Dave Hable – President and CEO Pam Boone – CFO, EVP, Treasurer, Secretary

Chris Cooley – Stephens, Inc. Charles Haff – Craig-Hallum Joe Munda – Sidoti & Co.

Thank you, operator, and good evening everyone. With me on the line today is Pam Boone, our CFO.

A press release was issued today after the market closed, outlining our earnings for the fourth quarter and fiscal year 2014 ended July 31. Here's our agenda for today's call.

I will provide a high-level overview of our fiscal year and fourth quarter performance, followed by a brief review of our fourth quarter sales growth in our two primary businesses, before turning it over to Pam for some detailed financial color. I will return to provide a progress update on the targeted commercial launch of our next-generation portable vitrectomy system, the VersaVIT 2.0.

We will then open the line for questions. In the fourth quarter we reported revenues of $18 million, up 0.8% year over year, driven by a 2% increase in OEM sales and a 0.8% increase in ophthalmic sales compared to the prior-year period.

GAAP EPS was $0.06 compared to $0.06 last year, due to flat revenue growth and improvements in our gross margin, that were offset by increased operating expenses as we continued to invest in the business. Overall this was a good quarter as we achieved the revenue growth in our two largest business segments, ophthalmology and OEM, against a record fourth quarter in 2013, and we reported higher gross margins and profitability compared to last year.

Finally, our fourth quarter cash flow from operations was particularly strong, increasing almost 70% year over year to $4.2 million. On the ophthalmology side of the business, sales increased 0.8% year over year.

We reported 2% growth outside the U.S., offset by a 0.5% decline domestically. Total revenue growth in the ophthalmology business was driven by strong sales in emerging markets, contributions from our acquisition of M.I.S.S.

Ophthalmics, and to a lesser extent, sales of VersaVIT and accessories. Our base ophthalmic business continues to be a source of pressure on our total ophthalmic revenue growth, driven primarily by a difficult competitive environment in our three largest business product lines, laser probes, diamond-dusted membrane scrapers, and illumination probes.

In total, our base business continues to face low to mid-single-digit declines. However, if you exclude our three largest products, the rest of the business posted positive growth in the fourth quarter, a continuation of the trends we have seen throughout the fiscal year.

Turning to our OEM business in the fourth quarter, sales to our marketing partners increased 2% year over year, primarily due to the strong sales of Codman forceps and growth in Stryker tips and tubing. The capital equipment side of the business decreased approximately 30% year over year due to a sharp decline in sales of generators to our two major customers, Codman and Stryker.

In contrast, our disposable business grew by 7.5% compared to the prior year. As we explained previously, our capital equipment business continues to be prone to periods of volatility and slow growth.

Based upon the order trends of our marketing partners, at the time of our third quarter call, we cautioned that our capital equipment business would likely be detrimental to our performance this quarter, especially as compared to the record quarter of OEM sales we experienced in the fourth quarter of last year. We continue to focus on shifting the mix of our OEM business from capital equipment to disposables, but we continue to remain mindful that our OEM results may be adversely impacted by periods of volatility in the short term.

Total revenues for fiscal year 2014 increased 3.1% to $64.8 million. We posted high-single-digit growth in our OEM business this year.

Sales in Ophthlamic business were essentially flat, with low-single-digit declines in the U.S. As in 2013, our sales of VersaVIT systems and disposables helped to mediate weakness in our base business ophthalmic this year.

While we ended the fiscal year on a strong note with our fourth quarter results, our fiscal year was defined by mixed financial performance but also by positive development milestones, and overall we feel that we made the right investments to optimize the business for sustainable long-term growth in future years. With that, I'll turn the call over to Pam for a detailed review of our financial results.

Pam?

Thanks, Dave. Total sales increased 0.8% to $18 million, compared to $17.9 million in the prior-year period.

U.S. sales increased 0.4% to $13.4 million, while international sales increased 2.3% to $4.6 million.

International sales represented approximately 26% of total company sales this quarter, with the balance of 74% coming from domestic sales. Our international sales mix last year was approximately 25%.

Total company sales by product category, disposables and capital equipment, reflect a 7.5% increase in sales of disposables year over year and a 30.1% decrease in sales of capital equipment. Disposable sales accounted for approximately 86% of total sales this year, compared with 81% of sales last year.

Now for a look at total company sales performance by our ophthalmic and OEM business lines. Total ophthalmic sales increased 0.8% to $9.5 million this quarter, compared to sales of $9.4 million last year.

Ophthalmic sales decreased 0.5% in the U.S. and increased 2.3% internationally.

U.S. ophthalmic sales were adversely impacted by decreased sales of capital equipment and disposables in our ophthalmic base business, partially offset by increased sales of procedural kits.

