our distributor for China was here on Monday and so I met with Jack. He has seen 28% out the door sales so far this year. And they are not tracking that at this point and one of the reasons was during the second quarter they did not bring in as much inventories they typically would because there was some anticipated tax advantage to not having done that during the second quarter.
And I will give you a data point that really does illustrate this. One of the things we use is a measure of our ICL business is our Toric business because it's an on-demand order, in other words we don’t have any one that has a consignment of Toric ICLs because there is so many SKUs. So China in the second quarter Toric ICLs grew 45% whereas our myopic ICL actually declined 10%.
The myopic ICL that’s where the few distributors that do carry inventory that’s where they would purchase for their inventory. So obviously you can see in the numbers that they were down during the second quarter. So we’re expecting to see an uptick in our Asia-Pacific regions. Korea is making some pretty heavy investments. I was just in Korea few weeks ago, we went through the investments they plan the second half on the marketing side. They are in the process of engaging though I did not know for a pretty famous actresses in Korea who has had ICL to become spokesmen for the product and then we have also got our preloaded ICL for Europe.
So we expect those things to continue to help us. The continued expansion and penetration of CentraFLOW technology in the markets give us a price increase. So all those factors, you’re right it will be tight but we still see in our planning the path to get there.
Matthew O’Brien – William Blair
Along those lines when I was looking at the performance in the ICLs in the quarter, I think you started to allude to this but excluding Toric growth myopic was basically flat or up just slightly, is that math correct and then are you saying it's really more of an inventory adjustment that is the reason for the softness?
That’s really good math, Matt. Toric’s were up 19%, this is globally, and myopic ICL was only up 1%.
Matthew O’Brien – William Blair
Okay and it's just more of a function of the inventory adjustments from some of your distributors?
Exactly. So the myopic ICL that’s the only one that distributor can have inventory of and that’s why I say, we look at the Toric on a week to week, month to month basis. It really tells what the trend of ICL procedures are.
Matthew O’Brien – William Blair
Okay. And then last one for me and I apologize, on just the orders here as far as the number of questions but the warning letter – you provided some visibility into how everything transpired but what are the next steps from here and then specifically if you had approval for Toric tomorrow how long could you supply the market with your inventory?
Allow me to take the last one first. The next day, as I said we built over 6500 Toric ICLs those are all for the U.S. market, they are the U.S. product, they are not be used in any other market. So we have the inventory, we are ready to go. And as you know we have also trained surgeons as well. We will train more and continue to train.
So if we had approval tomorrow next week we would be able to ship product. On the side of the warning letter, we have our next monthly update which would be mid-August and we do continue to supply additional information but we’re also tracking. We have put out some goals and objectives to the compliance office here in Los Angeles and said here is what we’re going to do and we’re going to report every month whether we did these things or not. So we have a list of things that we’re continuing to do throughout and across all of our product lines.
It's anticipated that ones they have totaled reviewed our submission that they will most likely come back for a follow-up on it. And we don’t have any evidence of what timing on that would be at this point. We have asked if a face to face meeting was necessary and at this point they have said no.
Ladies and gentlemen our next question from Chris Cooley with Stephens. Please proceed.
Chris Cooley – Stephens
I just want to follow-on to Matt’s question I have one quick follow-up, when we think about the ICL growth in the quarter you alluded in your press release that increase pricing gave you 300 basis points there and as Matt picked up on as well, you have definitely benefited from the exports of CentraFLOW. So help us think about not so much, I understand these drivers but I guess if I ask it a little bit different way, can you grow double digits in the ICL if the AsiaPAC region doesn’t come back. I guess I’m also kind of curious a little bit about how much stocking you think you might get?
I’m assuming here in the current quarter now that the preloaded got approved in Europe a little bit earlier than anticipated. Just was really surprised by what looks to be the lowest growth rate you have had since the fourth quarter of ’12 in that ICL space here during the period and I just got one follow-up. Thanks.
Sure. Well with the APAC region specifically the one area we think will continue to be a drag on us and that region is Japan. Procedures in Japan refractive procedures overall just continue to have a challenge and that’s both on the lasik side and the ICL side as well. Patients don’t come in the door, it's kind of hard to do the procedures. But we do see and have pretty good visibility to the other major markets in APAC, Korea, China, and India those three markets and we do see good growth on the Horizon. I was in India just about a month ago, the CentraFLOW product has gone very well there. It's been very well accepted and I will give you a story, I will give you his name Dr. Reddy who is a very prominent surgeon in India. We sat with Dr. Reddy for an hour or so and he has a son who has been in his practice within for the last 4 or 5 years and his son is going to move out to a different town and open his own practice and he asked his dad what excimer laser should I buy? And his dad told him, son, with the CentraFLOW technology and the preloaded ICL that’s where refractive procedures are going and I wouldn’t suggest you invest in excimer laser.
