BLACK STORK RESEARCH

STAAR SURGICAL (NASDAQ: STAA): BAUSCH AND LOMB 2.0?

Summary of findings:

1) Up to 2017 Staar Surgical (“Staar”) was a boring healthcare company, growing revenue at single
digits and occasionally reporting operating profit.
2) In April 2017, CFO unexpectedly left.
3) In May 2017 Staar filed a Prospectus under the “shelf” registration process, outlining plans to
raise capital.
4) Starting from Q3 2017 growth at Staar mysteriously accelerated, and slowed down sequentially
in Q3 and Q4 2018, following $72M secondary share placement in Aug 2018.
5) A single distributor in China – Shanghai Langsheng – accounted for 70% of revenue growth
between 2016 and LTM Q3 2018. In Q3 2018 Shanghai Langsheng accounted for 42% of total
revenue vs just 11% in Q1 2015.
6) Our analysis shows that the acceleration of growth between Q2 2017 and Q2 2018 was driven
by a massive inventory build-up at distributor level, which inflated revenue reported during the
period by at least 17%.
7) We see other red flags supporting our view of aggressive revenue recognition by Staar:
a. Staar cut prices for their core product - ICLs - in 2017 and 9M 2018;
b. Staar permits product returns;
c. Days of sales outstanding ratio has been going up;
d. Staar made several amendments to revenue recognition policy in 2016-2018, each time
making it less conservative;
e. Since 2016 Staar has been reimbursing its customers for marketing and other costs
subject to minimum purchase levels;
f. In 2017 Staar commenced selling ICLs on consignment basis
g. In 2018, Staar changed the description of seasonality of its business.
8) In our opinion, now Staar management faces a hard task to DEFLATE an inventory bubble,
created during 2017-2018. We think because of this, Staar growth and/or profitability will
disappoint investors in 2019.
9) We set a price target at $18 with a 50% downside based on normalized sales for 2019 and
compression of EV/S multiple.

Sell-side analyst asking Staar CEO Caren Mason during Q3 2018 call:

Analyst: And is there any opportunity for your customers to stock? Or are most of the lenses you
shipped implanted within a few weeks?
Caren L. Mason, CEO: The latter. Almost all of our lenses are made and shipped on order.
Analyst: Right. So there's no channel to fill basically. These are all lenses that are implanted or
within a few weeks of shipment?
Caren L. Mason, CEO: The majority are -- most of our distributors pass the order to us when they
get the order. However, in some markets, where there's very high volume and there's a real
strong interest in lessening the lead time on Toric for example, we do have inventory, but we
manage very carefully. And the majority of the time, we have a maximum of 30 days inventory in
any one location.

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DISCLOSURE

I am/we are short STAA. All information for this report was derived from publicly available information.
Investors are encouraged to conduct their own due diligence into these factors. This report represents
the opinion of the author as of the date of this report. The information set forth in this report does not
constitute a recommendation to buy or sell any security. This report contains certain "forward-looking
statements," which may be identified by the use of such words as "believe," "expect," "anticipate,"
"should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All
are subject to various factors, any or all of which could cause actual events to differ materially from
projected events. This report is based upon information reasonably available to the author and obtained
from sources the author believes to be reliable; however, such information and sources cannot be
guaranteed as to their accuracy or completeness. This report reflects the author's opinion at the time of
publication. The author makes no representation as to the accuracy or completeness of the information
set forth in this report. The author may also cover his/her short position at any point in time without
providing notice. The author encourages all readers to do their own due diligence.

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COMPANY DESCRIPTION AND TIMELINE

Staar Surgical (STAA) is a producer of implantable collamer lens (ICL), an alternative to a popular laser
eye surgery called LASIC. ICL surgery is suitable mostly for people with high myopia (> 8.0) and is
substantially more expensive than LASIC. Total addressable market for ICL is thus just a fraction of total
myopia eye surgery market. FDA lists a number of risks associated with ICL surgery, including loss of
vision, risk of cataract, increased intraocular pressure etc.

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GROWTH ACCELERATION IN 2017-2018

While the average revenue growth between Q1 2011 and Q2 2018 was 7%, in H2 2017 growth
accelerated to 15% and further to 37% in 2018. According to the management of Staar, the acceleration
of growth was a result of “2017 investments in the clinical, quality, regulatory, research and
development, commercial and operations infrastructure”. We think that the recent growth at Staar was
driven by the increase of ICL inventories of distributors, which overstated revenue reported during Q3
2017-Q2 2018 (a period preceding the secondary share placement) by at least 17%. Because of the large
volumes of ICL inventories remaining at distributor level, revenues and/or profitability will fall short of
investors’ expectations in 2019.

