STAAR SURGICAL CO annual report, FY2018

STAAR Surgical Company — Form 10-K Summary

Reporting period: Fiscal year ended December 28, 2018. The supplied filing is the fiscal 2018 Form 10-K, not a 2017 Q4 filing; fiscal 2017 ended December 29, 2017. Fiscal years covered were 52 weeks.

Business context

STAAR designs, manufactures and sells implantable ophthalmic lenses and delivery systems. Its principal products are Implantable Collamer Lenses (ICLs) for refractive surgery and intraocular lenses (IOLs) for cataract surgery. The company operates as one ophthalmic surgical products segment and sells in more than 75 countries.

ICLs represented 81.5% of fiscal 2018 sales, compared with 75.4% in 2017.
IOLs represented 13.1% of sales, compared with 19.0% in 2017.
Approximately 94% of sales were generated outside the United States.
Shanghai Langsheng, the company’s China distributor, accounted for 37.2% of consolidated sales, or $46.1 million, versus 27.0% and $24.5 million in 2017.

Financial performance and liquidity

Metric	2018	2017	Change
Net sales	$124.0 million	$90.6 million	+37%
ICL sales	$101.1 million	$68.3 million	+48%; unit growth 54%
Gross profit	$91.5 million	$64.3 million	+42%
Gross margin	73.8%	70.9%	+290 basis points
Operating income	$6.6 million	$(3.6) million	Improved by $10.2 million
Net income	$5.0 million	$(2.1) million	Returned to profitability
Diluted earnings per share	$0.11	$(0.05)	Improved
Net cash from operations	$12.8 million	$2.9 million	Improved by $9.9 million
Capital expenditures	$2.2 million	$1.0 million	Increased
Cash and cash equivalents	$103.9 million	$18.5 million	+$85.4 million
Working capital	$123.9 million	$34.8 million	+$89.1 million

Operating expenses increased, but declined as a percentage of sales: general and administrative expense rose 24.8% to $24.3 million, marketing and selling expense rose 35.9% to $38.6 million, and research and development expense rose 9.9% to $22.0 million. Total selling, general and administrative expenses were 68.5% of sales, compared with 74.9% in 2017.

Cash increased primarily because of a public equity offering that generated $72.2 million of net proceeds in August 2018, supplemented by $12.8 million of operating cash flow and $5.2 million from stock-option exercises. The company stated that cash balances and expected operating cash flow should cover operational and business needs for at least the next 12 months.

Debt, obligations and balance sheet

Japan line of credit: approximately $3.8 million outstanding at December 28, 2018, with approximately $0.7 million available; the facility was scheduled for renewal in February 2019.
Capital lease obligations: $1.6 million, including $1.1 million due within one year.
Total liabilities: $34.9 million; stockholders’ equity: $132.4 million.
Contractual obligations totaled $20.1 million, including operating leases, capital leases, pension payments, the Japan line of credit, open purchase orders and other commitments.
Defined benefit pension plans were underfunded by approximately $5.3 million at year-end.
The company had approximately $135.0 million of U.S. federal net operating loss carryforwards, but maintained a full valuation allowance on U.S. deferred tax assets except for a refundable alternative minimum tax credit.

Material changes versus fiscal 2017

Revenue growth accelerated, driven primarily by ICL demand in Asia-Pacific. ICL sales increased 73% in the region, including 91% growth in China and 90% growth in Japan.
Gross margin expanded because of favorable product mix, higher production volumes and overhead absorption, and lower inventory provisions and freight costs.
The company returned to operating and net profitability after losses in 2017.
Cash and equity increased substantially following the August 2018 common-stock offering, which issued approximately 2.0 million shares.
Product mix shifted materially toward ICLs, while IOL sales declined to $16.2 million from $17.3 million.
The company adopted ASC 606 revenue recognition using the modified retrospective method. Management reported no cumulative-effect adjustment and no material impact on revenue recognition.
The FDA lifted its 2014 warning letter following a 2018 inspection and close-out letter. The filing states that internal controls over financial reporting and disclosure controls were effective, and the auditor issued unqualified opinions.

Guidance, outlook and management commentary

For 2019, management targeted ICL unit growth of at least 30% compared with 2018 ICL unit growth, overall revenue growth of approximately 20%, higher GAAP net income and positive full-year cash flow with an increased cash balance. The revenue target contemplated an approximately $3.6 million decline in Other Products sales, including a $2.6 million reduction in low-margin injector-part sales.

Planned investments include expanded Monrovia ICL capacity, reopening and expanding the Nidau, Switzerland facilities, and preparing the Lake Forest, California facility for potential presbyopia-lens manufacturing.
Management planned continued market-share expansion, increased direct-to-consumer marketing, surgeon training, clinical development and strategic alliances.
The company was conducting a multi-site clinical trial for an EVO+ ICL with an aspheric extended-depth-of-focus optic intended to support a future presbyopia claim in CE Mark markets.
The FDA approved the Visian Toric ICL for U.S. sales in September 2018; U.S. sales began in November 2018.

Key risks, contingencies and unusual items

Customer concentration: Shanghai Langsheng represented more than 37% of sales and 36% of trade receivables at year-end. Distributor underperformance or termination could materially reduce revenue.
Product concentration: ICLs are the highest-margin and largest product category; elective refractive procedures are generally paid out of pocket and may be sensitive to economic conditions and negative publicity.
Regulatory risk: Products require extensive approvals and ongoing compliance globally. Past FDA quality-system issues caused product-approval delays, although the 2014 warning letter was lifted in 2018.
Manufacturing and supply chain: Most products are manufactured at the Monrovia facility, and certain inputs are single-sourced. A facility disruption or supplier failure could interrupt production.
International exposure: Foreign operations account for most sales. The company does not actively hedge currency risk and is exposed to exchange rates, tariffs, political conditions and changing international regulations.
Tax assets: The ability to use U.S. net operating loss carryforwards is uncertain because of historical U.S. losses, expiration dates and potential Internal Revenue Code Section 382 limitations.
Other commitments: Pension obligations, operating leases, capital leases, open purchase orders and potential product-liability, recall, environmental, cybersecurity and tax claims could require additional cash.
Equity dilution: The August 2018 offering increased shares outstanding, and approximately $127 million remained available under the company’s universal shelf registration statement.

Important facts for investors to verify

Whether 2019 revenue, ICL-unit growth, GAAP net income and positive cash-flow targets were achieved.
Whether customer concentration with Shanghai Langsheng has increased or declined and whether the distributor remains financially and operationally reliable.
The sustainability of the 73.8% gross margin as product mix, pricing and manufacturing volumes change.
Progress, regulatory approval and commercialization prospects for the EVO+ presbyopia product and U.S. Toric ICL adoption.
Whether manufacturing expansion in Monrovia, Switzerland and Lake Forest proceeded on schedule and within budget.
Changes in cash, debt, pension funding, working capital and the use of proceeds from the 2018 equity offering.
The effect of ASC 842 lease adoption and other accounting changes beginning in fiscal 2019.
Potential exposure from regulatory compliance, product liability, recalls, foreign exchange, tariffs, cybersecurity and tax matters.