Now that’s an example of one I know but Dr. Reddy is a well-respected surgeon globally and he has done a lot of refractive procedures. He almost sounded like any (indiscernible) with some of the things Chris you have heard him say. So we do see a lot of momentum and so – as I said to Matt, it's going to be tight but in our projections as we currently see them today we believe we can get there and that remains our annual objective.
Chris Cooley – Stephens
Understood. And then could you maybe just revisit the V6A for us a little bit here. I understand it's up two diopters of accommodation there but what gives you confidence as you go into the CE Mark process here in the fourth quarter that you can really get this lens up on the market in the first half of next year I mean think the majority of us haven't seen a lot of data around this lens, so any color there would be greatly beneficial as to why you guys have confidence not only in the design but then also it's a timing from an approval process. Thanks so much.
So I think to start with Chris, first, we’ve taken a proven platform, the ICL platform over 450,000, these have be implanted. And we’re taking a well-known optic and extended depth of focus optic. This has been on the market for quite a while. Now we have added some new technology to it as well. We have done all of the bench work on these products and we’re currently manufacturing product. So the product is not much more challenging to make than a Toric ICL is.
So we feel very good about what we have seen, we’re going to do these confirmatory studies for which we’re recruiting patients now. If we’re able to match the product we have made with the patients that have already been recruited then we may have a shot though it's a slim window here. We may have shot to get some implanted prior to the ESCRS meeting and if we do then we will have some data there to discuss. If we don’t make it for the London meeting then as I said we will do it in October at the American Academy of Ophthalmology in Chicago.
Chris Cooley – Stephens
Could I also traditionally just have – ask what are the primary end points, what kind of data will we see when we let’s say hopefully the ESCRS and – so that we can kind of engage the performance of this lens. I mean what would your benchmark is against – help us just think about what kind of data we will be able to see?
I will tell you, if I can take that one offline we will go through the protocol with you. I don’t have it in front of me but it's a well-established protocol and well detailed.
And next question comes from Jason Mills with Canaccord Genuity. Please proceed.
Jason Mills – Canaccord Genuity
I want to start just another question on the ICL procedure volume data much appreciated in the press release but I think engage the demand as well and I’m just curious the comps that you’ve faced – you will face from a ICL procedure standpoint in the second half of the year. You went through some of the other drivers many of which are ones that perhaps could benefit you from a stocking perspective and the Toric ICL data was very helpful.
From just a talk [ph] standpoint wondering what the procedural volume comps will take for you by region in the second half of the year.
Yes, so the third quarter comp is kind of low but then the – our fourth quarter usually has a pretty good spike and that’s mainly because of Korea and the high season which starts in January. So we have taken that into account. For example our third quarter ICL sales last year were 10.7 million and over 12 million that we did this quarter you can see that on a comparative basis that’s we should be able to beat that.
Jason Mills – Canaccord Genuity
So I guess I’m asking is just from procedure volume more so than revenue just trying to tease out in stocking [ph] areas the fluctuations, just in-market demand and how was it last year on a year-over-year basis so that we can kind of see the group last year third quarter globally, I can’t remember what it was – I am actually looking for you to help me do my job.
We do see a little downturn in the European markets particularly during July and some of August but it starts to rebound toward the end of the quarter and then a larger increase during the fourth quarter.
Other markets, there isn't except for Korean in fourth quarter. There isn't a lot of seasonality compared to comps.
Jason Mills – Canaccord Genuity
Okay I can go into with you a little bit more offline. In United States beyond the Toric ICL approval which you’re waiting for, can you talk a little bit about and give us an update on your thinking for CentraFLOW and V6A, regulatory pathways and processes to get there here in the U.S.?
V6A there is nothing to talk about on that yet. That’s going to be a wait and see and as you know with these new products the Europe is the first market that you go after but on CentraFLOW you may recall back in December we had a meeting with the agency and we have been working on a protocol as well as trying to get some sizing data together for the agency and I believe by the end of this week we’re supposed to have some of that sizing data for the agency and at which time we’re going to request another face to face meeting to see if the protocol we have in place now is meeting the needs they have.
Jason Mills – Canaccord Genuity
So you expect to have to do a clinical trial there?
We do and you know the agency has said that we would, though I in the slimmest of terms still hold out. Maybe there is a chance we won't have to. I mean you that is getting stronger and stronger. The longer we wait with over 70,000 successful implants to-date.
Our next question comes from Jim Sidoti with Sidoti & Company. Please proceed.
Jim Sidoti – Sidoti & Company
I just want to be clear with the warning letter, is it affecting your ability to manufacture or sell nay devices you have now and do you think it's delaying the approval for Toric at all?
First answer is no. I mean there is nothing in the warning letter that stops us from manufacturing and shipping all the previous approved products that are made here in the U.S. So, no, we continue to make, there is no recall issue and I think if you look at the general categories there is a lot of documentation in there as well as the software and shelf life issue.