Exhibit 1: Staar sales

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
USD m 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018
Sales by geography:
Japan 4,287 3,980 4,249 4,466 4,240 3,989 4,029 5,071 3,799 4,417 4,633 4,575 5,083 6,692 6,006
China 2,371 3,327 3,095 3,778 3,078 4,417 4,254 4,270 4,463 5,862 7,164 6,392 7,910 13,965 13,349
United States 2,866 2,723 2,873 2,442 2,516 2,420 2,419 2,504 1,958 2,092 1,896 1,138 1,756 1,895 1,676
Others 9,334 8,627 8,533 10,172 9,435 10,148 9,350 10,292 10,130 9,565 9,780 12,747 12,344 11,353 10,739
Total 18,858 18,657 18,750 20,858 19,269 20,974 20,052 22,137 20,350 21,936 23,473 24,852 27,093 33,905 31,770
Growth, yoy:
Japan -14% -13% -11% -6% -1% 0% -5% 14% -10% 11% 15% -10% 34% 52% 30%
China 7% 31% 6% 123% 30% 33% 37% 13% 45% 33% 68% 50% 77% 138% 86%
United States 0% -7% 0% 0% -12% -11% -16% 3% -22% -14% -22% -55% -10% -9% -12%
Others -7% -14% 12% 32% 1% 18% 10% 1% 7% -6% 5% 24% 22% 19% 10%
Total -7% -7% 3% 26% 2% 12% 7% 6% 6% 5% 17% 12% 33% 55% 35%
% of total:
Japan 23% 21% 23% 21% 22% 19% 20% 23% 19% 20% 20% 18% 19% 20% 19%
China 13% 18% 17% 18% 16% 21% 21% 19% 22% 27% 31% 26% 29% 41% 42%
United States 15% 15% 15% 12% 13% 12% 12% 11% 10% 10% 8% 5% 6% 6% 5%
Others 49% 46% 46% 49% 49% 48% 47% 46% 50% 44% 42% 51% 46% 33% 34%
Sales by channels:
Sales to Shanghai Langsheng 2,074 2,985 3,000 3,792 3,083 4,405 4,211 4,327 4,681 6,142 7,511 5,547 7,857 13,901 13,343
Other sales 16,784 15,672 15,750 17,067 16,186 16,569 15,841 17,811 15,670 15,794 15,962 19,305 19,236 20,004 18,427
Growth, yoy:
Sales to Shanghai Langsheng 49% 48% 40% 14% 52% 39% 78% 28% 68% 126% 78%
Other sales -4% 6% 1% 4% -3% -5% 1% 8% 23% 27% 15%
% of total:
Sales to Shanghai Langsheng 11% 16% 16% 18% 16% 21% 21% 20% 23% 28% 32% 22% 29% 41% 42%
Other sales 89% 84% 84% 82% 84% 79% 79% 80% 77% 72% 68% 78% 71% 59% 58%
Sales by products:
ICL sales 12,254 12,236 12,907 14,146 13,180 15,408 14,801 15,722 15,271 16,317 18,110 18,627 21,158 27,292 26,418
IOL sales 5,358 5,204 4,390 4,905 5,067 5,068 4,649 4,923 4,606 4,377 3,892 4,383 4,058 4,186 3,824
Other surgical products 1,245 1,217 1,453 5,723 1,022 498 602 1,492 473 1,242 1,471 1,842 1,877 2,427 1,528
Growth, yoy:
ICL sales 0% 1% 21% 56% 8% 26% 15% 11% 16% 6% 22% 18% 39% 67% 46%
IOL sales -19% -19% -24% -11% -5% -3% 6% 0% -9% -14% -16% -11% -12% -4% -2%
Other surgical products -6% -16% -19% 180% -18% -59% -59% -74% -54% 149% 144% 23% 297% 95% 4%
% of total:
ICL sales 65% 66% 69% 57% 68% 73% 74% 71% 75% 74% 77% 75% 78% 80% 83%
IOL sales 28% 28% 23% 20% 26% 24% 23% 22% 23% 20% 17% 18% 15% 12% 12%
Other surgical products 7% 7% 8% 23% 5% 2% 3% 7% 2% 6% 6% 7% 7% 7% 5%

Source: Company, own calculations

Virtually all sales to China go through a single distributor Shanghai Langsheng, which is the largest
customer of Staar, accounting for 42% of revenue in Q3 2018.

