STRATA Skin Sciences' (SSKN) CEO Michael Stewart on Q4 2015 Results - Earnings Call Transcript

| About: STRATA Skin (SSKN)

STRATA Skin Sciences, Inc (NASDAQ:SSKN)

Q4 2015 Results Earnings Conference Call

March 10, 2016 04:30 PM ET

Executives

Michael Wood - IR, LifeSci Advisors

Michael Stewart - President and CEO

Christina Allgeier - CFO

Analysts

Swayampakula Ramakanth - H.C. Wainwright

Operator

Good day, and welcome to the STRATA Skin Sciences Fourth Quarter 2015 Earnings Call. Today’s conference is being recorded. At this time, all participants are in a listen-only mode. [Operator Instructions]. I would like to remind everyone that this conference is being recorded.

And would now like to turn the conference over to Mr. Michael Wood of LifeSci Advisors. Please go ahead sir.

Michael Wood

Thank you and good afternoon everyone. Before we begin, I would like to remind you that management’s comments today may include forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. These statements include, but are not limited to plans, objectives, expectations and intentions and other statements that contain words such as expects, contemplates, anticipate, plan, intend, believes, assumes, predicts and variations of such words or similar expressions that predict or indicate further events or trends, but do not relate to this historical matter.

These statements are based on the company's current beliefs or expectations and are inherently subject to significantly known and unknown uncertainties and changes in circumstances, many of which are beyond the company's control. There can be no assurance that beliefs or expectations will be achieved. Actual results may differ materially from beliefs or expectations due to financial, economic, business, competitive, market, regulatory and political factors or conditions affecting the company and the medical device industry in general. Given the uncertainties affecting companies in the medical device industry, any or all of the company’s forward-looking statements may prove to be incorrect. Therefore, you should not rely on any such or any such factors or forward-looking statements.

In addition, more specific risks and uncertainties facing the company are set forth in the company’s reports on Forms 10-Q and 10-K filed with the SEC. STRATA Skin Sciences urges you to carefully review and consider the disclosures around its SEC filings, which are available at sec.gov and strataskinsciences.com.

I will now like to turn the call over to STRATA's President and Chief Executive Officer, Michael Stewart. Mike, please go ahead.

Michael Stewart

Thank you, Michael. Good afternoon, everyone and welcome to STRATA Skin Sciences fourth quarter earnings conference call. I am excited this is our first quarterly conference call since we change the name of our company to STRATA Skin Sciences effective in early January. We rebranded the company to reflect the major changes we've accomplished over the past year. These changes include a new senior management team that is now directing the company including my leadership as CEO of STRATA and Christina Allgeier as CFO. In addition we acquire the XTRAC and VTRAC businesses in June 2015 through FDA approved systems which generated over $30 million in revenues in 2014 and over 70% of those revenues are recurring. I'll update you on our business and Christina will review the financial results for the quarter in more detail.

To start I'd like to review our summary financial information. STRATA's total revenues for the fourth quarter were $9.5 million, which were up 13.9% sequentially over the third quarter of 2015. The third quarter was the first full quarter of our ownership of the XTRAC and VTRAC businesses. Gross margin was 63.2%. Cash on the balance sheet at the quarter end was $3.3 million and we had positive non-GAAP adjusted EBITDA in Q4 making it two quarters in a row. The number of XTRAC systems deployed in the United States as of yearend 2015 increased to 718, up 16% from 620 systems as of a year ago. During 2015 we added 98 net systems. This level of net additions was consistent with our goal of adding approximately 100 net systems each year or roughly 25 per quarter.

Since the implementation of the direct to patient marketing model in 2012 the number of system placements has increased by over 250% from 268 systems at the beginning of 2012 to 718 at yearend 2015. STRATA's growth has been driven by a direct to patient marketing campaign that is utilized to drive patients to our clinical dermatologist customers and to create awareness. These efforts are supported by our robust sales organization including direct sales associates, clinical resources and sales management personnel as well as our in-house call center patient advocates and reimbursement group. We continue to be very encouraged by the performance and prospects for our recurring XTRAC business.

