1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 4, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition period from _________________ to __________________
Commission File Number: 0-27598
IRIDEX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0210467
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
1212 TERRA BELLA AVENUE
MOUNTAIN VIEW, CALIFORNIA 94043-1824
(Address of principal executive offices, including zip code)
(650) 940-4700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes [X] No [ ]; (2) Yes [X ] No [ ]
The number of shares of Common Stock, $.01 par value, issued and outstanding as
of August 11, 1998 was 6,474,144.
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IRIDEX CORPORATION
Table of Contents
Page
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of July 4, 1998 and
December 31, 1997 3
Condensed Consolidated Statements of Income for the three months
and six months ended July 4, 1998 and June 30, 1997 4
Condensed Consolidated Statements of Cash Flows for the six months
ended July 4, 1998 and June 30, 1997 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 8
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18
SIGNATURE 19
INDEX TO EXHIBITS 20
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IRIDEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JULY 4, DECEMBER 31,
1998 1997
-------- --------
(unaudited) *
ASSETS
Current assets:
Cash and cash equivalents $ 5,794 $ 9,990
Available-for-sale securities 5,226 3,588
Accounts receivable, net 7,473 6,057
Inventories 6,096 3,976
Prepaids and other current assets 414 451
Deferred income taxes 550 550
-------- --------
Total current assets 25,553 24,522
Property and equipment, net 2,276 2,133
Intangible assets 44 --
Deferred income taxes 31 31
-------- --------
Total assets $ 27,904 $ 26,686
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 835 $ 752
Accrued expenses 1,904 2,051
Current portion of capital lease obligations 2 3
-------- --------
Total current liabilities 2,741 2,806
Stockholders' equity:
Common Stock 65 65
Additional paid-in capital 21,654 21,552
Unrealized holding losses on available-for-sale securities (1) (2)
Retained earnings 3,445 2,265
-------- --------
Total stockholders' equity 25,163 23,880
-------- --------
Total liabilities and stockholders' equity $ 27,904 $ 26,686
======== ========
- -----------
*Derived from the 1997 audited financial statements.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
July 4, June 30, July 4, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
Sales $ 6,002 $ 4,356 $ 11,874 $ 7,676
Cost of sales 2,487 1,843 4,977 3,280
-------- -------- -------- --------
Gross profit 3,515 2,513 6,897 4,396
-------- -------- -------- --------
Operating expenses:
Research and development 677 471 1,223 892
Selling, general and administrative 2,160 1,400 4,135 2,724
-------- -------- -------- --------
Total operating expenses 2,837 1,871 5,358 3,616
-------- -------- -------- --------
Income from operations 678 642 1,539 780
Other income, net 117 160 248 315
-------- -------- -------- --------
Income before provision for income taxes 795 802 1,787 1,095
Provision for income taxes (270) (288) (607) (396)
-------- -------- -------- --------
Net income $ 525 $ 514 $ 1,180 $ 699
======== ======== ======== ========
Net income per common share $ 0.08 $ 0.08 $ 0.18 $ 0.11
======== ======== ======== ========
Net income per common share -
assuming dilution $ 0.08 $ 0.08 $ 0.17 $ 0.11
======== ======== ======== ========
Shares used in per common share
calculation 6,469 6,385 6,464 6,371
======== ======== ======== ========
Shares used in per common share -
assuming antidilution calculation 6,855 6,668 6,834 6,654
======== ======== ======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
---------------------
July 4, June 30,
1998 1997
-------- --------
Cash flows from operating activities:
Net income $ 1,180 $ 699
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 329 161
Provision for doubtful accounts (20) 10
Changes in operating assets and liabilities:
Accounts receivable (1,396) 249
Inventories (2,120) (712)
Prepaids and other current assets 37 (394)
Accounts payable 83 224
Accrued expenses (147) 61
-------- --------
Net cash provided by (used in) operating activities (2,054) 298
-------- --------
Cash flows from investing activities:
Purchases of available-for-sale securities (16,077) (12,485)
Proceeds from sale of available-for-sale securities 14,440 8,372
Acquisition of property and equipment (472) (344)
Acquisition of intangible assets (44) --
-------- --------
Net cash used in investing activities (2,153) (4,457)
-------- --------
Cash flows from financing activities:
Payment on capital lease obligations (1) (4)
Issuance of common stock, net 102 26
-------- --------
Net cash provided by financing activities 101 22
-------- --------
Net decrease in cash and cash equivalents (4,106) (4,137)