Our international ophthalmic sales performance was primarily driven by increased sales from M.I.S.S. Ophthalmics.

Sales performance was favorably impacted by foreign currency and was partially offset by decreased sales of ophthalmic capital equipment and disposables. Total OEM sales for the fourth quarter increased 2% compared to last year.

We saw increased sales of disposables to our OEM partners, Codman and Stryker, offset by decreased sales of our electrosurgical generators to Stryker, and to a lesser extent, lower sales of generators to Codman, compared to last year. OEM revenue also included deferred revenue of $322,000 recognized in the fourth quarter of both fiscal year periods.

Now for a brief review of the rest of the P&L for the fourth quarter of 2014. Gross profit for the fourth quarter was $10 million or 55.5% of sales, compared with $9.7 million or 54.2% of sales in the year-ago period.

Gross margin in the fourth quarter fiscal year 2014 was impacted by the mix of products, including both the increase in our international sales and the increase in the percentage of our OEM sales. We have been focused on continuous improvement, including our manufacturing costs and expenses over the past few years.

Based upon these efforts, we believe we've taken over $3 million out of our cost basis since starting on these initiatives approximately five years ago. Total operating expenses were $7.8 million or 43.5% of sales in 4Q, compared to $7.5 million or 41.8% of sales last year.

Research and development expenses were 6.4% of net sales in the quarter, compared with 5.5% in the prior-year period. Sales and marketing expenses were $3.7 million or 20.6% of sales, versus $3.4 million or 19.3% of sales for the same period last year.

General and administrative expenses were $2.7 million or 15.1% of sales, versus $2.9 million or 16.3% of sales for the same period last year. Sales and marketing expense was the primary contributor to the total increase in operating expenses in the fourth quarter.

The year-over-year increase in sales and marketing was primarily due to investments in VersaVIT 2.0 commercialization, specifically the cost burden of upgrading a large number of our existing users at no charge to their practice. We continue to expect that the total cost of these activities will be approximately $0.30 a share after tax, with the majority of these expenses falling in the first half of 2015.

We view this as an investment to drive the long-term growth of the VersaVIT platform, an allocation of capital today that will return handsomely as their utilization and our revenue from packs and accessories grow over time. Total operating expenses in the fourth quarter included $163,000 related to the impacts on the medical device excise tax, compared to $129,000 in the fourth quarter of 2013.

We also incurred approximately $104,000 of incremental expenses related to the company's exit activities at its King of Prussia facility. We continue to expect to incur an estimated $500,000 of expenses related to the closure of this facility over the next two fiscal quarters, and anticipate more than $1.1 million in annual cost savings beginning in the third quarter of fiscal 2015.

GAAP operating income declined 2.5% to $2.2 million in the quarter, compared with operating income of $2.2 million in the fourth quarter of fiscal 2013. Reported GAAP net income decreased 2% to $1.4 million or $0.06 per diluted share, from $1.4 million or $0.06 per diluted share for the same period of fiscal 2013.

Earnings before interest, taxes, depreciation and amortization, or EBITDA, increased 4.2% to $2.8 million this year, compared to $2.7 million in the fourth quarter of fiscal 2013. For the fiscal year ending July 31st, total sales increased 3.1% to $64.8 million, compared to $62.8 million last year.

Net income increased 19.7% to $3.1 million or $0.12 per diluted share, compared to net income of $2.6 million or $0.10 per diluted share last year. Turning to the balance sheet, at quarter-end we had $15.4 million in cash, that was up $2.7 million sequentially, and no interest-bearing debt.

Our days sales outstanding ratio is 82 days, down from 84 days at the end of the fiscal year, due to timing of sales throughout the quarter. Our inventory position was $15.1 million, up 2.1% year over year, driven by a $3.7 million investment to support new product introductions.

This inventory balance represents 194 days of inventory on hand versus 178 days last year. Cash provided by operating activities in fiscal 2014 was $5.7 million, compared to cash provided of $3.7 million in fiscal 2013.

The change in cash flow from operations is largely as a result of higher net income and the benefits from deferred income taxes, offset by higher working capital balances compared to last year. Now I'll turn the call back to Dave for an update on our progress with the commercialization of VersaVIT 2.0.

Thanks, Pam. Let me start with a brief recap of the performance of the first-generation VersaVIT system during the quarter and update on the progress we have made since the recent launch of VersaVIT 2.0.

Our first-generation VersaVIT was a key contributor to ophthalmic growth again this quarter, and we have now completed more than 10,000 vitrectomy procedures including evaluations with our system alone, of which nearly 7,000 were completed in 2014. Total vitrectomy procedure performed with our system in the fourth quarter were up more than 20% sequentially and more than 170% year over year.