I'd like to cover some key aspects of the XTRAC procedure what makes it attractive to clinical dermatologists and how we are structured to continue to grow the XTRAC businesses. XTRAC is cleared by the FDA for the treatment of four dermatological conditions psoriasis, vitiligo, atopic dermatitis and leucoderma. Psoriasis is the main driver and is a disease that affects 7.5 million Americans and about 125 million people worldwide. It’s an autoimmune disease for which there is no cure but for which remission can be achieved through the use of the XTRAC. The XTRAC treatment procedure is effective in the clearing of psoriasis plax and as reported in clinical studies remission can last for three to six months or longer. And since there is no cure for psoriasis, the disease returns and the patient goes back to the dermatologist for an additional series of treatments.

The number of treatments varies based on the severity of the disease, and typically six to 10 treatments are required in order to reach 75% improvement. Since patients often prefer greater than 75% clearance as measured by their patch score, the average number of treatments can be greater. The treatment time with the XTRAC is very reasonable and patients receive two to three treatments per week. XTRAC treatments will be planned by the dermatologist and can be performed by the dermatologist or by a physician extender such as a nurse physician assistant or medical technician. These delegation rules are set by each state's medical board.

Additionally as new pharmaceutical treatments come into the market, we believe the number of patients seeking treatment, generates additional demand as those patients have the ability to have their remaining patches of psoriasis cleared with the XTRAC. Reimbursement levels for XTRAC procedures have remained relatively constant over the last several years which is excellent news for STRATA and our customers. While the actual reimbursement varies by insurer, the average CMS reimbursement rates are representative of the average rate supply.

Based on body surface area covered the three CPT codes have average rates which range from a $156 to $238 per treatment. These CPT codes went into place in 2003 and have been relatively stable since then. Payer coverage of XTRAC treatments for psoriasis is very broad with public and virtually all of the commercial healthcare plans having established coverage policies. In summary, XTRAC treatments for psoriasis has both consistent reimbursement and excellent payer coverage providing certainty for clinical dermatologists as to the potential revenues they can generate from having the system, which provides an effective clinical solution in their office.

In addition to psoriasis the XTRAC as I mentioned is also cleared to treat three other dermatological conditions, vitiligo is a disease that causes a pigment deficiency that affects approximately 2 million people in the U.S. and approximately 1% to 2% of the world's population. Currently about half of the insurance companies consider the treatment of vitiligo with the XTRAC a covered benefit. For vitiligo, again depending on the severity of the disease more treatments are typically necessary and range from 16 to 20 on average. The other clearances are for atopic dermatitis and leucoderma. Atopic dermatitis is a widespread disease affecting as much as 16% to 17% of the U.S. population. Coverage is very payer dependent, but appears to be increasing, especially in more severe cases.

Leucoderma, which is the re-pigmenting of scars is considered a cosmetic procedure and therefore not subject to reimbursement. And studies are continuing to broaden the use of the XTRAC. The 2016 International Journal of Dermatology just published a study conducted by Mount Sinai physicians showing excellent results of the XTRAC in treating chronic hand and foot eczema, a disease that is often recalcitrant with other therapies. Overall, we believe there about 2,500 to 3,500 potential sites for our XTRAC dermatological systems in the U.S. which represents a good growth opportunity both near and long term.

Another aspect that makes XTRAC attractive to dermatologists is the business model we employ which is fairly unique. STRATA's model is based on placing the XTRAC system in the dermatologist's office with no capital cost to the physician and charging a per procedure fee. These per procedure fees create a recurring revenue stream for the dermatologist and for the company. With our model our sales reps are focused essentially on selling a procedural solution to the dermatologists and not a capital sale. This avoids the hurdle of a capital outlay for the dermatologists. Since the later costs are semi-fixed to STRATA primarily consisting of depreciation over a five year life and service cost, the impact of the growing revenue stream of gross margin is very positive.

STRATA sales and marketing approach is highly differentiated. In addition to expanding the base of dermatologists under our agreements by directing the pace of marketing approach consists of an ongoing advertising campaign comprised of TV, radio, social media and digital to increase awareness and drive prospective patients to our call center or to contact us through the web. In the marketing area we have some new initiatives to highlight. First, we will shooting a new commercial for the XTRAC system. Our goal for this commercial is to have more of an emotional appeal to prospective patients rather than a purely consumer oriented DTC ad. We are also in the process of re-working our XTRAC website and that will go live in the second quarter and will tie in to and facilitate the patient's learning through the website in much the same way that our patient advocates accomplish this.