Cash and cash equivalents at beginning of period 9,900 14,107
-------- --------
Cash and cash equivalents at end of period $ 5,794 $ 9,970
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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IRIDEX CORPORATION
CONDENSED CONSOLIDATED
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements at July 4, 1998 and for the
three and six month periods then ended are unaudited (except for the balance
sheet information as of December 31, 1997, which is derived from the Company's
audited financial statements) and reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for a fair presentation of the financial position and operating results for the
interim periods. The condensed consolidated financial statements should be read
in conjunction with the audited financial statements and notes thereto, together
with management's discussion and analysis of financial condition and results of
operations, contained in the Company's Annual Report on Form 10-K and form
10-QSB, which were filed with the Securities and Exchange Commission on March
31, 1998 and May 15, 1998, respectively. The results of operations for the three
and six month periods ended July 4, 1998 are not necessarily indicative of the
results for the year ending January 2, 1999, or any future interim period.
2. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the current
year presentation. The reclassification had no impact on previously reported
income from operations or net income.
3. CHANGE IN FISCAL YEAR
On June 8, 1998, the Board of Directors approved a resolution to adjust the
Company's fiscal year end from December 31 to the 52 or 53 week period that
ends the Saturday nearest December 31, effective for fiscal year 1998.
4. INVENTORIES COMPRISE: (IN THOUSANDS)
July 4, December 31,
1998 1997
-------- --------
(UNAUDITED)
Raw materials and work in progress $ 4,077 $ 2,579
Finished goods 2,019 1,397
-------- --------
Total inventories $ 6,096 $ 3,976
======== ========
5. COMPUTATION OF NET INCOME PER COMMON SHARE AND PER COMMON SHARE -
ASSUMING DILUTION
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128, Earnings Per Share, and the provisions of
the Securities and Exchange Commission Staff Accounting Bulletin No. 98 and,
accordingly, all prior periods have been restated. Net income per common share
is computed using the weighted average number of shares of common stock
outstanding. Net income per common share-assuming dilution is computed using the
weighted average number of shares of common stock and dilutive common equivalent
shares from stock options. The Company has determined that no incremental shares
should be included in the computations of earnings per share and in accordance
with Staff Accounting Bulletin No. 98.
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In accordance with the disclosure requirements of SFAS No. 128, a reconciliation
of the numerator and denominator of net income per common share and net income
per common share-assuming dilution is provided as follows (in thousands, except
per share amounts):
Three Months Ended Six Months Ended
------------------------------ ----------------------------
July 4, 1998 June 30, 1997 July 4, 1998 June 30, 1997
(unaudited) (unaudited) (unaudited) (unaudited)
--------------- --------------- ------------- -------------
Numerator -- Net income per common share and per common
share -- assuming dilution
Net income................................................... $ 525 $ 514 $ 1,180 $ 699
========= ========= ========= =========
Denominator -- Net income per common share --
Weighted average common stock outstanding.................. 6,469 6,385 6,464 6,371
--------- --------- --------- ---------
Net income per common share.................................. $ 0.08 $ 0.08 $ 0.18 $ 0.11
========= ========= ========= =========
Denominator -- Net income per common share -- assuming
dilution
Weighted average common stock outstanding.................. 6,469 6,385 6,464 6,371
Effect of dilutive securities
Weighted average common stock options...................... 386 283 370 283
--------- --------- --------- ---------
Total weighted average stock and options outstanding......... 6,855 6,668 6,834 6,654
========= ========= ========= =========
Net income per common share -- assuming dilution............. $ 0.08 $ 0.08 $ 0.17 $ 0.11
========= ========= ========= =========
During the three months ended July 4, 1998 and June 30, 1997, options to
purchase 137,168 and 212,114 shares, respectively, at weighted average exercise
prices of $9.95 and $7.94 per share, respectively, were outstanding, but were
not included in the computations of net income per common share-assuming
dilution because the exercise price of the related options exceeded the market
price of the common shares. These options could dilute earnings per share in
future periods.
