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STAAR Surgical Company (NASDAQ:STAA)

Q2 2012 Earnings Conference Call

August 1, 2012 16:30 ET

Executives

Doug Sherk – Investor Relations

Barry Caldwell – President and Chief Executive Officer

Deborah Andrews – Chief Financial Officer

Don Todd – President, Asia-Pacific

Hans Blickensdoerfer – President, Europe, Middle East, Africa, and Latin America

Don Fagen – Vice President, North America

Analysts

Chris Cooley – Stephens Inc

Raymond Myers – The Benchmark Company

Christine Healy – Canaccord Genuity

Rick D'Auteuil – Columbia Management

Joe Munda – Sidoti & Company

Bruce Jackson – Northland Capital Markets

Jason Mills – Canaccord Genuity

Larry Haimovitch – HMTC

Operator

Thank you for standing by. Welcome to the STAAR Surgical Second 2012 Financial Results Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Wednesday, August 1, 2012.

I would now like to turn the conference over to Doug Sherk. Please go ahead sir.

Doug Sherk

Thank you, operator, and good afternoon, everyone. Thank you for joining us for the STAAR Surgical conference call and webcast to review the company’s financial results for the second quarter which ended on June 29, 2012. The news release announcing the second quarter results crossed the wire about a half an hour ago and it’s available at STAAR’s website at www.staar.com. Today’s call is also being broadcast live via webcast.

In addition, a slide presentation will accompany remarks by management. To access both the webcast and the presentation slides, go to the Investor Relations section of STAAR’s website at www.staar.com. If you are listening via telephone to today’s call, I would like to review the slides that accompanying management’s remarks. Please navigate that a live webcast as I have just reviewed and choose the no-audio/slides-only option. In addition, an archived replay and slides will be available on the STAAR website.

Before we get started, during the course of this conference call, the company will make forward-looking statements. We caution you that any statement that is not a statement of historical fact is a forward-looking statement. This includes any projections of earnings, revenues, sales, profit margin, cash or other financial statements. Any statements about plans, strategies or objectives of management for future operations or prospects for achieving such plans, any statements concerning proposed new products, including expectations for success of the ICL or other products in the U.S. or international markets, government approval of new products or developments or other future actions of the FDA or other regulators, the outcome of product research and development or any clinical study, any statements regarding future economic conditions or performance, the size of market opportunities, statements of beliefs and any statements of assumptions underlying any of the foregoing.

These statements are based on expectations and assumptions as of the date of this conference call and are subject to numerous risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These risks are described in the Safe Harbor statement in today’s press release and in the Risk Factors section of our Annual Report on Form 10-K, investors or potential investors should read these risks. STAAR assumes no obligation to update these forward-looking statements to reflect future events or actual outcomes and does not intend to do so.

In addition to supplement the GAAP numbers, we have provided non-GAAP adjusted net income and basic and diluted net income per share information that excludes manufacturing consolidation expenses, gains on foreign currency, or losses on foreign currency, fair market value adjustments for warrants and stock-based compensation, we believe these non-GAAP numbers provide meaningful supplemental information and are helpful in assessing our historical and future performance. A table reconciling the GAAP information to the non-GAAP information is included in our financial release, which is available on our website and in our slide presentation.

Now, with that out of the way, let me turn the call over to Barry Caldwell, President and Chief Executive Officer of STAAR Surgical.

Barry Caldwell

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

I’ll start with an overview of the quarter and ask our commercial heads to weigh in at times. I will also review our 2012 key metrics in light of the results for the quarter. Deborah will provide a detailed look at our second quarter financial results and discuss progress with our manufacturing consolidation project.

Before we take your questions, I will review with the three commercial heads anticipated progress and key drivers during the second half of the year and our expected performance. As we announced a couple of weeks ago, our second quarter revenue growth was not what we had expected. So, it was an unusual combination of three dynamics, which limited our sales.

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

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

The first dynamic was that our ICL growth in China was flat during the quarter. You can see on the slide the excellent growth that we have experienced in China over the past 2.5 years. The average year-over-year growth rate has been 95% or basically doubling over the previous quarters, over a nine-quarter period.

