STRATA Skin Sciences, Inc.
Q3 2015 Earnings Call Transcript

Published: 13 Nov 2015

[Operator:]

Good day, and welcome to the MELA Sciences Third Quarter 2015 Earnings. 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. I would now like to turn the conference over Paul Arndt, Managing Director of LifeSci Advisors. Please go ahead sir.

[Paul Arndt:]

Thank you, Camille 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 our 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 our current beliefs or expectations and are inherently subject to significant known and unknown uncertainties and changes in circumstances, many of which are beyond our control. There can be no assurance that our beliefs or expectations will be achieved. Actual results may differ materially from our 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 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. MELA Sciences urges you to carefully review and consider the disclosures found in its SEC filings, which are available at www.sec.gov and www.melasciences.com. I will now turn the call over to MELA Sciences’ President and Chief Executive Officer, Michael Stewart. Mike, the call is yours.

[Michael Stewart:]

Thanks, Paul. Good afternoon, everyone and welcome to MELA Sciences’ third quarter earnings conference call. There are slides that we will be referring to that can be accessed at melasciences.com. This report includes the first full quarter of results of our recent acquisition of the XTRAC and VTRAC businesses that were acquired on June 22. Our 10-Q for the third quarter will be filed on Monday, November 16. Joining me today on the call is Christina Allgeier, MELA’s new Chief Financial Officer. Christina had been Chief Accounting Officer for PhotoMedex prior to MELA’s acquisition of the XTRAC and VTRAC businesses and has now been appointed to the CFO position replacing Bob Cook who has resigned his officer positions. Bob will be staying along with the company in the transition role until mid-January 2016. We will continue to strengthen and add to the management team as required to build a solid foundation and execute on our vision. I will update you on the quarterly activities and Christina will review the financial results for the quarter, which were driven primarily by the XTRAC business with which Christina is quite familiar. The total revenues for the third quarter were $8.3 million. Gross margin was 63.4%. Cash on the balance sheet at the quarter end was $3.2 million and we had positive non-GAAP adjusted income. Christina will walk through the detail of the numbers and break them the recurring dermatology business as well as the equipment sales, which are primarily international. The number of XTRAC systems deployed in the United States as of September 30 increased to 698, up from 664 at the end of June. Referring to Slide 2 which includes historical data from PhotoMedex filings pre-acquisition, since the end of 2012 to the third quarter of 2015, the number of deployed systems has nearly doubled. And as you see on Slide 3, the associated revenues, inclusive of the periods prior to the acquisition, has more than tripled over the same timeframe. This growing is being driven by a direct-to-patient marketing campaign, including advertising through TV, radio, social media and digital and supported by a robust sales organization, including 34 direct sales associates, clinical resources and sales management personnel as well as in-house patient advocacy and reimbursement groups. The transition of these activities in the third quarter went very smoothly. While overall gross margin was 63.4%, the gross margin of the recurring XTRAC business, as shown on Slide 4, has continued to significantly increase over that same 2012 to 2015 timeframe increasing from 40% in 2012 to 67% in the third quarter 2015. The average revenue per laser a measure that we focused on has increased over this timeframe as well annualizing the third quarter 2015 recurring revenues now exceeds $42,000 per laser. What I would like to do now is walk you through the XTRAC laser, what drives its use by dermatologists and how we are structured to continue to grow the XTRAC business. Referring to Slide 5, the XTRAC is a UV light excimer laser system, cleared by the FDA for the treatment of four dermatological conditions

[Christina Allgeier:]