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WE THINK THE ACCELERATION OF GROWTH DURING Q3 2017 – Q2 2018 WAS DRIVEN BY THE
INCREASE IN INVENTORIES OF DISTRIBUTORS, NOT END DEMAND

We collected data points on the total number of implanted ICLs, as reported by STAA between 2010 and
2018 (Appendix 1). Typically, Staar presents these numbers at the bottom of a press release (Appendix
2). Other sources of these data points are Staar website and presentations for investors. The table
below summarizes all data points for implanted ICLs starting from 2010. Dates in the first column show
when Staar disclosed each data point for the first time.

Exhibit 2: Number of ICLs implanted per day

Total ICLs ICLs
ICLs implanted
implanted, Days implanted per
during period
cumulatively day
01-Jan-10 150,000
23-Jun-10 180,000 173 30,000 173
02-Nov-10 195,000 132 15,000 114
04-Jan-11 200,000 63 5,000 79
27-Jun-11 225,000 174 25,000 144
14-Sep-11 250,000 79 25,000 316
20-Apr-12 300,000 219 50,000 228
08-Apr-13 350,000 353 50,000 142
14-Aug-13 375,000 128 25,000 195
30-Jan-14 400,000 169 25,000 148
31-Jul-14 450,000 182 50,000 275
04-Nov-14 475,000 96 25,000 260
25-Feb-15 500,000 113 25,000 221
17-Dec-15 550,000 295 50,000 169
30-May-16 600,000 165 50,000 303
10-Oct-16 650,000 133 50,000 376
02-Mar-17 670,000 143 20,000 140
11-May-17 700,000 70 30,000 429
10-Feb-18 775,000 275 75,000 273
13-Mar-18 785,000 31 10,000 323
14-Apr-18 800,000 32 15,000 469
22-Aug-18 850,000 130 50,000 385
12-Sep-18 900,000 21 50,000 2,381

Source: Company, own calculations

We are highly sceptical regarding the spike in daily implantations between 22 Aug 2018 and 12 Sep 2018
(the last data point). How could have Staar increased implantations by a magnitude of 5-6x within such a
short period? While it took 11 months to increase the number of implanted ICLs from 700,000 to
800,000; and over 4 months to increase the number of implanted ICLs from 800,000 to 850,000; the
increase from 850,000 to 900,000 took just 21 days. We think that by reporting 900K number
prematurely Staar decided to cover up the growing divergence between ICL revenue and the number
of implanted ICLs.

Based on the numbers presented above and ICL unit price data from Exhibit 4 we calculated quarterly
numbers of implanted ICLs, which should reflect the end demand. We also calculated unit sales of ICLs
by dividing total ICL revenue by average selling price.

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We took the level of ICL inventories held by distributors at the end of Q4 2009 as a starting point and
calculated cumulative change in ICL inventories at distributor level since then (See “ICL inventories held
by distributors” column in Exhibit 3).