So, let’s look to see what we believe happened to interrupt our growth rates and trends. There was a lot of media coverage in the China market on complications associated with LASIK. According to our research, this coverage resulted in a significant slowdown in all refractive procedures in the market. Don Todd, who is our President of Asia Pacific, would you add a little more color for the challenge we face.

Don Todd

Yes, Barry. The media coverage commenced in response to comments by an influential Taiwanese doctor and generated widespread negative attention regarding LASIK throughout China beginning in February and going through April timeframe. One Chinese online media outlet cited an alarming statistic that one in every five LASIK patients will suffer complications. Then in mid-April, there was another round of media coverage focused on a group of Chinese doctors recommending against LASIK for military personnel. Our customers in China reported a sharp decline in appointments regardless of the procedure and the results were – was the flattening of ICL procedures that created about $1 million decline in our expected second quarter revenue.

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

Barry Caldwell

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

Hans Blickensdoerfer

Sure, yes, Barry. In Spain, we transitioned from a distributor model to a direct sales model through a combination of the distributor not reordering products to inventory as we would normally have done, and also our responsibility to buy back his inventory during June, the market generated about $500,000 less in sales than what we would have expected for the quarter. This resulted in ICL sales in Spain declining by 28% during the quarter as compared to prior year. Now, we have meaningful revenue upside for the second half of the year as we will be enjoying end customer pricing with distributor price.

Barry Caldwell

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

Hans Blickensdoerfer

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

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

Barry Caldwell

Great, Hans. Thank you. Don, how about the U.S. market?

Don Fagen

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

Barry Caldwell

Good. It is nice Don to see a return of the military after we have had several quarters of decline.

So, now, let’s review the 2012 key metrics in relation to the results from the second quarter. The red arrows reflect a disappointing quarter and also how tough we are on grading in our results and I’ll go over that. As we have reviewed, revenues actually declined 2% during the quarter and ICLs only increased 4% obviously both misses on the first two lines. The third line on our gross margin, it was 69.3% for the quarter, which was a 250 basis point improvement over prior year. Still, it lagged behind the 70.3% margin for first quarter. So, as a result of that, we did mark it as not achieved, though we do believe, we are still on track to achieve our annual target up 71% in this metric. Deborah will discuss this in more detail in a few moments.

On the fourth line, though we are not profitable on a GAAP basis, you can easily see that the 700,000 investment in manufacturing consolidation lift our bottom line to a loss. We are also profitable on a non-GAAP basis, as you will see. Nevertheless, we graded it as a miss, so we do not see this interfering with our ability to the GAAP profitable or the full year. Deborah will discuss manufacturing consolidation in more detail, but overall, we are on schedule even ahead of schedule on the regulatory approval side while experiencing no disruption to our customers in supply or quality.

After Deborah goes into the financial details, we’ll return to discuss second half key drivers and expected results, with a quick glimpse into what we’ve seen during the first five or four weeks I should say of the third quarter.

Now, I’d like to turn the call over to Deborah for more thorough review of the second quarter financial highlights. Deborah?

Deborah Andrews

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

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

Operating expenses also increased due to a $342,000 increase in stock-based compensation. We estimate the annualized cost of the headcount addition will be approximately $2 million and the expense associated with the transition in Spain will continue through February 2013, at which time, the normal logistics costs are being directed in market will begin. In terms of gross profit margin our gross profit margin increased year-over-year reaching 59.3%, a 250 basis point improvement over Q2 2011. And despite the 2% decrease in our sales, our gross profit dollars actually increased 1.7%. This improvement in gross profit and gross profit margin is primarily due to improved ICL mix, but also due to improved ICL and IOL manufacturing costs and higher average selling prices. ICL revenue represented 54% of total sales compared with 51% in the second quarter last year.

We continued to expand IOL gross margin in all five categories of IOLs we offer despite a decrease in sales. Overall, IOL gross margin were 60% which was a 300 basis point improvement over the 57% in Q2 of 2011. Our overall margin of 69.3% was down from the record 70.1% we reported in Q1 primarily due to a lower mix of ICL sales, 54% in Q2 versus 56% in Q1 and higher mix of lower gross margin IOLs to China which had a significant increase over prior year.

