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PhotoMedex, Inc. (NASDAQ:PHMD)

Q2 2014 Results Earnings Conference Call

August 7, 2014 8:30 AM ET


Kim Sutton Golodetz - Senior Vice President, LHA

Dr. Dolev Rafaeli - Chief Executive Officer

Dennis McGrath - President and CFO


William Plovanic - Canaccord Genuity

Keay Nakae - Ascendiant

Anthony Vendetti - Maxim Group

Jim Sidoti - Sidoti & Co.


Good day, everyone. And welcome to the PhotoMedex Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Kim Sutton Golodetz, Senior Vice President of LHA. Please go ahead.

Kim Golodetz

Thank you, Operator. This is Kim Golodetz with LHA. Thank you all for participating in today's call. Joining me this morning from PhotoMedex are Dr. Dolev Rafaeli, Chief Executive Officer; and Dennis McGrath, President and Chief Financial Officer.

Earlier this morning, PhotoMedex announced financial results for the 2014 second quarter. If you have not received this news release or you would like to be added to the company's distribution list, please call LHA in New York at (212) 838-3777 and speak with Carolyn Curran.

Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements that involve risks and uncertainties regarding the operations and future results of PhotoMedex.

I encourage you to review the company's filings with the Securities and Exchange Commission, including without limitation, the company's Forms S3, S4, 10-Qs and 10-Ks, which can be accessed in the Investor section of the company's website at

These reports identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, August 7, 2014. PhotoMedex undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call.

With that, I'll turn the call over to Dr. Dolev Rafaeli. Dr. Rafaeli?

Dr. Dolev Rafaeli

Thank you, Kim. Welcome to the second quarter 2014 earnings call. My name is Dolev Rafaeli; I'm the CEO of PhotoMedex. Joining me today is Dennis McGrath, President and CFO.

Our press release was earlier today and Dennis will follow my -- me to provide more details regarding to our financial performance.

Our revenue for the second quarter were $52.1 million, including $13.1 million contributed from LCA clinics for the period from May 12th the date of acquisition through the end of the quarter, which represents 34 out of 64 business days.

Comparing this year to last year’s second quarter, there are some key things to note. Our U.S. consumer direct revenue were off by approximately $9 million both annually and sequentially. This directly correlates to an intentional significant reduction of our U.S. short form TV no!no! advertising in the second half of the second quarter.

As a reminder, short form TV advertising consists of 60, 90 and 120 spots, largely purchased on the so called remnant markets. In the U.S. markets we spent just under $9 million on no!no! hair advertising, which this media was spent during Q2 with the vast majority of that spend on short form TV. This is approximately $4 million less than the prior quarter and the prior year.

As you are aware from previous reports, $4 million in advertising at a 3.0 MER represents approximately $9 million in net of deferral -- represents $9 million net of deferral in high margin consumer revenues after accounting for related estimated sales allowances. Our use of short form TV in the lastly three years represents the majority of our U.S. advertising and generates about 65% of our DTC channel revenues.

Cpk a measure of response and defined as call per $1000 of media spend dropped abruptly about midway through the quarter, we believe the largest contributor to this event is a significant drop in consumers watching television during this time period as measured by a markets statistic called HUT, which is a statistic based upon Nielsen Media Research.

HUT or Home Using Television at a particular time is expressed as a percentage of all homes with television. HUT differs from the more common metrics called Rating because it combines all viewing rather than identifying specific program viewing. It is used to decide media pricing on the one hand and ad reach on the other. Fewer people watching TV makes media more expensive for us and less effective in terms of ROI.

The market consequences caused by the dropping HUT is that the large branded advertisers are provided additional quality advertising that comes out of the remnant pool of media as the broadcasters make good on minimum audience guaranteed to those advertisers.

This in turn affects the quality of the media we can purchase. Rather then spend the money on expensive advertising that would have low effectiveness, we curtail the spending budgets to prevent a challenging situation from becoming worse.

The difference in retail sales is approximately $5 million less in HSN revenue as the dates for the prior year versus the current year were not aligned. Last year, we had a July 4 weekend TS event, with shipment occurring in the second quarter, where this year we had only a weekday event in the second quarter.

Just this past weekend, we had held a highly successful TS event with results on plan as we sold out a very special color. Another weekend TS event is scheduled for the fourth quarter.

As referenced in the last year’s second half, we had HSN events in July and December. This $5 million decrease in television home shopping sales was partially offset by an 18% increase in sales to Bed Bath & Beyond.

Regarding our Kyrobak product, we began running TV media for our Kyrobak product for lower back pain in January. For the quarter we realized $1.1 million in revenue, up from $441,000 in the previous quarter.

We are making terrific progress with this product and I note that the most recent weeks in the third quarter realized MER in the U.S. between 2.5 and 2.75, and greater than 3.0 in the U.K. So we are approaching our traditional metric goal.