Exhibit 3: ICL sales and ICL inventories held by distributors

Cumulative
ICL units
Days in ICL units ICLs change of ICL
End of implanted ICL Price per Unit sales,
Quarter a implanted YoY YoY Unit sales implanted, inventories
quarter during the revenue ICL unit cumulative
quarter per day cumulative held by
quarter
distributors
(a) (b) (a) * (b) (c) (d) (c)/(d) (e ) (f) (f) - (e)
Q4 2009 0
Q1 2010 02-Apr-10 91 173 15,780 5,860 20% 529 11,072 15,780 11,072 -4,708
Q2 2010 02-Jul-10 91 167 15,242 5,864 9% 529 11,080 31,023 22,152 -8,871
Q3 2010 01-Oct-10 91 114 10,341 6,034 21% 529 11,401 41,364 33,553 -7,811
Q4 2010 31-Dec-10 91 91 8,319 6,542 13% 529 12,361 49,683 45,914 -3,769
Q1 2011 01-Apr-11 91 144 13,075 -17% 6,898 18% 538 12,831 62,757 58,745 -4,012
Q2 2011 01-Jul-11 91 151 13,766 -10% 8,293 41% 538 15,426 76,523 74,171 -2,352
Q3 2011 30-Sep-11 91 301 27,387 165% 7,902 31% 538 14,699 103,910 88,869 -15,041
Q4 2011 30-Dec-11 91 228 20,776 150% 8,981 37% 538 16,706 124,686 105,575 -19,111
Q1 2012 30-Mar-12 91 228 20,776 59% 8,605 25% 569 15,111 145,463 120,686 -24,776
Q2 2012 29-Jun-12 91 162 14,710 7% 8,606 4% 569 15,113 160,172 135,799 -24,373
Q3 2012 28-Sep-12 91 142 12,890 -53% 9,111 15% 569 16,000 173,062 151,799 -21,263
Q4 2012 28-Dec-12 91 142 12,890 -38% 8,758 -2% 569 15,380 185,951 167,179 -18,772
Q1 2013 29-Mar-13 91 142 12,890 -38% 10,631 24% 586 18,129 198,841 185,308 -13,532
Q2 2013 28-Jun-13 91 189 17,237 17% 11,261 31% 586 19,204 216,078 204,512 -11,565
Q3 2013 27-Sep-13 91 172 15,689 22% 10,725 18% 586 18,290 231,766 222,802 -8,964
Q4 2013 27-Dec-13 91 148 13,462 4% 11,511 31% 586 19,630 245,228 242,432 -2,796
Q1 2014 28-Mar-14 91 227 20,689 61% 12,241 15% 593 20,631 265,917 263,063 -2,854
Q2 2014 27-Jun-14 91 275 25,000 45% 12,172 8% 593 20,514 290,917 283,577 -7,339
Q3 2014 26-Sep-14 91 266 24,184 54% 10,640 -1% 593 17,932 315,101 301,510 -13,591
Q4 2014 26-Dec-14 91 238 21,661 61% 8,994 -22% 593 15,158 336,762 316,668 -20,094
Q1 2015 27-Mar-15 91 204 18,580 -10% 12,254 0% 588 20,851 355,342 337,519 -17,823
Q2 2015 26-Jun-15 91 169 15,424 -38% 12,236 1% 588 20,820 370,766 358,338 -12,427
Q3 2015 02-Oct-15 98 169 16,610 -31% 12,907 21% 588 21,962 387,376 380,300 -7,076
Q4 2015 01-Jan-16 91 192 17,427 -20% 14,146 57% 588 24,070 404,803 404,370 -433
Q1 2016 01-Apr-16 91 303 27,576 48% 13,180 8% 609 21,628 432,378 425,998 -6,380
Q2 2016 01-Jul-16 91 329 29,909 94% 15,408 26% 609 25,284 462,287 451,282 -11,005
Q3 2016 30-Sep-16 91 376 34,211 106% 14,801 15% 609 24,288 496,498 475,571 -20,927
Q4 2016 30-Dec-16 91 166 15,088 -13% 15,722 11% 609 25,799 511,586 501,370 -10,216
Q1 2017 31-Mar-17 91 232 21,100 -23% 15,271 16% 599 25,480 532,686 526,850 -5,836
Q2 2017 30-Jun-17 91 343 31,208 4% 16,317 6% 599 27,225 563,894 554,074 -9,819
Q3 2017 29-Sep-17 91 273 24,818 -27% 18,110 22% 599 30,216 588,712 584,291 -4,421
Q4 2017 29-Dec-17 91 273 24,818 64% 18,627 18% 599 31,079 613,530 615,370 1,840
Q1 2018 30-Mar-18 91 326 29,696 41% 21,158 39% 564 37,517 643,226 652,887 9,661
Q2 2018 29-Jun-18 91 398 36,262 16% 27,292 67% 564 48,394 679,488 701,281 21,793
Q3 2018 12-Sep-18* 75 944 70,769 185% 26,418 46% 564 46,844 750,257 748,125 -2,133
* - for Q3 2018 number of ICL units implanted per day and per quarter are presented till 12 Sep 2018 as this is the latest data point provided by Staar.

Source: Company, own calculations Acceleration of ICL revenue growth during Q3 2017 – Q2 2018 was a result
of the accumulation of 31,600 ICL units at distributor level

We are getting 31.6K figure as a difference between the cumulative inventory levels at the end of the
period (21.8K) and at the beginning of the period (-9.8K). This is equal to $18.2m or 16.7% of all revenue
reported during Q3 2017 – Q2 2018.

In our view, distributors in China and South Korea are the most likely candidates to hold the excessive
ICL inventory, accumulated during 2017-2018, as these are the largest distributor markets for Staar. In
other key markets (Germany, Spain and the US) Staar sells directly.

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The graph below is a visualization of Exhibit 3:

Source: Company, own calculations

We would like to highlight the following:

1) Change of inventories held by distributors show high correlation with ICL revenue growth. This
means that acceleration/deceleration of ICL revenue growth is mostly driven by
accumulation/distribution of inventories by distributors, not changes in the underlying demand.
2) Between Q2 2017 and Q2 2018 ICL inventories held by distributors increased by approximately
31,600 (equal to $18.2m). To put this in perspective, this is more than total ICL sales in Q4 2017.
3) Huge increase in implantations during 21 days in Aug-Sep 2018 (2,381 ICLs per day) has
supposedly ELIMINATED the large part of excess inventories accumulated by distributors. We
think there is no way such volume of ICLs could have been implanted in such a short period of
time given that historically around 200-400 ICLs were implanted per day.