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

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

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

Moving on, our manufacturing consolidation project is progressing on schedule. Expenses during the quarter as I said were about $700,000 and the year-to-date total is $1.3 million. We expect to spend about $2.3 million in total during the year. We began shipping the first of our IOLs to Japan during July and expect to be shipping all IOLs for Japan from the U.S. during the fourth quarter. We are on schedule to start shipping the first Visian ICLs from the U.S. during the first quarter of 2013.

We believe that the transition will be significantly beneficial specifically improving our cost of goods and creating a more favorable cash structure. Once the manufacturing consolidation is fully implemented, we believe we can improve gross margins nearly 80% and we believe that it will drive our tax rate from 50% to 10% beginning in 2014. We estimate the consolidation project including the impact of our tax strategies will result in anticipated savings exceeding $100 million for the aggregate period of 2014 to 2021.

And based on the expected revenue growth and financial benefits from the manufacturing consolidation, we expect our results in 2014 to look something like this. Revenues over $100 million, our gross margins should be at or near at 80% and even if we have higher than expected expenses of $50 million, our earnings before tax would be $30 million, if the tax rate is 10%, we should drive 27% for the net income line.

This concludes my comments. I would like to turn the call back over to Barry.

Barry Caldwell

Thanks Deborah. So, that shows the short fall in second quarter, it doesn’t impact our expectations for 2014 after consolidation. Okay, now let’s review our expectations for the remainder of the year and key events which will help to drive our results. I’d like to provide you with the metrics we are striving to achieve during the second half of 2012. They are, one, to generate solid double-digit total revenue growth versus the second half of 2011. Second, will be to grow our Visian ICL revenue at the rate of 25% versus what we achieved in the second half of 2011. I might add this assumes a little rebound to growth in China not much. So, any additional growth from that market should be an upside. Three, continuous improvement from our second quarter results quarter-by-quarter of our gross margins, so that we achieve 71% for the full year, our gross margin of the (current year) through the first half is 69.8% as a reference. Fourth, be profitable in the third and fourth quarters. And five, continue to mange our consolidation projects, so we don’t sacrifice supply or quality.

So, now let’s look at our full year 2012 metrics and the changes with these two metrics overall to revenue and total revenue and ICL growth. And as you can see the first two they’re okay, those are growth drivers. Here are some of the key events and activities which will help drive our results during the second half. We have two users meetings coming up, one during August in the United States and the other during September in Europe.

These meetings have been very successful in the past as leading ICL surgeons share their experiences with the technology in an educational way, which helps to generate better outcomes and more interest in the ICL technology. We also have the ESCRS meeting upcoming during the first half of September. We will be highlighting the V4c success and our two new IOLs, KS-SP and the nanoFLEX Toric. Later in September, we have planned a STAAR Symposium highlighting our direct presents in the market during the Spanish society of ophthalmologist annual meeting.

We expect that all of these events will lead to increased awareness of the benefits of the ICL technology and a greater adoption rate. Let's discuss the IOL business for a few minutes Don and Hans. How do you see the impact of these two new IOLs in your region and I'll turn to Hans first.

Hans Blickensdoerfer

Barry as you know we have a three piece preloaded acrylic IOL in Europe. Some surgeons prefer a single piece model is about 15 terms of surgeon preference. This is particularly important to the German, the French and the Italian markets. IOL sales in these markets during Q2 declined by about 21% and we believe this product will help in all three of these markets. Now with nanoFLEX Toric IOL this is the new product for us and it is a market with good pricing and the segment is growing. This will have a positive impact with second half and rolling into 2013.

Barry Caldwell

Good, okay Don Todd.

Don Todd

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

Barry Caldwell

Okay, thanks Don and Hans. Our IOL business during the quarter declined by 4% over the prior year though this was a 6% increase over the first quarter of this year. Like a comparison two of the big competitors here Novartis, which is or was Alcon reported the global IOL sales were flat during second quarter. And Abbott which used to be AMO has reported their cataract business actually declined by 2.1% during the quarter. During the second quarter we had decline in the U.S. IOL sales is well as Europe. Don Fagen can you give us some insight on this segment?