The gaining factor to increase this revenue ramp most significantly has been our level of inventory but we have product on order and expect to have adequate inventory to support our growth plans.

There are two clinical trials that are news worthy. One with the Kyrobak and one with no!no! hair. The Kyrobak study titled a novel continues passive motion device for self treatment of chronic lower back pain, a randomized controlled study was accepted for publication by the Chartered Society for Physiotherapy better known as CSP in the pre-review Journal Physiotherapy.

CSP is the professional, educational and trade union bodies for the 50,000 chartered physiotherapist, physiotherapy students and assistance throughout the United Kingdom. The study enrolled 36 participants with pain level under six by the Numeric Pain Rating Scale, NPRS. The scale has scaled from zero to 10. 28 participants completed the treatment.

Participants are randomized to receive a device either on enrollment or three weeks later as a waitlist control. Safe treatment with Kyrobak was prescribed for 10 minutes, one to three times daily for three weeks. The treatment period was followed by a three-week follow up period.

Three week for safe treatment with the device significantly reduced pain levels in comparison to the waitlist control. Before to after treatment the change in NPRS was a decrease of 1.4 points versus a decrease of 0.1 points for the control.

This benefit was maintained during the follow up period before treatment to after follow-up the decrease in NPRS was 1.1 points. Daily NPRS values showed a gradual and steady reduction over the treatment periods.

The preliminary evidence suggests that the device maybe beneficial for short-term relief of nonspecific chronic lower back pain, particularly in participants with moderate never pain levels. A longer treatment period may achieve additional pain reduction.

In addition, we announced in the separate press release today that a new independent clinical study demonstrated a statistically significant reduction in hair re-growth following the us of the no!no! hair removable device, using the proprietary Thermicon technology. The study was conducted by the Consumer Product Testing Company, a world leader in contract laboratory testing for consumer, medical and healthcare products.

In all 44 participants were the variety of skin types and hair colors, and contradicting to misleading claims of certain competitors the statistically significant results of this clinical trial conclusively demonstrate a substantial reduction in hair re-growth.

We will closely evaluate the results of this study as a basis for expanding our advertising claims about the safety and efficacy of our no!no! hair removal device product and the product line.

In regard to the XTRAC product line, our XTRAC business was up 37% over last year and up 25%, sequentially. We spent approximately $900,000 with an average of $69,000 per week during the second quarter in XTRAC advertising representing a 60% of XTRAC revenue.

The gating factor to increase our media spend in this area and ramping revenues at a faster clip was the number of trained agents in our California call center and provider capacity during the summer months related to vacation schedules of practitioners and patients.

In June, we trained the LCA call center agents about five times the size of the California call center to handle the XTRAC patients which begin to remove the bottleneck. Consequently, we are increasing our media spend in the third quarter with an expectation that the -- by the end of the quarter XTRAC advertising will exceed $100,000 per week.

International consumer revenue excluding Japan increased 40% over the last year, with Brazil, Hong Kong and Columbia, the newest consumers geographies with revenues of $970,000 up from $275,000 in the first quarter and Germany with revenues of $394,000, up from $250,000 in the first quarter. In addition to all the other things I’ve mentioned, we’ve launched our recurring revenue model for psoriasis and vitiligo in India with a kick-off meeting with first group of physicians on Monday of next week.

Furthermore, we’re setting up operations in Korea and are about to commence a physician recurring revenue model of psoriasis and vitiligo there. At LCA, we’re very focused on optimizing the patient recording model and our on track to open the first XTRAC center of excellence inside a few of LasikPlus clinics later this year.

With that, I’m going to turn it over to Dennis to provide you with more specific color on the quarter. Dennis, please.

Dennis McGrath

Thank you Dolev. Good morning everyone. I’m going to provide you some basic metrics that seem to be asked on each call and happy to provide as much color as you’d like in the Q&A portion of our calls. Dolev mentioned second quarter revenues were $52.1 million, made up the following $28.5 million of consumer segment revenues with an 86% gross margin, $8.6 million in the physician recurring segment with a 60% gross margin, and $1.9 million in the professional segment with a 29% gross margin.

And the newest segment we referred to as the clinics business had $13.1 million in revenues with a 36% gross margin. As Dolev noted, this represents revenue only from May ‘13 through the end of the quarter for the acquisition accounting rules.

For the quarter, revenues from the clinic segments for the entire quarter was $21.8 million, representing about 15,000 Lasik procedures, which is about even with last year. There is a schedule in the press release that details the specific splits by each segment.

With regard to the physician recurring business since specifically the XTRAC, we increased our installed base with another 27 net locations for a total of 554 U.S. locations and as Dolev mentioned none of these locations were yet in a LasikPlus center.

Direct to patient XTRAC media spend was $901,000 for the quarter driving a cost per lead of $75 compared to approximately $126 in the second quarter last year, a decrease of approximately 40%. A positive trend we look to continue as we gain greater experience with targeting our media spend and the effectiveness of the LCA call center.