6. ADOPTED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement establishes requirements for disclosure of comprehensive
income, with reclassification of earlier financial statements for comparative
purposes. Comprehensive income generally represents all changes in stockholders'
equity except those resulting from investments or contributions by stockholders.
SFAS No. 130, which is effective for interim periods beginning after December
15, 1997, has been adopted by the Company. However, comprehensive income is
insignificant for all periods presented and, accordingly, no additional
disclosures have been presented in the accompanying financial statements.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the factors set forth under "Factors
Affecting Operating Results" and other risks detailed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed with the
Securities and Exchange Commission and detailed from time to time in the
Company's reports filed with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales of certain items
in the Company's income statement for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
July 4, June 30, July 4, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
Sales................................................. 100.0% 100.0% 100.0% 100.0%
Cost of sales......................................... 41.4 42.3 41.9 42.7
----- ----- ----- -----
Gross profit.................................... 58.6 57.7 58.1 57.3
Operating expenses:
Research and development........................... 11.3 10.8 10.3 11.6
Sales, general and administrative.................. 36.0 32.2 34.8 35.5
----- ----- ----- -----
Total operating expenses........................ 47.3 43.0 45.1 47.1
----- ----- ----- -----
Income from operations................................ 11.3 14.7 13.0 10.2
Other income, net..................................... 1.9 3.7 2.0 4.1
----- ----- ----- -----
Income before provision for income taxes.............. 13.2 18.4 15.0 14.3
Provision for income taxes............................ (4.5) (6.6) (5.1) (5.2)
----- ----- ----- -----
Net income............................................ 8.7% 11.8% 9.9% 9.1%
===== ===== ===== =====
Sales. Sales increased 38% to $6.002 million for the three months ended
July 4, 1998 from $4.356 million for the three months ended June 30, 1997. Sales
increased 55% to $11.874 million for the six months ended July 4, 1998 from
$7.676 million for the six months ended June 30, 1997. The growth in sales was
primarily attributable to increased unit volume as the Company expanded its
product offerings and broadened its customer base. Domestic sales of $3.753
million accounted for 63% of sales for the three months ended July 4, 1998
compared to $1.924 million or 44% of sales in the comparable 1997 period. The
increase in domestic sales was attributable primarily to sales of the DioLite
532 dermatology laser introduced in the second quarter of 1997 and an increase
in domestic sales of most products for ophthalmology. In addition, increased
domestic sales result in higher average selling prices as domestic sales are
primarily sold by employee sales representatives at higher average selling
prices than to the Company's international distributors. International sales of
$2.249 million in the three months ended July 4, 1998 decreased from $2.432
million in the comparable 1997 period. The decrease in international sales was
attributable to a reduction in sales to many Asian countries which continue to
be impacted by currency devaluations, offset in part by an increase in sales to
Europe. The increase in sales to Europe was limited due to delays in the Company
receiving CE certification. The Company received CE certification in June 1998.
While lower Asian sales in past quarters have been mitigated by product sales in
other regions and in the United States, the company expects lower sales to Asia
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to continue through the end of the year. The Company expects revenues from
international sales to continue to account for a substantial portion of its
sales. The Company expects future growth in sales to be primarily derived from
sales of the DioLite 532 and the OcuLight GL. There can be no assurance that
future currency fluctuations and other factors discussed above will not have a
material adverse effect on the Company's business, financial condition or
results of operations.