Don Fagen

Sure. First we had planned a decrease in some of our lower priced silicone IOL business and that’s happening. You’ll recall that over one year ago the NTIOL status, which provided an additional $50 reimbursement expired. We have maintained our nanoFLEX IOL pricing very well. It has actually gone up since last year. The major competitors are all getting very aggressive on their pricing for standard IOLs. With the expected cost reduction from our manufacturing project, we have given the sales team more flexibility in their pricing guideline to customers for the remainder of the year.

We have also adjusted their commission plans for the second half of the year to help drive nanoFLEX and silicone for IOL sales. We think it will have a positive impact during the second half.

Barry Caldwell

Good, great, thanks Don. As mentioned we’ve added 13 new direct employees during the first half of the year, which we believe will help bring additional value during the second half. And you can see for the slide, there is a focus on consumer awareness or online marketing and actually we’ve extended the offer and it’s been accepted for the 14th add, which would come in Japan. We are rapidly expanding our consumer awareness campaigns around the Visian ICL. Our focus is online marketing and advertising, consumer driven websites moving interested – trying to move interested patients on the technology directly to ICL surgeons, practice development, and even more traditional direct-to-consumer testing.

Finally, a member of the famous Black Eyed Peas band, apl.de.ap, recently had ICLs implanted. The story was presented on Good Morning America last week and the link here is attached, if you’d like to view it. Also is the link to the Visian ICL block site on the ICL procedure, which appeared the very same day. Obviously, apple is a huge store with the ICL target market, and we are looking ways to potentially partner with them to expand consumer awareness of the ICL technology and the great results we can offer the patients like himself.

Bottom-line is that we had a disappointing first half of the year. We are also very encouraged about our opportunities to rebound very quickly during the second half. We believe we are gaining market share with the ICL in most of not all major markets. Our July revenues go only one month of a three-month period and not yet audited gives us solid confidence in this rebound. During July for example, ICL revenues increased 25% globally and that was with minimal growth in China.

There is no guarantee that this will be the trend for the remainder of the quarter. But it does give us a very good start overall to the third quarter. We will be presenting that the Canaccord Genuity Conference in Boston on August 15. So, if you would like to to see us, you can contact that group and get a slot.

And with that, I think we are ready take your question so, operator, could we please open the line for questions and answer. Operator?

Question-and-Answer Session

Operator

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

Chris Cooley – Stephens Inc

Thank you, can you hear me, okay?

Barry Caldwell

Yes, hi, Chris.

Chris Cooley – Stephens Inc

Hey, how are you.

Barry Caldwell

Good.

Chris Cooley – Stephens Inc

I just wanted to – I guess my first question, I have a follow-up, I just want to make sure I fully understand what’s giving you confidence here in the second half of the year relative to the first half performance and you’ve held out a couple of different items and so may be you could help us, I guess two parts of this and the follow-up. When I think about the gross targets, hope us understand the unit volume growth versus pricing and how that compared versus the prior year to get to these numbers. And then secondly I’m little confused. You cite a couple of different users meeting has been potential catalyst in the back half of the year. In prior calls you called out meetings like the World Congress and ESCRS has been a detriment to your performance in that quarter. But those surgeons were out the market. But into these conferences, should we take from that or infer from that that you’re basically saving there is a big fourth quarter as suppose to more metered growth through the third and the fourth quarter, thanks.

Barry Caldwell

Okay, multiple things in there. So, let me first take the top one in terms of confident, I think that you asked. One points to the start we’ve had in July. I think we’ve seen several things turnaround in July that though we can guarantee. We think we’ll continue throughout the quarter. And I think that’s happen in all three markets. So, may be I think I’ll just throw the ball over and let all three of the commercial hedge just quickly on confidence throw out to Chris that you see that does help your confidence level. Hans, I’ll start with you and we’ll just go around the table.