Couple of noteworthy items isolating certain expenses which amount to approximately $9.1 million in additional charges to the second quarter P&L in the sales and marketing area, first. Overall sales and marketing expense was about even with last year.

However, offsetting the significant decrease in consumer advertising that Dolev mentioned were the following handful of items that amount to about $5.6 million. First, we added LCA's advertising for this tough period in the quarter, up $2.7 million; The XTRAC advertising $900,000; the Kyrobak advertising about $900,000; Brazil advertising about $400,000, Germany advertising about $600,000 and NEOVA advertising about $150,000.

In the G&A area about $3.5 million as follows. We incurred $500,000 in litigation cost to pursue a company that’s infringing upon our no!no! patents. We incurred just under $2 million in LCA-Vision deal costs and an additional $1 million of depreciation, amortization related to the increase in acquisition assets being added to the balance sheet in mid-quarter.

On the balance sheet, cash of $36.7 million represents cash per diluted share of $1.96. In connection with the acquisition of LCA, we incurred $85 million of debt consisting of $75 million in acquisition financing and $10 million in working capital line, all of which was drawn to purchase LCA.

Among the other conditions to the credit agreement, there were two main financial covenants tied to define adjusted EBITDA, both of which triggered a default by us. The bank has issued a default notice and waiver rights which was filed in our 8-K this morning.

We’ve hired a financial advisor to assist in working with the company in the banks as we endeavor to regain compliance with the credit agreement provisions, which generally deal with our leverage ratios of debt-to-EBITDA as defined in credit agreement. In the meantime, the outstanding debt will be classified as current obligation until mutual agreement between the company and the banks can be worked out.

Our quarterly report on Form 10-Q will be filed with the SEC on Monday, August 11. And our next earnings call is scheduled for Thursday, November 6th.

With that operator, we would like to open it up for questions.

Question-and-Answer Session


(Operator Instructions) And we’ll take our first question from William Plovanic at Canaccord Genuity.

William Plovanic - Canaccord Genuity

Great. Thank you. Can you hear me?

Dennis McGrath

Yes, we can.

William Plovanic - Canaccord Genuity

Okay. So a couple of questions here. The first one being, you pulled back on the media spend obviously due to the increased rates. Has that corrected itself and have you started re-spending it to this point?

Dennis McGrath

So we have the last couple weeks from July to measure. We've had some spike in response and we've had some weeks where we move sideways. We’re tempting to move that back up but it hasn't gotten back to normalized levels. An interesting area of observation is that even though short-form TV did what it did in the response, we see other aspects or media that have not changed.

For instance, our online or our newsprint or radio had the same response rates and conversion rates. So we do believe it's isolated to this area. We’re working our ways through that.

William Plovanic - Canaccord Genuity

Okay. And then how do you view the trade-offs to the media spend, consumer versus physician recurring to the slowdown, the ramp of the Kyrobak or physician recurring, does it change anything else?

Dennis McGrath

No, not in our view. We are dealing with the short-form TV as it relates to that. Only Kyrobak, the response has been extremely good and on the XTRAC. Again the numbers are substantially less than what we, on a weekly basis, than we spent on a no!no!

William Plovanic - Canaccord Genuity

But if the cost is higher for the other products, wouldn't you stop spending there as well on the short-form?

Dennis McGrath

Well, we haven’t pushed it as far as we can. It’s in the early stages of trial, as you know from our past methodology. And the early returns are pretty good. But if you look at the Kyroback for instance, we had $1.1 million in revenue. We spent $900,000 for the quarter. And as Dolev mentioned, the most recent weeks have been pretty good and they are the weeks of July.

So whether or not short-form TV, Cpk and the HUT had an impact, on that, the numbers, were rather small to see that and the most recent success in the last couple weeks of July, which as I mentioned we had some bright spots in July and some weeks we move sideways. So I don't think there's a correlation to be made there.

William Plovanic - Canaccord Genuity

Okay and then. As you think about the integration of LCA, have you fully integrated that to this point from all the back office overhead what have you?

Dennis McGrath

Not completely. Yeah, there is game plan that we’re executing against all that we found so far is, leads us to believe that the estimates we provided when we first did the acquisition call are on target. In fact, there may be more opportunity than we had initially identified.

The back office operations you’ll see them fully integrated as we move through the fall. We do have a timeline we’re executing against, including commonality of financial reporting platforms that the IT group has now put in place with LCA. Our teams in the marketing side are working as one. We believe that there's opportunity to not only optimize for the messaging but also the cost side of the LCA advertising, we’re working towards that.

William Plovanic - Canaccord Genuity

My last question and I'll just put this last one was with the breaking of the covenants. Typically, that means an increased interest rate in some form of payments. Is that what we should expect on this?