Thanks Mike. Good afternoon everyone. As Mike has stated, revenues for the third quarter were $8.3 million. This is the first full quarter of activity for the acquired XTRAC and VTRAC businesses, which accounted for $8.2 million of those revenues. With the acquisitions, we have organized our business into there operating segments to better align the organization based on our structure, products and services offered, markets served and types of customers. They are as follows. The dermatology recurring procedure segment drives revenues from the XTRAC procedures performed with our 698 installed MELA lasers. The dermatology procedures equipment segment generates revenues from the sale of XTRAC and VTRAC units as well as from spare parts and service. These sales are mainly driven from our master distributor in the international market. The dermatology imaging segment generates revenues from the sale and usage from our MelaFind devices. On Slide 11, you will see the results of operations by each business segment. The dermatology recurring procedure segment had a gross profit margin of 66.9% and provided an allocated net profit of $805,000, while the dermatology procedures equipment segment had a gross profit margin of 48.9% and provided an allocated net profit of $454,000. The dermatology imaging segment had negative gross margin and an allocated net loss of $450,000. Net loss for the third quarter was $12.2 million including $3 million non-cash deemed dividend. The deemed dividend was a result of modification of the warrants held by major investors in the June financing. As approved at the stockholders meeting the exercise price on their previously issued warrants were reduced to $0.75. The deemed dividend was determined as a difference between the warrants fair value immediately before and immediately after that modification. As you can see on Slide 12, non-GAAP adjusted net income was a positive $389,000 for the third quarter. The non-GAAP adjusted net income was determined as EBITDA and other non-cash adjustments. As a result of our operations, includes significant non-cash charges, we believe that this presentation provides a better understanding of our current financial performance and is one of the important practices of the company moving forward. The other adjustments included stock-based compensation of $1 million and a change in the fair value of warrants’ liability of $1.3 million. As Mike presented earlier, the main financial driver of the business is the XTRAC business. The XTRAC’s recurring revenues have significantly grown over the last 3 years and we reiterate our guidance of continuing revenue growth in this segment in the mid to high-teens or an annual basis. We believe this growth will lead to a continued improvement in the EBITDA in 2016. With our cash balance at the end of the quarter of $3.2 million and the expected positive cash flows over the coming quarters, we believe that we have sufficient cash resources to fund and grow our operations for the foreseeable future. We expect to refinance the $10 million bridge loan that was issued at the time of the acquisition of the XTRAC and VTRAC businesses in the near-term. I will turn it back to you Mike.

[Michael Stewart:]

Thank you, Christina. We had – as we stated in the press release, we had sequential recurring revenue growth of 5% in the third quarter. We have previously indicated guidance on the revenue side of recurring revenue growth in the mid to high-teens, for which this was right in line, along with positive EBITDA on 2016 and we reiterate that guidance. We look forward to providing more detail in the future as we continue to execute on our plans and vision and we are looking forward to an exciting 2016. With that, let me turn the floor over for questions. Operator, please open for questions.

[Operator:]

Thank you. [Operator Instructions] We will take our first question from Swayampakula Ramakanth with H.C. Wainwright.

[Swayampakula Ramakanth:]

Good afternoon Michael, how are you doing?

[Michael Stewart:]

Hi, okay. I am doing great. How are you?

[Swayampakula Ramakanth:]

Alright. So I would like to understand what are the drivers that seem to be favorable that you are confident of your guidance that you are giving in terms of the growth?

[Michael Stewart:]

So what we do to drive the business is, as I have stated we do two things. One, we expand the number of practices. We have been continuing to do that on a quarterly basis. We have 34 new placements within the quarter. So we are expanding the number of systems placed to driving the revenue. And then our marketing campaign, which really is consist of quite a few different aspects. It has the advertising campaign. We are advertising through television, radio, social media and digital and we monitor that on a weekly basis looking at what the results are in various geographic areas and we target certain geographic areas where we have a significant base of customers to be able to drive the growth. We get a result from that directly and then we get a result that we kind of refer to as a halo effect, which the awareness that’s going out in the marketplace gets the growth to be well beyond what we can directly attribute to the advertising campaign. But those are the main drivers. It’s the sales force operating, providing those services through the reimbursement group and we have patient advocates talking to the patients when they call us on the phone and then booking their appointments with the dermatologist. And we – we are very lately penetrated into the psoriasis market, with 7.5 million patients suffering from psoriasis another 2 million from suffering vitiligo, the opportunity we are just – even given the growth that we have had over the last 3 years is still significant going forward.

[Swayampakula Ramakanth:]

Okay. Thanks and thanks for that explanation. And then can you hear me, alright?