Hans Blickensdoerfer

Sure, Chris. So the – our Q1 was a bit weak as we just illustrated here in the call. Q2 already was much stronger than Q1. And as Barry was saying we see the continuation of the growth just leading into the startup of Q3. We have the Spanish project which was – it’s very exciting and we are gaining here on the pricing level. But more importantly I think we’re gaining through obtaining control in this market taking over the management of the business and much rather than just relying on the third party, our distributor there. So, from my point of view I’m very confident that the second half of the year is going to be significantly better than the first half.

Don Todd

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

Don Fagen

Hey Chris, it’s Don Fagen here. With regards to North America I see us coming to a tipping point to a degree that tipping point being it’s time for some of the things we’ve been working on for a half year, two years to really click in. And as Barry said in July we were starting to see evidence of that. Some of those elements would be social media, a lot of works we’ve done behind the scenes here over the past six months is all increasing their size of the department. So, I see that as starting to kick in. Three or four months ago I’d go and talk to doctors and one of the first thing they will say, hey are people calling in asking about the ICL and nine times out of ten they say no. Now when I go in and talk I’d say at least half of them are saying yeah we’re actually getting some phone calls. So, there is some unique activity taking place there. And the other thing is practice development, business development some might call it. This all falls under a STAAR University program. The practice development that’s the hand-to-hand combat out there with our key accounts giving everyone for them from the person answering the phone to the coordinator to the doctor should integrate ICL as part of the overall with practice service. We’re starting to see that get some traction.

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

And last but not least here, I’m seeing an up-tick in both the civilian as well as the military number of units year-over-year. So, again I see this all – the tipping point is coming to fruition. I don’t know if its going to be huge, but I’ve used it leaning in a very positive direction as of end of July.

Barry Caldwell

Great. Thanks all three of you. And Chris, I have one other thing on is a consumer awareness. We’re seeing some pretty interesting data here in terms of website hits concerning the ICL name and for example one of the data points that we just recently looked at here on add names and the ICL name in the U.S. showed that for every three hits that LASIK received over a monthly period, the ICL received one hit. We thought that was pretty doggone good. So, we continued to track that and monitor that we haven’t invested in consumer awareness both here in the U.S. we have a three person department here now and in the markets with several individuals.

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

Chris Cooley – Stephens Inc

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

Barry Caldwell

Yes.

Chris Cooley – Stephens Inc

Can you help me reconcile that?

Barry Caldwell

Yes, yes. 56% was just in the European markets when Hans was specifically speaking to that about the European economy, 61% is the rate now for all approved markets now. Of course, we are adding markets. So, it’s hard to compare quarter-over-quarter as we add market.

Chris Cooley – Stephens Inc

Thank you so much.

Barry Caldwell

Operator, next question?

Operator

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

Unidentified Analyst

Good afternoon, this is (indiscernible) Matthew O’Brien.

Barry Caldwell

Hi.

Unidentified Analyst

I just had a quick question I know you mentioned in the news headline influence in China and then your initiatives in spreading the ICL awareness. We were just curious as to how you plan to distinguish your procedure from the LASIK surgery per surgeon, specifically in China, and just the behavior in that market to be more open to the ICL surgery?

Barry Caldwell

Great. Yeah, thank you, thank you for the question. First of all, I normally and I thought this way you’re going, I get the question that hey, there is bad news about LASIK, this should be really good news for the ICL. The answer is no and yes. At least initially what it does is it just chills the market, puts the market to a halt in the decision-making process for patients. Further down, it does help us as patients start to look at an alternative for LASIK, which they might not have considered before. Now, we already had planned the consumer awareness that I spoke of earlier. And we have added an individual in the China market, so that makes us with five employees in China working with our distributors there. And her focus is just on that on online marketing, websites, consumer awareness. So, we’ll be using that vehicle for the most part in the China market, which is coincidentally we’ve already had those plans in place. There wasn’t something new that came up after this event happened. Anything else Don you’d like to add?

Don Todd

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

Operator

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

Raymond Myers – The Benchmark Company

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

Deborah Andrews

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

Raymond Myers – The Benchmark Company

There is no impact on gross margin?