Dennis McGrath

That’s yet to be determined. As we’re working through the banks, the financial advisor is going to come in and work with me particularly and my team to validate the assumptions going forward with the bank. The bank has put a reservation of rights which simply says you’re not going to take any action at this point in time.

We are waiting for some of the next steps which include things that banks were going to want to see as we work through this short-form TV area and the rest of our business. So those possibilities exist as tools to bring about resolution of this but it’s yet to be seen.

William Plovanic - Canaccord Genuity

And actually if I could go back, on the short-form media spend, I mean, this is obviously causing the slowdown. It occurred halfway through the quarter, should we just basically assume that that will continue in perpetuity in terms of how we look at the business?

Dennis McGrath

We’re not ready to assume that. We are willing -- we are working through that. And the reason I can conclude that is that in other forms of online, newsprint, radio were there most recent response TV, this weekend with HSN, the response has been extremely good. The fact that the HUT numbers dropped and there is a macro condition which we can’t control where -- branded advertiser get more eyeballs and more allocation of the remnant pool is something that is hard to predict and in our mind, may or may not exist in perpetuity.

We don’t think it will. We don’t have enough experience here in the last four weeks to conclude one way or the other. But we’re not ready to say this is a short-term or long-term possibility. It appears to us that it may be a short-term, but we don’t have enough to conclude more than other

William Plovanic - Canaccord Genuity

Great. Thank you for taking my questions.


We’ll move next to Keay Nakae of Ascendiant.

Dennis McGrath

Keay, good morning.

Keay Nakae - Ascendiant

Hi. Thanks for the questions here. Dennis or Dolev, I guess my key concern at this point is, if you're -- in trying to be disciplined, aren't going to invest in the short-form because of the response rates, yet you know that's the key driver of no!no! high gross margin sales. If you follow this quarter with a similar kind of result, next quarter whereas I can leave you with respect to your lender in the covenants?

Dennis McGrath

Well, certainly that’s said reasonable question and we are working towards that end. Couple observation is however and more macro in its -- in response, because the specificity of your questions and the answers there will be working through with the financial advisor in the banks in the upcoming weeks.

But when you consider the traction that is gained on the XTRAC business and the possibility of exceeding this year, let’s say, in that $35 million plus range versus where we were last year or the year before and a reasonable increase as we go forward. That alone with the contribution margins that drives, certainly gives you the sense of liquidity to satisfy the cash obligations related to that whether or not it’s sufficient to satisfy the other covenants remains to be seen.

In addition, the marketing engine that we’ve developed to be able to advertise and sell so product and a philosophy that’s used in no!no! to have build out our geographic footprint We have found throughout that messaging is transportable from geography to geography and we have new initiatives that are taking route and Kyrobak is an extremely bright spot particularly in the last -- in the couple of weeks where you're selling a couple $1000 a week of product and you can even do the math in 50 some weeks.

You’ve got $15 million business and we had the additional inventory on hand, we would be able to sell that. But again as high margin business, you get a $300 ASP and you’ve got a $30 COGS. So there are several things to be optimistic about. This is definitely disappointing in terms of the short-form TV. There are a number of things that themselves can satisfy the financial obligation of that.

And we’re working through short-form TV aspect of it. And also our past history has been that in every week, there is a portion of our advertising that is experimental in the messaging, for the language that has yield consistent results in the past and there's no reason to doubt that that will continue to be the same as we manage through this.

There are other tactics and strategies that can be done to deal with the short-form TV aspect of the media and we’re exploring them as we go through this in the event that the short-form TV is a longer period of time than what we think it might be.

Keay Nakae - Ascendiant

Is there any way to try to generate increased sales in some of the other more emerging markets like Germany and Brazil for the no!no!?

Dennis McGrath

There is -- there are specific challenges in Germany we’re working through that are unique to Germany unlike the U.K. and other places particular as it deals with credit cards. In assuring our collectibility of our sale that’s been made over there and we’re putting things in place to see if we can solve that issue. Once solved, then we can turn on more media.

Brazil, very similar things. The thing -- the two of the areas that Dolev mentioned that also tie into your question for both India and Korea. In Korea, we have more than 100 locations with the XTRAC. It is a well-known accepted therapy over there. And we believe it’s a reasonable speed ramp to be able to convert that into a recurring revenue model. And we are in the process of taking advantage of that.

In addition, Dolev mentioned India, we have worked on this for couple of months. We’re kicking off recurring revenue model. It’s a big population dealing with vitiligo. There has been some test sites over there that have done extremely well in the concentrated population centers. And we’re going to try and take advantage of that which -- when you add that to what’s occurring here in the U.S. on the XTRAC, again high-margin business becomes another avenue of support as we go forward.

Keay Nakae - Ascendiant

And then just in terms of some of the gating items that you talked about, I guess the first one inventory for Kyrobak what are you doing there to improve that situation? And the second part is the call center for California XTRAC or U.S. XTRAC, I guess, ex-LCAV, what needs to be done there to improve those efficiencies?