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OTHER RED FLAGS

According to a research paper “Detection-Controlled Prediction of Accounting Irregularities: Channel

Stuffing as an Illustrative Case” there are several warning signs, indicating possible channel stuffing:

Channel stuffing is typically achieved by offering lucrative incentives, including deep discounts,
rebates, and extended payment terms, to persuade distributors and retailers to buy quantities in
excess of their needs. Distributors frequently retain the right to return any unsold inventory which
calls into question whether the transaction is a bona fide sale or more in the nature of goods sent on
consignment. The accounting irregularity in the context of channel stuffing thus occurs from
recording revenues prematurely and from the failure to adequately provide for bad debts and sales
returns that are bound to follow the excess shipments.

Source: LINK

We found the evidence of these red flags in Staar financial statements.

Deep discounts: After a long period of growth ICL prices started declining in 2017 and the decline
accelerated in 9M 2018.

Exhibit 4: ICL revenue and ICL unit price

ICL unit Price per Change,

ICL revenue
sales ICL, $ YoY
2010 24,300 45,914 529
2011 32,074 59,661 538 1.6%
2012 35,080 61,604 569 5.9%
2013 44,128 75,253 586 3.0%
2014 44,047 74,236 593 1.2%
2015 51,543 87,702 588 -0.9%
2016 59,111 97,000 609 3.7%
2017 68,325 114,000 599 -1.6%
9M 2018 74,868 132,755 564 -5.9%
Source: Company, own calculations

Staar confirmed the decline of ASPs during 2017 and 9M 2018 in its financial statements.

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Exhibit 5: Decline in ASPs in 2017 and 9M 2018
2017 Gross profit for the year ended December 29, 2017 was $64.3 million, a 10.1% increase compared to the $58.4 million
10-K reported for the year ended December 30, 2016. Gross profit in 2017 increased 10.1%, slightly ahead of the increase
in net sales. Gross profit margin increased to 70.9% of revenue for fiscal year 2017 compared to 70.8% of revenue for
fiscal year 2016, due to an increase in sales mix of Toric ICLs, improved country mix, lower unit costs and the cost of
sales related to the $0.6 million non-cash charge related to the immediate vesting of all unvested equity awards as a
result of the triggering of the “Change of Control” provisions of the Company’s equity incentive plan in 2016 which
was not repeated in 2017, largely offset by the increased mix of lower margin injector and other product sales and
lower ICL and IOL average selling prices.
Q3 2018 Gross profit for the three months ended September 28, 2018 was $23.9 million or 75.1% of sales, an increase of 42%
10-Q from $16.8 million, or 71.8% of sales, reported during the same period of 2017. Gross profit for the nine months
ended September 28, 2018 was $68.5 million or 73.9% of sales, an increase of 46% from $46.9 million, or 71.3% of
sales, reported during the same period of 2017. The improvement in gross margin for both periods resulted
primarily from lower unit costs as a result of significantly increased production volumes resulting in better overhead
absorption, favorable product and country mix, and due to lower freight and inventory provisions, partially offset by
the effect of lower average selling prices.

Source: Company filings

Rebates: In 2016, Staar added the following paragraph to its revenue recognition policy:

Beginning in 2016, the Company entered into certain strategic cooperation agreements with
customers in which, as consideration for minimum purchase commitments the customers
make, the Company agrees to pay for marketing and support of Company products. The
Company accounts for these arrangements in accordance with ASC 605-50, Revenue Recognition
– Customer Payments and Incentives. The provisions in these arrangements allow for these
payments to be made directly to the customer in lieu of marketing and support or, payments can
be made for distinct marketing and support services provided by the customer or another party.

For payments the Company makes to the customer for which no distinct service is provided, the
Company records these payments as a reduction of revenues as incurred. For payments the
Company makes to another party, or reimburses the customer, for distinct marketing and
support services, the Company recognizes these payments as a sales and marketing expense
as incurred.

Source: 2016 10-K

Such reimbursements are an easy way to inflate revenue: a customer buys more lenses than can be sold,
and Staar makes reimbursements of “marketing costs” for those lenses bought above normal levels.

Product returns/Extended payment terms: 2017 10-K revenue recognition policy:

The Company generally permits returns of product if the product is returned within the time
allowed by its return policies and records an allowance for estimated returns at the time
revenue is recognized. The Company’s allowance for estimated returns considers historical trends
and experience, the impact of new product launches, the entry of a competitor, availability of
timely and pertinent information and the various terms and arrangements offered, including
sales with extended credit terms.

Source: 2017 10-K

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Growing DSO: Growing Days of Sales Outstanding is another indicator of Staar shift towards
aggressiveness in its revenue booking practices.