Deborah Andrews

No impact on gross margin.

Raymond Myers – The Benchmark Company

Right, right. Once you shift from four manufacturing plants globally to one, will that impact your cost of sales?

Deborah Andrews

Well, absolutely yes. Once that’s fully completed, it will reduce our overhead cost and improve our cost of goods.

Raymond Myers – The Benchmark Company

And when will that be?

Deborah Andrews

2014.

Raymond Myers – The Benchmark Company

Is it an all enough type of thing, when…

Deborah Andrews

No, we are beginning this year obviously we’re transitioning the Japan IOL manufacturing, but you are really not going to see measurable improvements until the consolidation project is complete.

Barry Caldwell

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

Operator

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

Christine Healy – Canaccord Genuity

Hi, this is Christine for Jason. Thanks for taking the call.

Barry Caldwell

Hi.

Christine Healy – Canaccord Genuity

Hi, I had couple of questions for you. First Deborah, I missed in my note taking, could you go over the margins by ICL and IOL, I missed that in my note.

Deborah Andrews

Okay.

Barry Caldwell

The IOL gross margin was 60%.

Christine Healy – Canaccord Genuity

60, okay.

Barry Caldwell

Yeah, and that versus – that versus 57 a year ago, the ICL we didn’t cope, but I’m just assuming for the – it was in the 85 range, it’s been 85 quite consistently.

Deborah Andrews

Right.

Christine Healy – Canaccord Genuity

Great and then for Don Fagen, I am wondering if now that we have some military personal who have returned to the states. Are you expecting the mix in the U.S. to return to more greater percentage coming from military sales.

Don Fagen

A greater percent of overall business from military.

Barry Caldwell

Overall business of ICL.

Christine Healy – Canaccord Genuity

In the U.S. for ICL.

Don Fagen

I would guess on based upon what we are seeing and what we are hearing, a military the second half going to grow greater than our civilian the second half, probably a fair statement.

Barry Caldwell

Fair statement.

Don Fagen

Yeah, correct.

Barry Caldwell

So that mean yes the second half, I believe there is a 11% of overall military sales made up of component during the second quarter has likely is going to increase the second half.

Don Fagen

Sure, great.

Operator

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

Rick D'Auteuil – Columbia Management

Hi.

Barry Caldwell

Hi, Rich.

Rick D'Auteuil – Columbia Management

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

Barry Caldwell

Okay. Let me answer it first and then, I let Hans add more to it. Though we don’t report Spain alone, you do a pretty good job of guesstimating what percent it was of our business last year and you are fairly closed. It will positively impact our margins because the revenues will get, will be 2X of what we previously had been getting. So, if sales are flat the third and fourth quarter of this year versus last year will show 2X in terms of our revenue result. That revenue result on the same cost of goods obviously will raise our gross margin. It will help contribute to our drive to get the 71% overall. But one of the thing I should also point out is that we will have a little bit heavier operating expenses, the rest for the year because there are some additional cost incurred with the distributor because remember we are moving – we’ve moved him out earlier, we transitioned earlier, we had until the end of February I believe next year. So, these still going to get a margin between now and then that will show up in our operating expense line. I think we pointed out there was about a $175,000 expense during the second quarter that would be just associated with that. Those kinds of cost will continue through first quarter of next year, then we will go to what the cost basis would normally be for being direct in a market and we are actually in a partner with the same distributors, he is going to be our logistics partner and we will continue to pay him for those efforts, but that will go back to a more normal rate. Hans anything, what would you like to add?

Hans Blickensdoerfer

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

Rick D'Auteuil – Columbia Management

Theoretically it will actually go up as a percent of Europe and because of the dynamics that Barry talked about.

Barry Caldwell

Exactly.

Rick D'Auteuil – Columbia Management

Thank you.

Operator

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

Joe Munda – Sidoti & Company

Good morning guys.

Barry Caldwell

Hi, Joe.

Joe Munda – Sidoti & Company

Thanks for taking my questions, real quick, lot of my questions were answer, but I’d like to focus a little bit on the U.S. and what you guys are doing with the military, I believe if I’m correct, didn’t you lose a surgeon in the military one was retiring and you are waiting for one to get trained, is that correct?