Dennis McGrath

Let me give you some color on both. So the Kyrobak, we launched the media in January. And from our past reports, we tend to be a fairly cautious groups. So we bought a minimum amount of inventory. We started the media, the sales pace surprised us on a good side. We’re selling at a much faster pace than what the inventory we brought in both here in and Europe. And we’ve order additional product. It’s en route, as it arrives we’ll be able to increase our media for that. And that itself could be a substantial opportunity in the second half of this year that we didn’t bake into our model.

The call center just to give, kind of, a framework of what it means for us, up until just the last several weeks, we have increased our media in the -- for the XTRAC business taking phone calls in a group in California that are limited by space in headcount that deal with two things, inbound calls and response to the media and insurance validation, patient calls in, talks about the disease, affirm that it's psoriasis before looking insurance company with the detectable and co-patient coverage limits are scheduled appointment into a third-party provider and that headcount limited how many calls we could take in given week and therefore how much media we could drive.

So, with LCAV having an in-house call center that, Dolev mentioned, substantially larger than that group roughly five times the size and having some capacity. In the last month and a half, we cross trained that group to be able to take inbound calls and the initial test from our agents there of taking those calls was extremely good and we’re gradually shifting over the throughput of those inbound calls to that call center group.

And that gives us the bottleneck or the throughput to be able to overcome the bottleneck that California provided and that’s gating factor there. And we believe they are fully trained, we believe that they handle the call so far in a very professional manner. The conversion rates are extremely high and at own step-up positive things as we begin to open up our own dedicated centers in the LasikPlus clinics in the upcoming fall.

Keay Nakae - Ascendiant

Okay. Yes. Thanks again for information. And then just a final question related to any extraordinary expense you might anticipate in Q3 whether legal or integration of the acquisition related?

Dennis McGrath

Yeah. So there will be some integration costs in the third quarter. We continue to integrate the LCA business into one company worldwide. All of the deal expenses are behind us in the second quarter. There are some remaining legal obligations related to some of the disputes over the acquisition and the remaining class-action suit, which you saw the press release on no!no! and its effect on this today, which we think might have an impact on that. They are covered by insurance. So that some of the cost burden associated with that is mitigated beyond that. I don't see any other significant costs.

Keay Nakae - Ascendiant

Okay. Thank you very much.

Dennis McGrath

Thanks Keay.


We’ll go next to Anthony Vendetti at Maxim Group.

Dr. Dolev Rafaeli

Good morning, Anthony.

Anthony Vendetti - Maxim Group

Good morning, guys. Hey. Just wanted to if we could -- just drill down a little bit more on the no!no!, because obviously the advertising issue is there, but what substantially changed from the second quarter last year other than a little bit with the July 4th timing that caused this kind of significant reduction, a, in $1,000 and as you saw that start to happen you pulled back on advertising, but as best you can tell, what do you think the factors that led to that?

Dennis McGrath

So the largest drop year-over-year comparison is the $9 million in direct consumer area, which is about $12 million in gross revenue half -- before you take off the estimates through returned and charge backs from credit card companies.

So it's specifically that and the vast majority of our media -- the drill it’s -- we get generally three times our media in revenue, dropped your media by four, that’s the mechanical aspect of it.

Specifically, there's not much more color than has been provided about, why we think that impact. So in the middle of the second quarter we see and that every week in the U.S. we do review of probably 75 slides on a variety of metrics of the U.S. performing media in the North American market. And we start to see the Cpk drop below thresholds.

And digging in the first instruction is to the media buyers to cutback the media, if you’ve got non-effectiveness and we -- and that’s the first lever you pull. You’re not sure that you are dealing with issues that are controllable, meaning, where our media buyers are buying media or macro conditions.

And you continue to do that and if you would see a chart of comparing media spend Cpk or MER's you would see a declining line from the middle of May through the end of June and then start to see a recovery in July, the first week in July and it's just the mechanical way we approach it, as we went through that process and continuing to drop media progressively in the short form TV area, we start to get some of these macro stats that, Dolev mentioned, homes using television and the implications of that feedback were getting from our market intelligence that we suffered can’t the consequence of the quality media pool in remnant advertising when as free advertising to large branded companies, which means the pool that we can buy from is -- slim packing, you could buy some but it's the low effective areas from past experience and had we bought it just would have made circumstance worst and that’s what happened through the quarter. I’m not sure there is much more color I can give other than mechanically that's what we went through.

Anthony Vendetti - Maxim Group

Okay. And then the default, is that with your main vendor, how much are you in default in terms of the covenant and just a little more color on what the game plan is to work through that, basically what's the worst case scenario there as best you can tell?