Exhibit 6: Days of sales outstanding

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018
Revenue 18,858 18,657 18,750 20,858 19,269 20,974 20,052 22,137 20,350 21,936 23,473 24,852 27,093 33,905 31,770
Accounts receivable 11,035 12,478 12,776 15,675 16,227 16,112 14,372 16,344 15,621 16,426 16,237 20,035 22,960 26,233 23,732
Days of sales outstanding 53 61 62 68 77 70 65 67 70 68 63 73 77 70 68
DSO, last 4 quarters average 57 58 59 61 67 69 70 70 68 68 67 69 70 71 72

Source: Company, own calculations

Changes in revenue recognition between 2016 and 2018: In our view, changes to revenue recognition
policy, made during 2016-2018, make revenue recognition less conservative.

 In 2017, Staar commenced selling ICLs on consignment basis. Consignment sales are more
beneficial to customers, as they pay only when goods are sold to end buyer.

2016 10-K 2017 10-K

The Company’s products are marketed to ophthalmic
surgeons, hospitals, ambulatory surgery centers or
vision centers, and distributors. IOLs may be offered
to surgeons and hospitals on a consignment basis.
The Company’s products are marketed to ophthalmic
surgeons, hospitals, ambulatory surgery centers or
vision centers, and distributors. IOLs and ICLs may be
offered to surgeons and hospitals on a consignment
basis.

 In Q1 2018 Staar extended the list of services, for which reimbursements can be made. While in
2017 10-k such list included “marketing and support of the Company’s products”, in Q1 2018 it
was extended to “marketing, educational training and general support of the Company’s
products”. In Q2 Staar disclosed that customers were making additional commitments beyond
just “minimum purchase commitments” as disclosed in Q1 2018.

2017 10-K Q1 2018 10-Q Q2 2018 10-Q

Beginning in 2016, the Company
entered into certain strategic
cooperation agreements with
customers in which, as consideration
for minimum purchase commitments
the customers make, the Company
agrees to pay for marketing and
support of the Company’s products.
The Company also enters into certain
strategic cooperation agreements
with customers in which,
as consideration for minimum
purchase commitments the
customers make, the Company
agrees, among other things, to pay
for marketing, educational training
and general support of the Company’s
products.
The Company also enters into certain
strategic cooperation agreements
with customers in which, as
consideration for certain
commitments made by the customer,
including minimum purchase
commitments, the Company agrees,
among other things, to pay for
marketing, educational training and
general support of the Company’s
products.

10 | P a g e
Changes in risk factor disclosures: In 2017, Staar made amendment to a risk factor pointing out
increased credit and collectability risk “with customers in certain international markets”:

Exhibit 7: Risk factor changes

2016 10-K
RISK FACTORS
The global nature of our business may result in fluctuations and
declines in our sales and profits due to fluctuations in foreign
currency exchange rates and other international risks.
2017 10-K
RISK FACTORS
The global nature of our business may result in fluctuations and
declines in our sales and profits due to fluctuations in foreign
currency exchange rates and other international risks.
…
Also, we are exposed to credit and collectability risk on our
trade receivables with customers in certain international
markets. There can be no assurance we can effectively limit our
credit risk and avoid losses and our ability to transfer foreign
earnings to the U.S. may be subject to taxes or restricted or
result in incurring substantial costs.

Moreover, during 2015-2017 Staar changed text of another risk factor, indicating growing competition
from low-cost producers in Asia.

Exhibit 8: Risk factor changes

2015 10-K 2016 10-K 2017 10-K

RISK FACTORS
We compete with much larger
companies.
In a ddi ti on, s ta rt-up competi tors
from a low cost manufacturing
geography a re begi nni ng to a ppea r
i n s ome ma rkets wi th thei r vers i on
of a n i mpl a nta bl e conta ct l ens .
RISK FACTORS RISK FACTORS
We compete with much larger We compete with much larger
companies. companies and low-cost Asian
manufacturers.
In a ddi ti on, start-up competi tors In a ddi ti on, competi tors from As i a
from Asia a re begi nni ng to a ppea r a re begi nni ng to a ppea r i n s ome
i n s ome ma rkets wi th thei r low-cost ma rkets wi th thei r l ow-cos t vers i on
vers i on of a n i mpl a nta bl e conta ct of a n i mpl a nta bl e conta ct l ens ,
l ens , which competes with our ICL. whi ch competes wi th our ICL.

Change in seasonality pattern in 2018: In 2016 and 2017, Staar disclosed that seasonality did not
materially influence its sales. However, during Q3 2018 call the company disclosed that going forward
sales in the second quarter would be the highest, followed by the third.