Barry Caldwell

Yeah. Let me kind of paint the picture a little bit for everybody, you may recall probably around two years ago. Military represented about 25%, is that right Don?

Don Fagen

Correct.

Barry Caldwell

Of our U.S. sales you can see it was 11% quarter, so its dropped down and what happened was two our largest implanters in the U.S., one retired from the military and the second one was shifted off to Afghanistan. Now good news for us now that it’s just started to kick in and that’s why I think Don’s get a smile on his face about the second half of year with ICLs. Dr. Scott Barnes is now back in the battle at Fort Bragg, so we got him he was very a large implanter of ICLs. And then down at Fort Bragg Greg Parker who had retired it actually back on base on a civilian basis, civilian surgeon but one or two days a week Don.

Don Fagen

At least one day a week.

Barry Caldwell

Okay. So we are going see upside the second half from those two event plus we had been training a replacements as you pointed out Joe. And some of those we will also be taking on ICL procedures with first time in the second half of this year.

Don Fagen

Absolutely and we just got text yesterday we’ve said here at meeting and Dr. Barnesof this will launch ongoing 27 ICLs next week. Is that record, very positive. We told him no.

Joe Munda – Sidoti & Company

And Barry I mean other plan I know doing these two basis is there plans to I mean is it just getting doctor format and training is there other based opportunities I mean?

Barry Caldwell

Yeah, yeah. I think we have been training doctors some of the smaller volume basis these are two very large basis. So that’s where the higher volumes will come from but so the smaller basis are starting to pickup well too from the training we've done the past six months or so.

Joe Munda – Sidoti & Company

Any European like any basis in Europe, that US as any possibilities there in Germany?

Barry Caldwell

No, really it’s everywhere Scott Barnes has going to Germany before putting some Toric ICL because he can’t do that in U.S., but no not a whole lot of volume there usually bring a surgeon I'm sorry soldier back to the US over night problem.

Joe Munda – Sidoti & Company

And had you get that translate over into the US. I know you spoke about the guys from block out piece you talk about social media. Can you give us a little bit more color I mean it seems like you having success military and then kind of this dropping off once you get to this civilian stock?

Barry Caldwell

I think Don put it civilian sales were up 6% first quarter in the U.S. and I'm sorry second quarter they were also up first quarter number of top my head. So our civilian business has been helping to make up for the lag in military over the last six quarter or plus. So, I think we will see growth second half and both segments but the military grow faster than civilians second half.

Operator

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

Bruce Jackson – Northland Capital Markets

Good afternoon.

Barry Caldwell

Hi, Bruce.

Bruce Jackson – Northland Capital Markets

So I'm just couple of questions about Japan, Japan was up this quarter I want to know this status of the (indiscernible) contract in all the training is going with them and also if you could talk a little bit about with the sales during came from this quarter in terms over the ICLs versus IOLs?

Barry Caldwell

Okay. First was talk about Japan, talk about, there are going sensitive about talking about their volumes. But I will say this overall will not close doing quite well in Japan. Are there growing nicely quarter-over-quarter and Don you say this before what I would like ICL quicker absolutely. And we're trying to help them and support them in every way we can't Don as been a lot of this time there our Japan organization we got folks all our dedicated to these two large centers. And there we see progress we see more progress to come in the future. Don, is there anything you would add?

Don Fagen

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

Barry Caldwell

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

Bruce Jackson – Northland Capital Markets

Okay, I guess my question was in terms of the sales growth in Japan. This quarter was it mostly driven by the ICL through the IOLs.

Barry Caldwell

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

Bruce Jackson – Northland Capital Markets

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

Barry Caldwell

Yeah that’s the KSSP, the single piece preloaded acrylic. We do offer a three piece acrylic preloaded in Japan, but about half of the market prefers the one piece versus half the market prefer in a three piece. And having our sales reps have been telling our docs that in Japan that the single piece is going to be coming anytime because we had approval for over nine months as Don painfully point out to be. So, this is – this will help them in terms of maintaining accounts and also expanding the new accounts that would even try the three-piece because they prefer the single piece lenses.