Dennis McGrath

So, the $85 million total debt is with the Syndicate Group of Banks and so it's one credit agreement and two provisions, first provisions is a leverage ratio of total debt to trailing four-quarter EBITDA and the covenant was at 2.5 to 1 start coming into this year $40 million of the EBITDA on the trailing four quarters as of December 31st, your comfortably within that ratio coming into the year.

As you look back, historically, we’ve generated EBITDA between $8 million and $12 million on a quarter almost like clock work. You drop off that level the EBITDA, where breakeven or slightly below it affects the trailing four quarters

And the second covenant which is also tripped, which is somewhat tied to EBITDA but mostly designed so that we would only buyback, recall the restricted payments but only buyback stock. If we had substantial EBITDA and that coverage -- that ratio was stripped mostly because last year we were buying back stock.

If you take those restricted payments out, we don’t have the challenge there with that one. So the main one is total debt divided by EBITDA and if we recover and get back to normalized quarterly EBITDA levels, we work our way through it. And some of the new initiatives themselves can generate substantial components.

As far as what we’re doing about it, we’ve met with the banks. We’ve been in regular discussions with them for last couple of weeks. So on Monday, we’ve received the -- this week we received the reservation of rights. We interviewed a couple financial advisors that will help us go through the information we provided the banks, validate the assumptions, continue to dialogue with them.

We expect to receive some additional instructions from the bank as we work through this process. And that will continue to drive our business and generate cash flow to mitigate these issues. So it will be more upon us as we work through this process, but it’s a process that will take several weeks.

Anthony Vendetti - Maxim Group

So the covenant was 2.5 to 1. What was the calculation, total debt to the trailing four quarters EBITDA and when did that -- did that trip right after June 30th or when did that actually trip?

Dennis McGrath

We have an obligation to report to the banks within -- and certify that we’re within the covenant within 45 days after the end of the quarter.

Anthony Vendetti - Maxim Group

Okay. And the ratio, what was the ratio, Dennis?

Dennis McGrath

The trailing 12 month of EBITA was around $16 million and so you are in excess of five.

Anthony Vendetti - Maxim Group

Okay. And then just in terms of Brazil and maybe Dolev, you could help with this too. In terms of Brazil and Japan, I know, you’ve been working through trying to get a new distributor or -- work through the Japan situation, which used to be a good market for you. Where are you with that? And then just an update on Brazil, how that’s going? I know purchased a distributor out there.

Dennis McGrath

Yes. So Brazil, we turned off the media during the World Cup because all eyeballs were on the World Cup. We’re just starting back up that process. So it’s still early in the game there. We do have a team down there that’s working on it. We are in retail presence and we’re expanding our retail presence in there. As far as Japan, there is no further update at this point.

As we’ve told you in the past, we've interviewed couple of different groups. We’re unsure about them but frankly the likely way to increase in the Japan market is to have our own presence there. And that's an area that we continue to debate internally as to the benefit versus the cost. And so, there is no further progress out there. Dolev, any other comments on either one?

Dr. Dolev Rafaeli

Yeah. Two more comments. Good morning, Anthony. In Brazil, we’ve updated in last quarter that we have essentially took position in most of the major retailers in the São Paulo state region. We’re focusing on that state. We haven’t gone to other states. São Paulo state represents roughly 25% percent, maybe 30% of the Brazil economy and we are focusing there.

We took position in most of the leading retailers. We have between 120 and 150 points of sale, that’s increasing every other week as they’re adding point of sale. And we’ve commenced on direct advertising at the end of last year. We’ve stopped that advertisement leading into the World Cup. We’re starting it backup now.

The advertising is going to take a vacation again around national elections in Brazil, which are in September. Because of media rates, the advertisement is targeted to develop the positioning in the retail, as well as the direct sales. We’ve mentioned, the Q2 results compared to Q1, Q1 was the first full quarter we ran in Brazil, Q2 was almost double that in sales.

Moving forward plan in Brazil is as we’ve explained before. We expand the retail presence in São Paulo state. We opened up the advertising when we can do this with media rates and we do direct sales. And when we see the business in São Paulo state stable, we will move on to the next geographies in Brazil. It’s a big country and its very segmented in terms of retailers. They focus on states. And then in terms of media, they focus on states as well. I think, that adds color to Dennis’ remarks.

Anthony Vendetti - Maxim Group

Yes, thank you. Just in terms of a couple of the bright spots, XTRAC continuous to grow, but it's still only 4% of revenues. What do you think is the opportunity with XTRAC, if you had to look out over the next couple of years? Where could that get as a percent of revenues? And then maybe it's too early to try to project for Kyrobak, but how about NEOVA, just a little color on some of the other business lines and what the opportunity is there?

Dr. Dolev Rafaeli

Dennis before you jump in -- Anthony, in order to answer your question, let’s refocus on the numbers. The XTRAC revenue with the growth rate represented and the numbers that Dennis quoted, I just want to kind of explain the numbers. At the current cost per lead and the current spend from $900,000 and $75 cost per lead, we handled 12,000 leads last quarter. That’s roughly double what we handled the previous quarter.