Gross Profit. The Company's gross profit increased 40% to $3.515 million
for the three months ended July 4, 1998 from $2.513 million for the three months
ended June 30, 1997. For the six months ended July 4, 1998, the Company's Gross
profit increased 57% to $6.897 million as compared to $4.396 million for the
comparable period in 1997. Gross profit as a percentage of net sales for the
three months ended July 4, 1998 increased to 59%, compared to 58% for the three
months ended June 30, 1997, due primarily to increased domestic sales which are
primarily sold by employee sales representatives at higher average selling
prices than sales to the Company's international distributors, offset somewhat
by lower average selling prices for the DioLite 532 and certain other ophthalmic
products. The Company expects that the percentage of international sales is
likely to increase during the remainder of 1998, which would negatively impact
average selling prices. In addition, ongoing competitive pressure on the prices
of the Company's products may result in a decline in average selling prices. The
Company intends to continue its efforts to reduce the cost of components and the
costs associated with new product introductions, and expects its gross profit to
continue to fluctuate due to changes in the relative proportions of domestic and
international sales, costs associated with additional new product introductions,
pricing and a variety of other factors.
Research and Development. Research and development expenses increased by
44% to $0.677 million for the three months ended July 4, 1998 from $0.471
million for the three months ended June 30, 1997, but remained relatively the
same as a percentage of net sales at 11% for the three months ended July 4, 1998
and for the comparable prior year three-month period. For the six months
ended July 4, 1998, research and development expenses increased 37% to $1.223
million as compared to $.892 million for the six months ended June 30, 1997. The
increase in absolute dollars in research and development expenses during this
period was primarily attributable to an increase in personnel as the Company
strengthened its product development efforts. The Company expects these expenses
for research and development to continue to increase in absolute dollars during
the remainder of 1998 in connection with new product development activities.
Sales, General and Administrative. Sales, general and administrative
expenses increased by 54% to $2.160 million for the three months ended July 4,
1998 from $1.400 million for the three months ended June 30, 1997, and
increased as a percentage of net sales to 36% for the three months ended July
4, 1998 from 32% for the comparable prior year three-month period. For the six
months ended July 4, 1998, sales, general and administrative expenses increased
by 52% to $4.135 million from $2.724 million for the six months ended June 30,
1997. The increase in absolute dollars in sales, general and administrative
expenses was primarily due to the hiring of additional sales, marketing and
administrative employees to address new opportunities, to support expanding unit
volumes and the expenses associated with the OcuLight GL and DioLite 532.
Furthermore, the increase in domestic sales caused an associated increase in
direct selling expenses. In addition, during the three months ended July 4,
1998, the Company continued full scale implementation of a new company-wide
enterprise resource planning ("ERP") system and expects the implementation of
this system to be completed by September of 1998. The Company expects sales,
general and administrative expenses to continue to increase during the balance
of 1998 to support the increasing unit shipment volumes, additional employees
and the implementation of the new ERP system.
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Income Taxes. The Company's effective tax rates for the three and six
months ended July 4, 1998 was 34%. This rate differs from the federal statutory
rate primarily due to state income taxes, offset by the utilization of tax
credits, non-taxable available-for-sale security investments and tax benefits
from the Company's foreign sales corporation.
LIQUIDITY AND CAPITAL RESOURCES
At July 4, 1998, the Company's primary sources of liquidity included cash
and cash equivalents and available-for-sale securities of $11.0 million. During
the six months ended July 4, 1998, the Company used $2.1 million in operating
activities. Sources of cash included net income of $1.2 million, depreciation of
$0.3 million and increases in accounts payable of $0.1 million, offset by
increases in accounts receivables of $1.4 million and inventories of $2.1
million. The increase in inventory is primarily due to increased finished goods
inventory. The Company used $2.2 million in investing activities during the six
months ended July 4, 1998, primarily from the net purchase of $1.7 million of
available-for-sale securities and by the acquisition of $.5 million of property
and equipment. Net cash provided by financing activities during the six months
ended July 4, 1998 was $0.1 million, which consisted primarily of issuance of
stock. The Company believes that, based on current estimates, its current cash
and cash equivalents, and available-for-sale securities will be sufficient to
meet its anticipated cash requirements through 1998.