Operator

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

Jason Mills – Canaccord Genuity

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

Barry Caldwell

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

Jason Mills – Canaccord Genuity

Okay, great, thanks so much.

Barry Caldwell

Thank you.

Operator

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

Larry Haimovitch – HMTC

Good afternoon.

Barry Caldwell

Hi, Larry.

Larry Haimovitch – HMTC

Hi Deborah, I know you don’t have enough to be thinking about so, I thought I give you something else to think, right.

Deborah Andrews

Alright, thanks Larry.

Larry Haimovitch – HMTC

The beloved, beloved medical device tax.

Deborah Andrews

Right.

Larry Haimovitch – HMTC

It looks like it’s going to start January one. Do you have any kind of estimate on what that’s going to cost STAAR at this point? And Barry, do you have any response to the cost that it will impose some companies are talking about price increases, other people talking about reducing play headcount just wondering what your thoughts are on that.

Barry Caldwell

Yeah, good question. Let me dive in first. First of all, just to make sure we are on the same pages of 2.3% tax. It’s for U.S. sales only so that helps us today, in that 80% of our sales were outside…

Larry Haimovitch – HMTC

Yes.

Barry Caldwell

On the ICL side, which is about half of our U.S. sales, we will pass that on to the end consumer. We’ll raise our price in U.S. for that. On the IOL side, we will have the opportunity to do that. So, we will have to – we’ll have to pay the tax on that our sales and if you look at half of the U.S. sales 2.3%, you are talking 200,000 or less in 2013.

Larry Haimovitch – HMTC

Yeah, I didn’t think your impact was up so, for you it’s a relatively modest impact then.

Barry Caldwell

Correct. And if anything we are adding employees as we bring manufacturing here. So and maybe one of the few U.S. companies that are increasing headcount in the U.S.

Larry Haimovitch – HMTC

Yeah. Okay thanks Barry.

Barry Caldwell

Thank you, Larry.

Operator

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

Unidentified Analyst

Hi.

Barry Caldwell

Hi, Patrick.

Unidentified Analyst

I just – most of my questions have already been answered but I just wanted to make a comment with regard to your announcement of the individual with the black eyed peas. I think that’s a great way to go to get a awareness to build the awareness around the product. I’m glad you finally get around to it. Is that suggest is number of years ago but bottom line is I think that gets the awareness out there and I would suggest looking for someone in the sporty world.

Barry Caldwell

Yeah, I must admit that until the story came out last week, I thought black eyed pea was a vegetable and I thought apple was a fruit, but I have embraced it very quickly, I had come to learn that apple, the app is kind of like Tiger Woods would be to me.

Unidentified Analyst

Yeah.

Barry Caldwell

And some of you may know the Tiger Woods is by May in the U.S. considered to be the turning point behind LASIK.

Unidentified Analyst

Yeah exactly that’s the exact point I made several years ago that if you could find somebody and not necessarily that hope high profile but just somebody to drive our consumer awareness because people do the research the ICL will sell itself.

Barry Caldwell

But we’re hoping to have the Apple ICL rap soon.

Unidentified Analyst

Sounds good thank you very much.

Barry Caldwell

Thank you, Patrick.

Operator

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

Bruce Jackson – Northland Capital Markets

Hi thanks. Just one more follow-up question, are we still on track for a pre-loaded nanoFLEX in Europe during 2013?

Barry Caldwell

Yeah, first of all, the preloads comes with the V5 ICL first. And then we will transfer that same technology to the nanoFLEX and that should be later in 2013 yes, and we should still be on target for that.

Bruce Jackson – Northland Capital Markets

Okay, great. Thank you.

Barry Caldwell

Thank you.

Operator

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

Barry Caldwell

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

Operator

Ladies and gentlemen, this does conclude the conference call. If you would like to listen to the replay of today’s conference, please dial 1800-406-7325 or 303-590-3030 and entering the access code of 455-0885. Thank you for you participation. You may now disconnect.

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