To put things in perspective, that’s 12,000 out of 10 million patients in the U.S. We can move ahead and start treating a patient whether it’s in one of the providers that we work with today, 574 of them -- sorry, 564 of them or whether it’s in XTRAC center of excellence, which would be a Lasik clinics, only if that patient is within driving distance of that clinic.

So some of these patients fall off naturally because we don’t have them covered with clinics. Some of the other patients fall of because of insurance -- because they lack insurance coverage. So our ability to grow from some almost no leads generated about 2.5 years ago to a run rate, not a run rate but an actual lead count of about 12,000 last quarter was built on an existing very small infrastructure that was inside PhotoMedex.

In order to be able to handle a $100,000 per week, which is what the run rate that, that Dennis was talking about. For advertising for next quarter, we will be closer to 18,000 leads at the same cost per lead mentioned above. That required us to double the call center capacity.

These 18,000 leads assuming that we can maintain the cost per lead and we can maintain the conversion rate between a lead and a patient in treatment and we can maintain the number of visits that they show up in a clinic, represents each one of these that show up for treatment represents about $2,000 per year for the company, if they show up in a provider, that is a franchisee or about $4,000 a year for PhotoMedex, if they show up in an XTRAC center of excellence, which would the LCA clinic.

The 12,000 leads do not end up. Today, the conversion is that they were about last quarter about 2,200 appointments, people showing up for treatment, which is about $400 per appointment. So the revenue opportunity that we have 2,000 if it’s a franchisee or 4,000 if its center of excellence is built on an appointment cost of $400. That has been very consistent, since the time we started advertising.

Every time we grow the advertisement, we increase it, we optimize and it stabilizes back to these ratios. About $75 cost per lead, about $400 cost per appointment. I think, Dennis, if you take it from here.

Dennis McGrath

Yeah, so that’s where I was going to hit, Anthony. This is a large underserved patient population. And we have been working over the last two years to move from kind of a non-controllable environment where we were relying upon the physicians to do their own recruiting, the effective protocol of treatment with the highest and best patient care to more of the controllable environment where we can kind of dictate the growth and the customer patient satisfaction requirement.

And a little bit of color on both. So you’ve got 10 million patients in the United States between vitiligo and psoriasis and the vast majority of those patients are therapy, the XTRAC therapeutic work. So to move from being hold into beholden into being of 50 therapies in a general derm practice by being able to recruit the patient, vetting their -- the quality level of that patient meeting their disease and their insurance reimbursement and delivering them to a general derm practice certainly gives us priority to move that patient from place to place and the attention that’s received at the general derm practice.

And by building a marketing platform that delivers the predictability of dollars spent gets you a yield of gross revenue as we've indicated here for the last several quarters. It appears as though without further improvement between 15% and 18% is the media spend to the gross revenue.

So you can do projection if you can, let’s be, theoretical about it, double the revenue, double the media, you should be able to more than double the revenue associated with it. That’s the predictable model. And getting more granular on that, we've experimented as we've explained in several of our calls as we’re revolving this platform, we started with a few cities. We’ve moved to more. We went to national cable TV. We supplemented it with local advertising based upon where our lasers were, which was dictated by where the highest conversion levels were. So that model is getting very predictable.

In addition, we continue to explore ways to increase the patient satisfaction with our therapy. And in that regard, we deem that to be where does the patient get the highest and best care, particularly, if they can get a therapeutic response with fewest number of treatments.

And that means where the practices that are going to give the most aggressive treatment so that you don't impose a convenience factor on the patient. And we’re getting smarter about that. And we’re getting smarter in the technological advancement of our equipment to drive that patient quotient of satisfaction of fewer treatments. In fact, we just recently filed a patent in that regard, with the technology we believe.

Once we get it through FDA clearance, we’ll assist both our practitioner, our own clinics to minimize the number of treatments to get a long-lasting response to this therapy, which may sound counterintuitive, meaning you want fewer treatments by each patient. But by driving that end point, many more patients will come to this therapy because of only needing up the treatments that deliver the response of their disease.

And by far, ours is the safest and most effective therapy of any of the choices for psoriasis patient out there. So hopefully that gives you plenty of color why we are optimistic about this …

Anthony Vendetti - Maxim Group

Yeah. That’s -- just real quick, how many XTRACs are in LCAV's 54 centers and how many do you expect to have by the end of 2014?

Dennis McGrath

So in my commentary I indicated that there are none as of June 30th. Our intent is to put a few in the upcoming months and ultimately, we expect all of the clinics where there is a fixed-site laser for Lasik to have them that's 47 of them.

The reason there will be a handful in there is it consistent with our conservative philosophy. You want to make sure that you put them in and you figure out the protocol. We think we have all figured out, you get all the certificate in place for reimbursement within insurance companies to make sure you get paid.