[Michael Stewart:]

Look, yes. You are little bit late, but go ahead.

[Swayampakula Ramakanth:]

Okay. So if you start looking through the business segments, certainly the recurring procedures seems to have the highest gross margin, whereas the procedures of imaging, obviously are not as high, so is there anything that could you folks can do to improve that margin, if so what, how would you do it and what could be the timeframe for that?

[Michael Stewart:]

Okay. I think I understood your question, but let me do it this way. So we are talking about gross margins and how they will improve over time. So it has improved over time as a result of the recurring revenue growing. And that happens because there is basically a semi-fixed component to the cost as we expand the number of units placed. Every unit that goes out gets depreciated over a 5-year period, that depreciation is a fixed amount going forward. The only other costs really are supporting that those lasers in the field as significant cost is the service or maintenance of those lasers. So as we grow the recurring revenue stream and increase the revenue per laser, which has been increasing sequentially, basically over the last 3 years, that has a positive impact on the gross margin and we will continue to do so. The other aspects of the business, the products business is as I said, primarily international and sold that’s the sale of products through distribution network. So as a result of it going through the distribution network, it therefore has lower gross margins. So I don’t see a significant increase happening in the gross margins on that part of the business, but that’s not the driving part of the business. The driving part is the recurring revenue.

[Swayampakula Ramakanth:]

Okay, thank you. That’s helpful.

[Michael Stewart:]

Next question?

[Operator:]

Our next question is from Kevin Kotler with Broadfin Capital.

[Kevin Kotler:]

Hey Mike.

[Michael Stewart:]

Hey, Kevin.

[Kevin Kotler:]

So, I just want to make sure, it’s clear because the press release, I think might have been confusing. You talk about 5% recurring disposable revenue growth, that sequential growth year-over-year numbers more like 20% growth, which is in line with your mid-teens guidance that you gave last quarter?

[Michael Stewart:]

That’s exactly right. Yes, I think we inadvertently left the word sequential out of the press release, we will reissue that, but the 5% was sequential growth within the quarter, which puts us right in line with our guidance that we had given previously and the continued guidance we are giving today.

[Kevin Kotler:]

Great. And the $42,000 recurring revenue per system or annualized revenue per system, that also seems up from our model is that up from last quarter as well?

[Michael Stewart:]

It is. That’s taking the third quarter and annualizing it to get to the $42,000 per laser and that has increased by about the same level. So, we have been increasing the recurring revenue per laser right in line with the overall increases in revenue.

[Kevin Kotler:]

That’s great. And then did you give an update on the imaging system? What’s the latest, where we are? I know people have been concerned about the burn rate on the clinical trial for MelaFind?

[Michael Stewart:]

Yes. So, I didn’t give a detailed description, because we are still working on it. We are – I did indicate that we are continuing to work on reducing the burn on that side of the business. We have – we did do a – in October, subsequent to the quarter end, we did a clinical trial, a reader study that we submitted to the FDA. We expect to get an answer from the FDA in the near-term sometime within this quarter is the expectation. Based on that outcome, I think we can get those costs very well in line. I had talked previously about being able to significantly cost reduce that product assuming that we can build the right market for it, which obviously in the U.S. is somewhat dependent on reimbursement, not for all customers, but for certain customers. So, I think we have an opportunity if we can get through the acceptance of that reader study with the FDA to try to mix that a salable product and something that can start to contribute. In the meantime, the burn rate has been reduced significantly and will actually be reduced even more from where we are today over the next quarter.

[Kevin Kotler:]

Right. But just to understand, if the FDA doesn’t go along and you have this post-market study, you are prepared to shut it down, did that won’t be a burn rate, is that fair?

[Michael Stewart:]

Exactly right. I mean, if we don’t have the ability to effectively market that product, then we will have to make a decision and that decision point will come after this review by the FDA. And if necessary, we will make the decision to stop marketing that product, eliminate the ongoing cost of the post-approval study, and then look at the technology, which we are already doing to see if there is some other type of device that could make sense out of it, but the cost of continuing to operate that part of the business would basically be eliminated.