Year 2000 Compliance. The Company uses a significant number of computer
software programs and operating systems in its internal operations, including
applications for various financial, business and administrative functions. In
addition, many of the Company's suppliers use similar applications. These
applications may contain source code that is unable to properly interpret
calendar years beginning with the upcoming year 2000. Systems that do not
properly recognize such date-sensitive information may fail or create erroneous
results. Because there are no internal calendars embedded in any of the
Company's products, the Company does not anticipate any problems with its
products related to the Year 2000 problem will develop. The Company is currently
installing a new ERP system which it believes will be fully Year 2000 compliant.
Based on this and other information currently available to the Company, the
Company believes that its internal systems currently are, or will be by such
time as is necessary to avoid a material adverse impact on the Company, Year
2000 compliant. Also based on information thus far available to the Company, the
Company does not believe that it will incur expenditures in dealing with Year
2000 issues that will have a material adverse effect on the financial condition
of the Company. In addition to the risks from failure of the Company's own
internal systems, the Company may also be exposed to risks from computer systems
of parties with whom the Company transacts business. For example, if the
internal systems of one of the Company's key suppliers developed problems such
that the supplier could not deliver parts to the Company on a timely basis, the
Company's financial condition could be materially adversely affected. The
Company intends to work with its suppliers to ascertain what actions, if any,
are needed. To date, the Company has spent approximately $250,000 on the ERP
system and does not expect additional costs for the ERP system and other
potential problems related to the Year 2000 problem to exceed $200,000.
There can be no assurances, however, that unknown costs necessary to update the
Company's systems or address potential system interruptions of the Company's or
its suppliers' systems will not have a material adverse effect on the Company's
business, financial condition or results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting Standards
No. 14, Financial Reporting for Segments of a Business Enterprise. The new
standard becomes effective for fiscal years beginning after December 15, 1997,
and requires that comparative information from earlier years be restated to
conform to the requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Continued Market Acceptance of the Company's Products. The Company
currently markets visible and invisible light semiconductor-based
photocoagulator medical laser systems to the ophthalmic market and a visible
light semiconductor-based photocoagulator medical laser system to the
dermatological market. The Company believes that continued and increased sales,
if any, of these medical laser systems is dependent upon the continued market
acceptance of these products. Medical equipment purchasing decisions and
continued market acceptance of the Company's products may in turn depend on
opinions of medical professionals, performance and price, product and treatment
familiarity, procedure reimbursement economics and other factors. The Company
believes that recommendations by ophthalmologists and dermatologists as to the
use of semiconductor-based laser systems is essential for the continued market
acceptance of the Company's products. Such medical professionals may not
recommend these laser systems or related treatments unless they conclude, based
on clinical data and other factors, that the performance of these laser systems
and treatments are a beneficial alternative to competing technologies and
treatments. Favorable recommendations from such medical professionals is
particularly important to the Company because the ophthalmic and dermatological
communities historically have used more established visible light, argon gas or
other ion-based photocoagulation laser systems. The Company's
semiconductor-based laser systems are relatively new to the marketplace. The
Company's infrared laser systems deliver invisible light to provide additional
and, in some instances, improved treatments. Because many ophthalmologists and
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other ion-based laser systems, they may be reluctant or unwilling to convert to
semiconductor-based or infrared laser systems. In addition, ophthalmic
procedures are typically reimbursed by third party payers who are increasingly
scrutinizing the level of reimbursement for treatment procedures. Furthermore,
changes in government legislation or regulation could effect reimbursement
levels. A reduction in the level of reimbursement for treatments administered
with the Company's ophthalmic products would negatively impact the saleableness
of such products. Dermatological procedures are typically paid for by the
treated patient. Any reduction in the perceived value of such treatments would
reduce the price level that dermatologists can charge and would negatively
impact the saleability of such products. There can be no assurance that the
Company's medical laser systems will continue to be accepted by the market. The
failure of medical professionals to recommend the Company's laser systems, the
introduction of improved alternative technologies or treatments, the reluctance
or unwillingness of ophthalmologists or dermatologists to convert to
semiconductor-based laser systems or to infrared laser systems, or reductions in
treatment reimbursements would negatively impact the market acceptance of the
Company's products. Any significant decline in market acceptance of the
Company's products would have a material adverse effect on the Company's
business, results of operations and financial condition.