In concert with these efforts we will be implementing a more robust social media approach as part of our marketing plan that we have had historically. As a result of our advertising and marketing via various media channels, prospective patients that contact our call center, will speak to our patient advocates who provide information regarding the XTRAC procedure as well as insurance information. We then recommend those patients to one of our now over 700 physician partners for evaluation. In many cases we actually booked the consultation appointment for the prospective patients. In addition to these direct leads, we believe there is a halo effect of our advertising to consumers, in which patients that visit the dermatologists ask about the XTRAC procedure without going through our call center, contributing to higher utilization within our customer base.

The growth of XTRAC revenues will continue to drive the profitability of the company. Our sales and marketing approach has a compounding impact for STRATA. We seek to grow the number of participating dermatologists now at 700 [new] team placements, while STRATA's direct to patient advertising campaign creates awareness and identifies new potential patients. We funnel these leads to our clinical dermatologist customers which increases their system utilization. We believe these combined strategies will lead to both revenue and EBIDTA growth.

With regards to the legacy side of the business the MelaFind which has always held promise of a significant market opportunity, we released earlier today that we have received an approval from the FDA to a PMA supplement that adds to the MelaFind labeling a classifier score and the statistically significant results of the supporting reader study conducted in support of the supplement. The classifier score allows the physician to factor quantitative results into what was otherwise a binary yes/no decision of the device. Increases in sensitivity from 76% to 92% and in specificity from 52% to 79% were realized in the study. The supplement approval was a major step in adding value to the MelaFind technology. We have additional challenges to overcome for example cost reduction and manufacturing initiatives as well as the reimbursement hurdles, but believe that this approval adds significantly to the product potential value.

We will continue to work on the creation of value for the MelaFind technology, and we’ll continue to update you on our progress in the coming quarters. Additionally we stated in the release that as a result of the data we provided to justify the addition of the classifier score, the previously mandated post approval study that was initiated in 2014 and had several years left to complete has been terminated. The elimination of this study will reduce the company’s expenditures in future years saving several million dollars of future costs to complete the study. Our operating costs on the historical MELA side of the business have been reduced significantly and there is more consolidation that will take place over the next two quarters.

At this time, I would like to turn the discussion over to Christina Allgeier, our Chief Financial Officer to address the fourth quarter financials. Christina?

Christina Allgeier

Thanks Mike. Good afternoon everyone. Revenues for the fourth quarter were $9.5 million and were up approximately 13.9% sequentially from the third quarter of 2015. We acquired the XTRAC and VTRAC businesses last June and therefore Q4 is the second full quarter of activity for the acquired businesses. Our XTRAC business generates recurring revenues from per procedure fees. In the fourth quarter recurring revenues of $7.5 million accounted for 79% of total revenue.

For the full year on a performance basis recurring revenues in 2015 were $26.6 million or 81% of total revenues, an increase of 16.1% year-over-year. The balance of the revenues is comprised of international sales of XTRAC and VTRAC systems and the associated products and maintenance revenues, as well as sales of MelaFind product. International sales drove the main increase in the other four quarter revenues with XTRAC and VTRAC sales of 27 systems in the fourth quarter up from 17 systems sold in the third quarter.

As presented in today’s press release non-GAAP adjusted EBITDA for the fourth quarter was $500,000 and was our second consecutive quarter of positive non-GAAP adjusted EBITDA for the company. This includes adding back depreciation and amortization expenses, cash and non-cash interest expense and income taxes. Other adjustments included change in the fair value of warrants and liability of $2.5 million and stock based compensation of $270,000. The fair value of the warrant liability is re-measured each quarter according to the methodology, described in the footnotes of our 10-K and recent 10-Q.

As our operations include significant non-cash charges, it is relevant for investors to consider our non-GAAP presentation. As of December 31st, STRATA had a cash balance of $3.3 million. For the fourth quarter we generated positive cash from operations of $400,000 and made a capital investment of just over $600,000 for systems placed into service. We expect to continue to generate positive cash flow during 2016 and we believe that we have sufficient cash resources to fund and grow our operations in the foreseeable future.