Exhibit 9: Revenue seasonality (percentage of annual revenue generated in each quarter)

Q1 Q2 Q3 Q4
While certain individual markets may be impacted by seasonal trends, in the
2016 aggregate, seasonality does not materially affect our sales. 23.4% 25.4% 24.3% 26.9%
While certain individual markets may be impacted by seasonal trends, in the
2017 aggregate, seasonality does not materially affect our sales. 22.5% 24.2% 25.9% 27.4%
We continue to believe that for the foreseeable future, our quarterly revenue
Q3 2018 call: cadence is likely to be the highest in the second quarter followed by the third. 21.9% 27.3% 25.6% 25.2%

Source: Company, own calculations

To summarize: We think Staar had a strong reason to overstate its reported revenue/profits ahead of
the secondary share placement in Aug 2018. In our view, numerous accounting tricks; various
concessions to customers; growth mostly driven by a single distributor in China; declining ICL prices,
increasing competition are signs of deteriorating fundamentals, not of a strong demand.

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SIMILARITIES WITH BAUSCH & LOMB CASE

While analysing Staar, we found a textbook case on channel stuffing: Bausch & Lomb in 1993. Because
of improper revenue recognition, 1993 net income was overstated by 11% and B&L subsequently
restated its financials, while the stock declined by 40%. For those interested in this case, SEC presents a
very detailed overview on its website.

We see the following similarities between the cases of Bausch and Lomb and Staar:

Criteria Staar Bausch & Lomb

Company operates in
lens/optical business
Incentive to meet the numbers
Product is sold through
distributors
Growing pressure from
competitors
Product returns are allowed
Sales on consignment basis
Aggressive
marketing/promotion
campaign
YES YES
Staar was planning a secondary Management pushed
share placement employees to meet annual
targets for 1993
YES (the largest distributor YES
markets are China and South
Korea)
YES, competition is growing YES
from low-cost producers in Asia
YES YES
YES (started selling ICLs on YES
consignment basis in 2017)
In 2016 started making YES
reimbursements for marketing
and other costs for the
commitment to minimum
purchase level. In 2018 changed
revenue recognition to expand
the list of services for which
reimbursements can be made.

Another similarity is that in B&L case a Hong Kong office was largely responsible for inflating sales. We
think in Staar case China and South Korea are the most likely markets where the excess ICL inventory
could be sitting.

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VALUATION

At present, sell-side analysts are projecting $154M revenue for 2019, which is 24% growth YoY. In its
Jan-2019 presentation, Staar guided for 20% growth, although with certain reservations (see in red).

Source: LINK

In our view, given the need for distributors to sell their elevated inventories, sales in 2019 will be much
lower than what is currently expected by the market.

Exhibit 10: Current market projections

US m 2016 2017 2018 2019
ICL revenue 59.1 68.3 101.3 131.2
growth, yoy 16% 48% 30%
Other revenue 23.3 22.3 22.6 22.6
growth, yoy -4% 2% 0%
Total revenue 82.4 90.6 124.0 153.9
growth, yoy 10% 37% 24%

Source: Company

Exhibit 11: Black Stork Research projections

USD m 2016 2017 2018 2019
ICL revenue (as reported) 59.1 68.3 101.3 87.7
growth, yoy 16% 48% -13%
Including:
Sales to end users 59.1 61.3 90.1 103.6
Increase/(decrease) of inventories by
distributors 7.0 11.3 -15.9
Other revenue 23.3 22.3 22.6 22.6
growth, yoy -4% 2% 0%
Total revenue 82.4 90.6 124.0 110.4
growth, yoy 10% 37% -11%

Source: company, own calculations

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We would like to highlight the following:

 We calculate dollar value of the “Increase of inventories by distributors” by multiplying change

in relative inventories from Exhibit 3 by ICL prices from Exhibit 4.
 “Sales to end users” are calculated as “Reported ICL revenue” less “Increase of inventories by
distributors”.
 For 2018, we include only increase of inventories at distributor level, which happened in H1
2018. Given that the latest data point on ICLs implanted is dated 12 Sep 2018, we cannot
calculate change in ICL inventories at distributors in H2 2018. We assume zero accumulation of
ICL inventories by distributors in H2 2018.
 To arrive to 2019 revenue we assume:
o 15% YoY growth in the underlying demand for ICLs (“Sales to end users”)
o Complete de-stocking by distributors to normal inventory levels during 2019.
o 0% growth for “Other revenues

As a result, we expect Staar to sell only c. $90m of ICLs, not $130m as currently expected by the market.
Such poor performance of ICL segment should result in total revenue declining by 11% YoY in 2019.