[Kevin Kotler:]

Got it. Okay. And did you – I mean, just in terms of XTRAC, are there anything in terms of R&D out 12 to 18 months that you are working on that could improve the profitability further of the technology?

[Michael Stewart:]

There are. One of the costs of operating the XTRAC laser is that it uses xenon chloride gas and that gas is a fairly expensive component to the ongoing maintenance. We are implementing actually in this upcoming quarter some software changes that will help to reduce that cost. But more important than that in the longer term, we have a whole list of potential projects and actually certain projects that are already underway to enhance the product even more than it is today. Some of them are a little bit longer term, but we think we have some ideas that can take the cost of the product down by a significant portion without affecting the way it operates and we have started those projects.

[Kevin Kotler:]

Great. Well, thanks a lot. Great quarter.

[Michael Stewart:]

Thank you, Kevin.

[Operator:]

[Operator Instructions] And we will take our next question from Jared Cohen with JM Cohen & Company.

[Jared Cohen:]

Yes, just one or two questions. First, now will the XTRAC business or the overall business, I know you said will be EBITDA positive, but will it also be free cash flow positive after interest expense once you do your refinancing?

[Michael Stewart:]

It will. We expect that the cash that we are going to generate with the business will fund our operations going forward and we won’t be in a position to be raising cash in the foreseeable future.

[Jared Cohen:]

Okay. I know you that with the MELA side of the business, I know you have talked about it, because I guess part of whether it’s a viable businesses with the part of it is also the codes, because have those codes been established or I know that’s part of it or not?

[Michael Stewart:]

So, yes, there were Level 3 codes established that will become effective or usable in January 2016. The problem with Level 3 codes is that, that gives you – that gives the physician the ability to record the procedure in that code, but there is no reimbursement associated with it. So, it doesn’t solve the reimbursement side of the question. It gives us the ability to market the product with that code to probably integrated health systems, where the payer and the provider are the same person and reimbursement in the traditional sense is not applicable, but it doesn’t give us the ability to go to the everyday derm and get them to be paid on doing the procedure. That process of establishing that level of reimbursement is a long process that will take likely. If it makes sense to do, likely years before we can get that fully implemented. The thing that we can do if we have the clearance with the product through the FDA and we have a product that’s capable of being marketed is we can establish an international market with that product and from a U.S. market standpoint primarily be looking at the integrated health systems.

[Jared Cohen:]

Okay. And lastly, because I saw you put out an 8-K on it, what beyond being with two directors? What beyond being directors? What type of consulting work are they going to be doing for you, because I saw that you put out something that they are going to be doing consulting work beyond just…

[Michael Stewart:]

Good question. That’s – those two directors, Sam Navarro and Jeff O’Donnell were instrumental in the acquisition of the XTRAC and VTRAC business and worked tirelessly in helping to get that acquisition done. They are established in the dermatology market. They have their fingers on the pulse of other companies and product lines that are in the marketplace that might make sense at some point to be a part of MELA Sciences. And our objective here is to – we set the base of the business with the XTRAC business that’s cash flow positive and contributing and growing. And then, it’s our intention to add to that. So, they will be working with me in trying to build this business up in a very significant way over the coming quarters.

[Jared Cohen:]

Okay. Alright, thank you very much.

[Michael Stewart:]

Thank you.

[Operator:]

That concludes today’s question-and-answer session. Mr. Stewart, at this time….

[Michael Stewart:]

Sure. I appreciate the questions and I think they were very good questions. I would like to add just one thing that we are very pleased with the progress that’s been made in the short timeframe since the acquisition on June 22, we will be looking at re-branding the company to better reflect its products, its markets and it’s potential in the dermatology field in the near future. We thank you for your interest in the company and we look forward to our next call when we report the fourth quarter and the full year 2015 results. Thank you very much and good night.

[Operator:]

Once again, that does conclude today’s call. We appreciate your participation.

[Michael Stewart:]

Thank you.

[Operator:]

Thank you. Have a good afternoon.