A notable event in the fourth quarter was the arrangement of a $12 million credit facility with a group led by MidCap Financial Trust which closed on December 30, 2015. Under the agreement the credit facility could be drawn down in two tranches. The first tranche of $10.5 million was drawn in the fourth quarter at closing. The proceeds of this first tranche were used to repay the $10 million principal dollar amount of short term senior notes plus other expenses from the acquisition of the XTRAC and VTRAC businesses. The remaining $1.5 million was drawn on January 2016. This is a five year credit facility with interest only payments for the first 18 months.

The main driver of STRATA is the XTRAC business. XTRAC’s recurring revenue has significantly grown over the last four years. For the full year of 2015 on a pro forma basis recurring revenue for the XTRAC systems increased by 16.1% to $26.6 million compared to $22.9 million in 2014. In terms of guidance we continue to expect year-on-year recurring revenue growth in the mid teens and we expect positive non-GAAP adjusted EBITDA to increase in 2016. The combination of revenue growth and the impact of cost reduction efforts taken over the last half of 2015 are expected to contribute to that increase in this non-GAAP adjusted EBITDA in 2016.

Keep in mind the XTRAC recurring revenues in the first quarter of each year is normally impacted by the resetting of deductibles by most of the third party insurers. While we expect year-over-year growth in line with our expectations, recurring XTRAC revenues will be lower in the first quarter of 2016 as they were in the first quarter of previous years.

The integration of the acquisition is partially complete. However we continue to consolidate the activities of the MelaFind business into our other facilities and continue to reduce costs where appropriate. The historical spend on the post approval study was approximately $500,000 per year and the elimination of the study in 2016 will result in immediate savings going forward. The expectation was that the study will continue for several years, therefore the elimination of the post approval study has saved the company future outlays of approximately $1.5 million to $2 million. Our 2015 10-K will be filed on Tuesday, March 15th.

Now I'll turn it back to Mike.

Michael Stewart

Thank you, Christina. We are enthusiastic about the XTRAC and VTRAC businesses and which the current management knows well. We have a robust business with strong capabilities in sales, marketing, reimbursement, support, regulatory and a customer base of 718 clinical dermatologists. STRATA Skin Sciences entered 2016 with an infrastructure that we believe positions us as the best in class player in medical dermatology and a partner of choice for emerging technologies looking for a strong and effective enterprise that can quickly scale and exploit unmet needs in the medical dermatology market.

We look forward to providing more detail to you in the future as we continue to execute on our plan and strategy and we are looking forward to an exciting 2016. Operator with that let me open for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Swayampakula Ramakanth with H.C. Wainwright. Please go ahead.

Swayampakula Ramakanth

Two questions. The first one being -- thanks for the guidance for 2016. But in terms of growth expectations there are basically -- trajectory expectations for 2016 in terms of XTRAC sales. What are the pushes in closing that number because you already have about 718 instruments placed and what are the things that could help increase placements from your expectation of about 100 odd instruments over the year or what could deter getting that number?

Michael Stewart

So there is two ways that we look at building the recurring revenue of the XTRAC business. One is through expansion of the customer base, replacement of additional systems. We've been pretty consistently able to drive about 25 net systems per quarter to increase. Given our pipeline of potential interest we don’t see that as an issue going forward. Things that would increase our rate of deployment of those systems are, in the dermatology world today there is a lot of consolidation going on. Individual derm practices are being bought by equity partners and decisions are being made by groups. So one of the things in our sights and in our discussions is in working with those groups to expand the business of the XTRAC throughout their customer bases. So that's one area where it could accelerate. As far as what could stop it from happening, I don’t see a lot today that could stop it from happening. There is still quite a few dermatology practices out there and still quite a few psoriasis and vitiligo patients, if you look at the number of psoriasis patients or vitiligo patients we are treating today you will have [tails] in comparison to what the market opportunity is. So the ability to grow this going forward I think is still there. The other is the utilization and we grow through the utilization of the machines that already exist and that's where our marketing approach of advertising, creating awareness and then driving patients into those existing practices helps to accelerate the growth of the recurring business.