Competition. Competition in the market for devices used for ophthalmic and
dermatological treatments is intense and may increase. This market is also
characterized by rapid technological innovation and change, and the Company's
products could be rendered obsolete as a result of future innovations. The
Company's competitive position depends on a number of factors including product
performance, characteristics and functionality, ease of use, scalability,
durability and cost. In addition to other companies that manufacture
photocoagulators, the Company's products compete with pharmaceutical treatments,
other technologies and other surgical techniques. The Company's principal
competitors in ophthalmology are Coherent, Inc., Nidek, Inc. ("Nidek"), Carl
Zeiss, Inc. ("Zeiss"), Alcon International ("Alcon"), Keeler Instruments, Inc.
("Keeler") and HGM Medical Laser Systems, Inc. ("HGM"). Of these companys, most
currently offer a semiconductor-based laser system in ophthalmology. The
Company's principal competitors in dermatology are Laserscope and HGM, neither
of which currently offers a semiconductor-based laser system in dermatology.
Other competitors have substantially greater financial, engineering, product
development, manufacturing, marketing and technical resources than the Company.
Such companies may also have greater name recognition than the Company and
long-standing customer relationships. In addition, there can be no assurance
that other medical companies, academic and research institutions or others will
not develop new technologies or therapies, including medical devices, surgical
procedures or pharmacological treatments and obtain regulatory approval for
products utilizing such techniques that are more effective in treating the
ophthalmic and dermatological conditions targeted by the Company or are less
expensive than the Company's current or future products. Moreover, there can be
no assurance that the Company's technologies and products would not be rendered
obsolete by such developments. Any such developments could have a material
adverse effect on the business, financial condition and results of operations of
the Company.
Risks of Manufacturing and Dependence on Key Manufacturers and Suppliers.
The manufacture of the Company's infrared and visible light semiconductor-based
photocoagulator medical laser systems and the related delivery devices is a
highly complex and precise process which requires the integration of components
with unique characteristics. Accordingly, problems may occur in the manufacture
of the Company's products which could prevent shipping of some products or could
result in reduced bookings, manufacturing rework costs, delays in collecting
accounts receivable, additional service and warranty costs and a decline in the
Company's competitive position. There can be no assurance that the Company will
be able to continue to manufacture its existing products or future products on a
cost-effective and timely basis. Although the Company assembles critical
subassemblies as well as the final product at its facility in Mountain View,
California, the Company relies on third parties to manufacture substantially all
of the components used in its products. There are risks associated with the use
of
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independent manufacturers, unavailability of or delays in obtaining adequate
supplies of components such as optics and laser diodes and potentially reduced
control of quality, production costs and the timing of delivery. The Company has
qualified two or more sources for most of the components used in its products.