We have been working on all of the documentation on the – in terms of design control and I believe we feel like we have supplied them with all of their needs on that category. On the calculator software you may recall that, a third party calculator. It was not ours but the agency deems since our website is tied to it that indeed we were endorsing it and we should have validated the software which we did not. So we stopped using that calculator. We went to a manual basically a manual system for our customers and they had to call us and we have submitted for – well you may recall first in the Toric ICL submission there is a calculator system in there and the agency even in the panel meeting pointed that out as a bright spot, that looked good. That calculator would be used for the Toric and the myopic ICL but in addition to that we separately filed a myopic ICL software calculator system which is under review by the agency and that was the point that we made in terms of just in the last few weeks, we got some additional questions on the software calculator. So they are continuing to review our submissions.
In terms of how we collected, complaint that on bolting [ph] we have changed that. We are now doing it exactly the way they have asked us to do which is basically a trending of on-label and off-label usage and then with the shelf life study and the issue there was this is that the guidelines, the myopic ICL in the U.S. was approved under the guidelines that said you could take basically a cataract IOL made of the same material and use that for your shelf life study to get approval of a non-cataract IOL or phakic versus non- phakic IOL if you would.
And the guideline still say that you can do that though the agency feels like that we should do an apples-to-apples so we began that testing, started it back in February and we will have the accelerated data available at the end of October and the real time data available in February.
Though the inspector, when she was here this was her comments not the agency’s that she wouldn’t see the shelf life has been a delay in any way in terms of any of our submissions or products.
Now how would this impact the Toric ICL? We don’t know. We don’t have any indication as we said here today one way or the other. If I guess if the agency called and said we’re ready to approve you tomorrow on Friday we would know.
We have given window after these panel meetings on the ophthalmic medical device side that after a favorable panel the window has been six weeks to 18 months. So we’re – since March, we’re getting close to six months maybe. So we’re still within that window. So we still don’t and we believe that at least to-date we have satisfied all the questions they have had. So we still don’t know what timing there may or may not be with the Toric ICL.
Jim Sidoti – Sidoti & Company
And then you indicated in the press release the sales and marketing cost have gone up as you prepare for the Toric launch and you brought on some sales people. Can you quantify how many people you have brought on and what your U.S. sales force is right now?
I believe we brought on four new sales reps, maybe 4 or 5, I don’t recall, Jim off the top of my head I can give you the data.
It was four and there was one back up [ph].
So we have added five reps. We also had to bring one of the specialist in from the field that help on the myopic ICL manual calculator system that we implanted. So the cost of that plus getting them up and going and train and the whole sales force retrained too on Toric.
Jim Sidoti – Sidoti & Company
Okay and how large is the U.S. sales force now?
That would be about, I’m going to guess but I can give you the correct numbers about 25 direct and about 10 independent reps. It's a total of 35 bodies.
(Operator Instructions). Our next question comes from Jan Wald with Benchmark Company. Please proceed.
Jan Wald – Benchmark Company
Maybe the best thing to help me and I apologize to everybody else on the call if you have already talked about this but there is a lot of moving parts of the company, you just talked a little bit what the rest of 2014 will look like in terms of spend. But how should we look out and understand R&D and SG&A expenses going forward. Will R&D come down? What you have the 6a kind of in hand or do you have new products that you’re looking, that will keep that R&D at the same level or maybe expand it and what’s going to happen with SG&A? Are you there? Do you have expand more? If you wouldn’t mind.
Let me first talk to the SG&A line, there should start to appear a lot of leverage in our P&L from what we have already invested in those areas. We’re not expecting major investments and we’re expecting though to invest in more consumer education on the ICL so I think the spending we will have in those areas will be reflected more of creating demand through those kinds of avenues rather than adding people. Around the G&A line I should specifically the one thing that is difficult to manage is your stock compensation expense. And I think that was about 700,000 more during the quarter than in the year ago period because stock price is higher now than it was in the year ago period.
On R&D though and part of the reason we’re spending more in R&D right now is we see these opportunities. You work on projects and when something starts to hit and particularly something like the V6A where you see a lot of opportunity in. We have been investing more in that area than we initially thought. Now right behind it we have got the V6B coming and at this point in time we would see an additional investment next year in that product. In general what we try to do on the R&D line and we have been going through a strategic planning process the last several weeks here is we’re looking to hold our R&D spending at about 11% rate overall, 10% to 11% but 11% as a stretch.
Now if our sales do better than that then obviously we will have more money to invest in R&D, no matter how good the project is you can only invest so much. So that’s kind of the guideline we’re trying to hold ourselves to.
We have no further questions. I would now turn the call back over to management for closing remarks. Please proceed.
Thank you operator and thanks all of you for your participation on our call today. We look forward to providing you updates on our progress and also reporting our third quarter earnings. Thank you and have a good evening.
This concludes today’s conference. You may now disconnect. Have a great day.
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