There are always something that have to be tweaked once your lifetime wanted it and we will do that in a handful of sites rather than law 47 and once we have that figured out then we will put them in all. The gating factor is not the manufacturing side of it. But it's really to gain assurance that what we intend to have happened in the clinic actually occurs on the execution side of this. That's why we'll do it with few clinics.

Anthony Vendetti - Maxim Group

Okay. Great. Thanks guys.

Dennis McGrath



(Operator Instruction) We will go next to Jim Sidoti of Sidoti & Co..

Dennis McGrath

Good morning.

Jim Sidoti - Sidoti & Co.

Good morning. Can you hear me?

Dennis McGrath

Yes. We can.

Jim Sidoti - Sidoti & Co.

Great. Just following up on the XTRAC. Can you just remind me what payment you're receiving now when a physician does a treatment and what that payment will be when you do the treatments in your LCA centers?

Dennis McGrath

Yeah. So I can give you some generalized response, right, and give you what the process looks like. So today physician can build from one or three CPT codes and those codes are distinguished by the amount of body surface area involve with psoriasis. And those codes range from roughly $150 to $250 and that varies by geography.

So there are other CPT codes, there are various factors including geographic centric overhead pools, for instance, Manhattan, New York versus Manhattan, Kansas will had different overhead pool. And so the reimbursement will be slightly higher in New York than it would be in Kansas for those factors.

But as a generalization a blended rate you should think about $100 to $75 is what the physician gets today and out of that we charge a fee per use. It also ranges from the CPT codes from $78 to $90. 90 being the largest code which is our C3, which is treating an area on the body that's about the size 8.5 by 11 sheet of paper, several lesion that’s sort of think.

So, in our own clinics, we will get the full amount of the blended $175 as I just described rather than the portion that we get by dealing with third-party general derm practice. Now keep in mind we have 550 practices out there, 47 clinics we've IDed in terms of our XTRAC and there is very little overlap of where we have clinics and where we have general derm practices.

In fact, unlike Lasik where the capture zone is significantly higher, you could 75 to 100 miles -- you could -- capture zone of patients. In the derm practice, it’s generally within a 10-mile radius, because of the convenience factor now. In Manhattan, it’s measured in blocks not miles. So it varies.

Jim Sidoti - Sidoti & Co.

But what was your cost fee, if you do it in your center? Is that, you have to incur some costs doing by yourself?

Dennis McGrath

There is some variable cost, the fixed overhead is generally already in existence, depending upon whether we bring a physician in or use an existing physician to deliver the therapy.

But, generally about 10% of the reimbursed rate is what you should expect in terms of the variable cost to treat that patient at the generalization. The other staff exist all the overhead, the reception area, the scheduling, all of that already exists. So, you don't have the same overhead pool that you might if you were starting to build from the ground up dedicated clinic to do so and these margins are extremely high.

Jim Sidoti - Sidoti & Co.

Okay. And then on the Kyrobak, what do you assuming for return rate for that?

Dennis McGrath

The return rates are coning down over that period of time, you remember and I will give you some more specificity. Any new geography or product line there is always a bolus of return that start and if you look at the return rate of our no!no! from the beginning of time in early days there was some volatility and then there is long declining steady line and we expect the same with Kyrobak.

In the six months or so, just under six months that we've been dealing with this. We’ve seen that to. There has been a number of things that we've done in the first couple months to drive down return rate where you had it in excess of 30% now see it below that and we expect to have that normalize as we increase that -- increase our reach on that.

It included a variety of things with our packaging and our messaging. It’s everything we tweak once we want a new program. In any new program two things drive your P&L. Its response and returns, and that's why we started a low rate and drill down on both and I think we are quickly approaching optimum levels.

Jim Sidoti - Sidoti & Co.

All right. And then finally on the debt, it's about $85 million. What was the interest rate now and it sounds like from your, the 8-K filed, you may have to pay an additional 2%, so what would it go to?

Dennis McGrath

Yeah. I’m going to give generally, there's obviously formula tied to a base rate and basis points over it. It's generally about three and quarter. The 3.5 and it varies by leverage and if you add 2 points to that that’s…

Jim Sidoti - Sidoti & Co.

Okay. So, should we assume that going forward that you refinance the debt with an interest rate around 5.5%? Is that reasonable or that's still to be determined?

Dennis McGrath

I wouldn’t -- I’m not prepared to make those assumptions. Certainly all those tools are available to us. The banks have been very professional with us and we intend to work through this process with them and expect to come to a resolution and common understanding as we go through this. So but to your point, no tools are taken off the table just our expectation is that we will be able work this effort. Thank you.

Jim Sidoti - Sidoti & Co.

All right. Thank you.

Dennis McGrath

Yeah. Thanks, Jim. So, Operator, that appears to be our last question. So, with that, thank you all for joining us. Look forward to reporting back to you on our November call. All have a great day. Thank you very much.


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

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