However, certain of the Company's products remain significantly dependent on
sole source suppliers. Certain diodes purchased from SDL, Inc. ("SDL") were not
readily available from other suppliers until the second quarter of 1997. During
1996 and the first quarter of 1997, the Company experienced delays in its
manufacturing of the OcuLight GL because of the inability of SDL to deliver
components in volume and on a timely basis. The Company continues to work with
this supplier to ensure such difficulties do not recur. During the first quarter
of 1997, the Company qualified Opto Power as a second source of this diode
component. Because laser diode components are extremely complex and difficult to
manufacture, there can be no assurance that the Company's suppliers of such
components will be able to timely deliver components in sufficient quantities to
meet the Company's requirements. Similar manufacturing issues or delays in the
delivery of other key components of the Company's products could also have a
material adverse impact on the Company. The Company does not have long-term or
volume purchase agreements with any of its suppliers and currently purchases
components on a purchase order basis. No assurance can be given that these
components will be available in the quantities required by the Company, on
reasonable terms, or at all. Establishing its own capabilities to manufacture
these components would require significant scale-up expenses and additions to
facilities and personnel and could significantly decrease the Company's profit
margins. The Company's inability to obtain components as required at a
reasonable cost, or at all, would have a material adverse affect on the
Company's business, results of operations and financial condition.
Dependence on International Sales. The Company derives, and expects to
continue to derive, a large portion of its revenue from international sales. In
1997 and 1996, the Company's international sales were $9.4 million and $6.1
million, representing 52% and 50%, respectively, of total sales. In addition,
for the three months ended July 4, 1998 and June 30, 1997, the Company's
international sales were $2.2 million and $2.4 million, representing 37% and 56%
respectively, of total sales. A large portion of the Company's revenues will
continue to be subject to the risks associated with international sales,
including fluctuations in foreign currency exchange rates, shipping delays,
generally longer receivables collection periods, changes in applicable
regulatory policies, international monetary conditions, domestic and foreign tax
policies, trade restrictions, duties and tariffs, and economic and political
instability. The recent currency devaluation in many Asian countries has had the
effect of significantly increasing the purchase price of the Company's products
to the Company's distributors and their customers in that region. Conversely,
because certain of the Company's competitors are based in Asia, the currency
devaluations may put additional downward pressures on the average selling prices
of the Company's products. Product sales were lower for the affected Asian
region during the first half of 1998 and the fourth quarter of 1997 primarily as
a result of the currency problem. The Company expects lower sales to the Asian
region to continue into 1998. Additionally, product sales to Europe were limited
in the second quarter of 1998 primarily as a result of delays in receiving CE
Certification. The Company received CE Certification in June 1998 and expects
sales to Europe to increase during the remainder of 1998. The Company also
expects revenues from international sales to continue to account for a
substantial portion of its sales. Accordingly, if the Asian economic
difficulties are prolonged, worsen or otherwise negatively impact the
saleability of the Company's product or if other government certifications
become required, these difficulties could negatively impact the Company's
business, results of operations, and financial condition. While these currency
and government approval factors and other factors listed above have been
mitigated by product sales in other regions and in the United States, there can
be no assurance that continuance or reoccurrence of the factors discussed above
will not have a material adverse effect on the Company's business, financial
condition or results of operations.
Quarterly Fluctuations in Operating Results. Although the Company has been
profitable on an annual and quarterly basis for the last five years, the
Company's sales and operating results have varied substantially on a quarterly
basis, and such fluctuations are expected to continue in future periods. The
Company's operating results
-12-
13
are affected by a number of factors, many of which are beyond the Company's
control. Factors contributing to these fluctuations include the timing of the
introduction and market acceptance of new products or product enhancements by
the Company and its competitors, the timing of receiving government approvals or
certification the cost and availability of components and subassemblies, changes
in pricing by the Company and its competitors, the timing of the development and
market acceptance of new applications for the Company's products, the relatively
long and highly variable sales cycle for the Company's products to hospitals and
other health care institutions, fluctuations in economic and financial market
conditions, such as the recent currency devaluation in Asia, and resulting
changes in customers' or potential customers' budgets and increased product
development costs. For example, the Company's gross profits as a percentage of
sales have generally declined in part as a result of increased competition which
have led to decreases in average selling prices, particularly with respect to
the Company's older products. Any inability to obtain adequate quantities of the