Swayampakula Ramakanth

Okay, thank you. In the fourth quarter we suddenly saw really good operational excellence in terms of cost containment. So going into 2016 and in completing the integration what sorts of places are still open to increase cost containment in the new year?

Michael Stewart

So basically the majority of the effort will go into continuing to make sure that we have the spending on the legacy product that’s not generating significant revenues today at the right level. So some of the steps that we took over the last several quarters was to move out of the manufacturing facilities in Germany, all the warehouses where the product was placed in the United States and consolidate everything into our own facilities to reduce those types of costs. There is more of that to go forward, and there is also because of this approval that we just received, some small investment that we will continue to make to try to realize the value that the MelaFind technology has. So while we are being conscious of what we are spending on MelaFind, we are also being optimistic about what we might ultimately be able to make that into. So those are the areas primarily. We are not going to reduce what we are doing from the standpoint of marketing. In fact we are investing in marketing with the new commercial, with the social media campaign because that is what has been driving this business for the last four years. And we will continue to do that.

Swayampakula Ramakanth

Okay. And then switching gears a little into the MelaFind space, so you got this new PMA supplement approved. So how is this classifier score going to help the dermatologists and what impact can you expect or can we expect in terms of acceptance of the product in the market as it is right now? I know there is a lot work that you are doing in terms of making this into a better instrument, smaller instrument and smaller footprint and all that kind of stuff. But as such with whatever you have right now how does this PMA supplement going to help?

Michael Stewart

So, it helps in this way. If you think of what the original PMA approval was, if the output of the device and the approval was for a binary result, which was basically an answer of yes or no that this lesion that's being examined has the potential to be melanoma or not. What the classifier score does -- and the classifier score was information that existed within the MelaFind from the beginning, we have just really brought it to the forefront to give the physician, the dermatologist the ability to weigh the probability of melanoma into his overall assessment of the patient. So the MelaFind is an aid to the dermatologist that he factors into his overall decision. And by having the classifier score it gives an additional information to be able to make the right decision relative to biopsy or not biopsy. Regards to the second half of your question.

Swayampakula Ramakanth

How is it going to help commercially?

Michael Stewart

Yes, so from a commercial standpoint we still have as you said a lot work to do, right. So this was -- we overcame a gauging factor here, a challenge that without having a classifier score within the output of the device. I think the binary output alone would make it extremely difficult to build a market out of that product. With this output now, there is the potential to do that. The other challenges that we have though are not insignificant either. So the ability to reduce the cost of the product, which I think we have -- we are working on and I think we have some good prospects to do, still has to be done. And then ultimately as you know, in order for this product to be effective in the market place, it has to provide some level of reimbursement to the dermatologists. So those are the remaining kind of major challenges. They won’t get accomplished in next year, doesn’t mean that we won't sell some MelaFind units in the next year, but it won't be a significant component of our revenues until we get those other challenges resolved.

Swayampakula Ramakanth

Okay. And then I just want to kind of really zoom into the last few words of that particular [cursor is], where you are talking about really bring out strategic assessment in MelaFind technology. So I wonder what is the assessment you are trying to do? What is the strategy here? Is this a strategy where you want to understand how you can grow this in your hands or you are looking for strategic divestment of this asset? What exactly should we understand when you say that?

Michael Stewart

So, what we believe we have is an asset, we have the MelaFind technology and it has capabilities, it's a proprietary technology and if we can resolve the issues that are in front of us to bring it to market then we will do that. If -- but we also know that we have an asset that has value that might be of interest to other and if it was then -- and that made more sense, then we would consider it. So it's really take this asset that we have that’s really not contributing significantly to the current business and find a way to create value with it and that as you know and I've just stated that value can come in many different ways. So we are hoping to looking at those different ways of creating value out of this technology.

Swayampakula Ramakanth

Okay, thank you very much.

Operator

[Operator Instructions]. And ladies and gentlemen that will conclude today’s question-and-answer session. I would like to turn the call back over to Michael Stewart for any additional or closing comments.

Michael Stewart

So I thank everybody for joining us on the call today. I appreciate your time and interest in STRATA Skin Sciences. We look forward to updating you on future calls, if not before. And thank you again for your attendance. Good night.

Operator

That will conclude today's conference. Thank you all once again for your participation.

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