We had 46 VersaVIT customers place orders for our VersaVIT disposables in the fourth quarter. These accounts represent the group of customers that have converted the VersaVIT, burned through their competitive and demo inventory, and found themselves in a position to order disposables for their daily usage.

Building on the progress we made with our first-generation system, we introduced our VersaVIT 2.0 in the fourth quarter with the targeted launch of this next-generation system. We have seen a very strong response from our surgeon customers who appreciate the added features and functionality of the 2.0, specifically the high-speed cutting, combined with active duty cycle control.

With the early feedback has been strong, we are especially pleased with the uptick in overall utilization of our VersaVIT systems in the field. We are seeing our VersaVIT systems represent an increasing share of vitrectomies for many of our surgeon customers.

More often than not, surgeons are using VersaVIT in more than 60% of their victretomy procedures, a three-fold increase compared to their previous use of the 1.0 system. As part of our commercialization of the VersaVIT 2.0, we are aiming to transition approximately 80% of the current installed base of VersaVIT first-generation systems within the first nine months of the launch.

We are basically on plan at this point. As expected, VersaVIT 2.0 contributed very modestly to our fourth quarter results as we were still progressing through the very early stages of launch.

Our U.S. sales reps and o-U.S.

distribution partners have more than forty 2.0 units in operation around the world, allowing surgeons to demo the system, and these evaluations are going very well. We are seeing our surgeon customers working with the 2.0 system for five weeks on average before fully adopting the new technology.

This is a meaningful reduction in the average evaluation time witnessed with the 1.0 system. In fact, in some cases, once the surgeons are comfortable with the new machine, we are actually having trouble pulling the demo unit out because they enjoy using it so much.

The early response has been consistent and compelling. Surgeons appreciate the system's value proposition, simplicity and clinical efficacy.

Our sales force and distribution partners are squarely focused on getting this new technology in the hands of the leading retinal surgeons around the world and our commercialization plan is progressing well. Surgeons have clinically tested the 2.0 system in more than 1,400 victrectomies through the end of fiscal 2014.

While we are competing in a volatile market with entrenched global competitors, the recent progress we have achieved in our ophthalmology business, specifically the procedure and revenue growth from VersaVIT, along with the positive feedback we have received on VersaVIT 2.0 in the first few months since its launch, gives us confidence that we have the right technology to disrupt this market by offering a highly-functional practitioner-focused innovative vitrectomy system that establishes ourselves as a leading manufacturers of systems and packs in the ophthalmic space. Looking ahead to fiscal 2015, we expect to work towards our goal of broad market adoption of the VersaVIT 2.0 system, with increasing contributions from our commercialization efforts coming in each quarter of the year.

Overall we expect the growth in our new products to offset continuing pressure on our base ophthalmic business in 2015 and for our ophthalmic business to post modest positive growth overall next year. On the OEM side of the business, we continue to believe this business is a mid to high-single-digit grower on annualized basis, driven by strong demand for our disposable products from our two largest OEM partners, Codman and Stryker, partially offset by declines in sales of capital equipment.

We are focused on leveraging our total company revenue growth and to improving gross and operating margin performance. As always, we will continue to identify and evaluate opportunities to use our strong balance sheet on smart, attractively priced acquisitions that will help us expand our ophthalmic business around the world.

With that, I'll turn it back to yourself, operator, to manage the questions. Thank you.

Hey, Chris.

Hi guys, good afternoon. Can you hear me okay?

Absolutely.

Super. Well, congratulations on a great fourth quarter.

Just two quick ones for me then I'll get back in queue. When, and I apologize, I think you ran through this, but when you're looking at the VersaVIT 2.0, could you just give us a little bit more color there in terms of what you're seeing in terms of the evaluation period, just the overall progression there, and if you're seeing anything new in terms of the conversion of those accounts that are trialing the 2.0?

Is it you are getting greater sales there, are you seeing them convert to consumable contracts fast? I just want to get a better understanding of how that process takes place, and then utilization on those systems versus the older gen-ones, if I could.

Thanks much.

Yeah. A couple of points I'd ask you to take away.

First of all, the evaluation time has vastly improved. I just said five weeks.

Taking to consideration those are early days and that will probably change as time goes on, but that's a big difference than what we experienced with 1.0. The other number I said was that the utilization, how many procedures they use as a percent of the total, has increased fairly significantly, from 20%, 25%, 30% of procedures, to 60%, even more in some cases.

So that represents a big near-term gain for us. All this is - has been taken in the context of what we've seen in the last couple of months, which is that a vast majority of units that are going into the field are done on a placement basis.

And this is an assumption that's been a moving target for us. So way back when, a couple of years ago, we thought we'd sell 50% of the units in placement, 50% of the units.

Then it got 60%, 70%. Now it's over 90%, are being put in for placement, again with a contract for committed disposables over one, two or three years.