Given that the company has been largely loss making historically, there is no history of P/E or even
EV/EBITDA multiples. Thus, we value company based on EV/S. Over the last five years the average EV/S
multiple has been 5.6x, although this period includes depressed multiple levels following FDA warning
letter in 2015 AND a euphoria period of April-December 2018 after the lift of FDA warning.

At present market values the company at 10x 2019 sales. We apply 8x EV/S multiple to our adjusted
2019 Sales (still a generous multiple for a company given its historical profitability and growth), which
results in $18 target price or 50% downside from the current levels.

Exhibit 12: STAA valuation

USD m
2019 Sales 110
EV/S multiple 8.0
EV 880
Less cash as of 30 Sep 2018 102
Market cap 778
Shares outstanding as of 26 Oct 2018 44.1
Target share price 17.6

Source: Own projections

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APPENDIX 1
Date Description
01-Jan-10 The ICL … has been
implanted in more than
150,000 eyes worldwide.
23-Jun-10 Over 180,000 Visian ICLs
have been implanted to date
02-Nov-10 Over 195,000 Visian ICLs
have been implanted to date
04-Jan-11 Over 200,000 Visian ICLs
have been implanted to date
27-Jun-11 Over 225,000 Visian ICLs
have been implanted to date
14-Sep-11 Over 250,000 Visian ICLs
have been implanted to date
20-Apr-12 Over 300,000 Visian ICLs
have been implanted to date
08-Apr-13 Over 350,000 Visian ICLs
have been implanted to date
14-Aug-13 Over 375,000 Visian ICLs
have been implanted to date
30-Jan-14 Over 400,000 Visian ICLs
have been implanted to date
31-Jul-14 More than 450,000 Visian
ICLs have been implanted to
date
04-Nov-14 More than 475,000 Visian
ICLs have been implanted to
date
25-Feb-15 More than 500,000 Visian
ICLs have been implanted to
date.
17-Dec-15 More than 550,000 Visian
ICLs have been implanted to
date.
30-May-16 More than 600,000 Visian
ICLs have been implanted to
date.
10-Oct-16 650,000 lenses and growing
02-Mar-17 More than 670,000 Visian
ICLs have been implanted to
date.
11-May-17 More than 700,000 Visian
ICLs have been implanted to
date.
10-Feb-18 Over 775,000 Visian ICLs
have been implanted to
date.
13-Mar-18 785,000+ ICLs™ Implanted
Globally
14-Apr-18 Over 800,000 Visian ICLs
have been implanted to
date.
22-Aug-18 850,000+ ICLs™ Implanted
Globally
12-Sep-18 More than 900,000 Visian
ICLs have been implanted to
date.
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LINK
https://www.sec.gov/Archives/edgar/data/718937/000114420410018099/v179088_10k.ht
m
https://staar.com/news/2010/staar-surgical-retires-promissory-note-early
https://staar.com/news/2010/staar-surgical-reports-continued-double-digit-core-revenue-
growth
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=1512277
https://staar.com/news/2011/staar-surgical-announces-first-visian-icl-v4c-implants-in-
europe
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=1606639
https://www.prnewswire.com/news-releases/staar-surgical-celebrates-over-300000-
successful-visian-icl-implants-at-ascrs-congress-148230435.html
https://www.sec.gov/Archives/edgar/data/718937/000114420413020627/v340740_ex99-
1.htm
https://www.sec.gov/Archives/edgar/data/718937/000114420413045310/v352919_ex99-
1.htm
https://staar.com/news/2014/kathryn-tunstall-appointed-to-staar-surgical-board-of-
directors
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=1953892
https://staar.com/news/2014/staar-surgical-gains-final-step-in-regulatory-approval-for-
visian-icl-with-centraflow-in-china
https://staar.com/news/2015/staar-surgical-reports-fourth-quarter-and-full-year-2014-
results
https://staar.com/news/2015/stephen-c-farrell-appointed-to-staar-surgical-board-of-
directors
https://web.archive.org/web/20160530050341/http://www.staar.com:80/
https://us.discovericl.com/blog/something-better-than-lasik-meet-the-visian-icl
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=2251182
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=2272202
https://web.archive.org/web/20180210152752/http://staar.com:80/our-mission
https://www.sec.gov/Archives/edgar/data/718937/000114420418014248/tv488242_ex99-
1.htm
https://web.archive.org/web/20180414050740/http://staar.com:80/our-mission
https://www.sec.gov/Archives/edgar/data/718937/000114420418045861/tv501434_ex99-
1.htm
http://phx.corporate-ir.net/phoenix.zhtml?c=71327&p=irol-newsArticle&ID=2367003
APPENDIX 2

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APPENDIX 2 – CONTINUED

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