So, you know, so that makes the payoff in terms of sales dollars a little delayed, but is net a great thing for us.

May I squeeze one other quick question as well?

Please. Yes.

You gave us some semblance of guidance there which really encouraged why I think, when you talked about modest to positive revenue growth in the ophthalmic business for the upcoming fiscal year in mid to high-single-digit OEM growth expected I think here for the current fiscal 2015. Any guidance that you'd give us just in regards to maybe gross and operating expansion for the year just based upon that type of revenue build?

Shoot that over to Pam.

Well, Chris, you know, we've said our R&D spend will be in the 6% to 8%. We've been on a little bit of a higher side of that recently given all the things that we're working on to get to market.

It went down in the fourth quarter.

It went down in the fourth quarter. So that's the range that we expect there.

And I would expect, as we said, the sales and marketing costs will go up to absorb the costs of upgrading our physicians. We expect about 80% of that and we expect that to cost about $0.03.

We did have a little bit of that in fourth quarter, but it's probably moved out a little bit. We do anticipate that that $0.03 will be spent in the first half of fiscal 2015.

Thank you, Pam.

Hey, Charles.

Hi. Thanks for taking my question.

So on the ophthalmology market, if I heard you correctly, you said low to mid-single-digit declines in the market, but you expect your ophthalmology business in 2015 to be a modest positive single-digit grower. Is that correct?

The second piece of that's correct. Take away the market piece in the first part of your summary.

So that implies that the overall dollar market, which wasn't my -- which was my intent. So we've got our base business that I talked about having the modest decline, offset by the growth in new products, the most significant of which is the VersaVIT, and that resulting in net positive growth, those two factors.

So I'm talking about our base business and new products as opposed to the market on the first one.

Okay. Great.

And then for interest expense, Pam, I noticed about $20,000. It's kind of a small amount, but I'm not used to seeing interest expense number.

Was that a one-timer or was there something going on there, or how should we think about that for 2015?

That's our commitment fee on the revolver.

Okay. So that would -- we should expect that each quarter in fiscal 2015 as well?

You would expect it to be about that 19, as it was in the full fiscal year, throughout the year. That's the commitment fee on the revolving line of credit.

Okay, great. Thank you very much.

Thanks, Charles.

Hey, Joe.

Good afternoon, Dave and Pam. Can you hear me okay?

Yeah. No, you're good.

Dave, I was wondering, can you give us a little bit more color on the competitive landscape in the base business and what you're seeing? Are you still seeing the aggressive discounting response from larger competitors?

Anything there would be helpful.

Yes. So, talking about the base business, the major dynamics we see at work are more competitors, first of all, overall, and discounting not at an accelerated rate but at, you know, the same kind of aggressive rates.

And as I've talked about in the past, as we see the advance of next-generation vitrectomy machines, ours included, standalone disposables that work with some of the other pieces of equipment becomes a more challenging value proposition. In other words, the bad guys have an improved version of a product that goes with their system, making ours as a standalone option more challenging.

So all those are challenges, but the net of all these result in the low-single-digit decline for the year, not certainly have the business falling off a cliff or some dramatic erosion. So we're actively managing that by targeting accounts to get the business back and investing where it makes sense, like in the last quarter I talked about the Directional Laser Probe II which is an upgrade of an important product line to us.

So we're taking it seriously, and then that result is low-single-digit declines.

Okay. And then I guess one follow-up, Pam, you talked about the transition of your customer base to the new machine.

You talked about $0.03. Is that $0.03 for the year or $0.03 a quarter, you think?

You had mentioned the first half of the year. Thank you.

So, $0.03 for the year, for the full year. We had a little bit of it in the fourth quarter.

We expect the rest of it to fall pretty much pro-ratably in the first half of 2015.

Okay. I'm sorry.

Just one other question. Dave, usually, you know, last year you saw a little bit of a drop-off between the fourth quarter and the first quarter.

Are we expecting a similar I guess step-down? It's been indicative in the last couple of years here.

Are we going to see a similar pattern or are we going to see sequential growth?

So it's a little early to tell. The dynamic, Joe, you're referring to is the August dynamic where, as everybody knows, Europe kind of shuts down.

And so, hence, we see a soft first quarter. So that would happen again.

But as hopefully I've given indication, our new product sales are robust. So that is unfolding.

And I'll pass on giving any specific prognostication for the first quarter, but [indiscernible].

Okay. Thank you.

Okay.

Okay. Operator, thank you.

Thanks everybody who tuned in to spend some time with us late this afternoon, tonight, depending on where you're located. And we look forward to driving the business, as we described.

A lot of the pieces are in place, we've been doing a lot of hard work, and we're actually all pretty excited about the opportunity. So we look forward to talking to you soon.

Thank you.