critical components used in the system products would adversely impact the
Company's ability to ship the OcuLight SL, OcuLight GL and the DioLite 532. In
addition to these factors, the Company's quarterly results have been and are
expected to continue to be affected by seasonal factors. For example, domestic
sales often decline slightly prior to the meeting of the American Academy of
Ophthalmology in the fourth quarter of the year. The Company manufactures its
products to forecast rather than to outstanding purchase orders, and products
are typically shipped shortly after receipt of a purchase order. While backlog
increased in 1996 and 1997 and decreased during the three months ending July 4,
1998, the Company does not expect significant backlog in the future and the
amount of backlog at any particular date is generally not indicative of its
future level of sales. Although the Company's manufacturing procedures are
designed to assure rapid response to customer orders, they may in certain
instances create a risk of excess or inadequate inventory levels if orders do
not match forecasts. The Company's expense levels are based, in part, on
expected future sales. If sales levels in a particular quarter do not meet
expectations, the Company may be unable to adjust operating expenses quickly
enough to compensate for the shortfall, and the Company's results of operations
may be adversely affected. In addition, the Company has historically made a
significant portion of each quarter's product shipments near the end of the
quarter. If that pattern continues, even short delays in shipment of products at
the end of a quarter could have a material adverse effect on results of
operations for such quarter. As a result of the above factors, sales for any
future quarter are not predictable with any significant degree of accuracy and
operating results in any period should not be considered indicative of the
results to be expected for any future period. There can be no assurance that the
Company will remain profitable in the future or that operating results will not
vary significantly.
Dependence on Development of New Products and New Applications. The
Company's future success is dependent upon, among other factors, its ability to
develop, obtain regulatory approval, manufacture and introduce on a timely and
cost-effective basis as well as successfully sell and achieve market acceptance
of new products and applications and enhanced versions of existing products. The
extent of, and rate at which, market acceptance and penetration are achieved by
future products, is a function of many variables, including price, safety,
efficacy, reliability, marketing and sales efforts, the development of new
applications for these products and general economic conditions affecting
purchasing patterns. Even if the Company's products achieve clinical acceptance,
there can be no assurance that the Company can successfully manage the
introduction of such products into the ophthalmic, dermatological or other
markets. The failure of the Company to successfully develop and introduce new
products or enhanced versions of existing products could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company is seeking to expand the market for its existing and new products by
working with clinicians and third parties to identify new applications for its
products, validating new procedures which utilize its products and responding
more effectively to new procedures. There can be no assurance that the Company's
efforts to develop new applications for its products will be successful, that it
can obtain regulatory approvals to use its products in new clinical applications
in a timely manner, or at all, or gain satisfactory market acceptance for such
new applications. Failure to develop and achieve market acceptance
-13-
14
of new applications or new products would have a material adverse effect on the
Company's business, results of operations and financial condition.
Management of Growth. With the introduction of new products, the Company
has recently experienced, and may continue to experience growth in production,
the number of employees, the scope of its business, its operating and financial
systems and the geographic area of its operations. This growth has resulted in
new and increased responsibilities for management personnel and has placed and
continues to place a significant strain upon the Company's management,
operating, inventory and financial systems and resources. To accommodate recent
growth and to compete effectively and manage future growth, if any, the Company
has been required to continue to implement and improve operational, financial
and management information systems, procedures and controls and to expand,
train, motivate and manage its work force. The Company is in the process of
implementing a new enterprise resource planning ("ERP") system to run the
Company's business transaction processes. The Company expects that the
installation and implementation of this new system will continue through the
third quarter of 1998. The transition to the ERP system is a highly complex and
technical process, and it is not uncommon for companies engaged in such a
transition to experience unexpected delays and technical problems. Because the
Company's operations are currently dependent on its existing system and will be
dependent upon the new system once it comes on line, the failure of the Company
to successfully implement the ERP system or difficulties encountered in the
changeover to the new system may have a material adverse effect on the Company's
business and results of operations. There can be no assurance that the Company
will be able to successfully install and implement the ERP system, and failure
to do so or difficulties encountered in the implementation process could have a
material adverse effect on the Company's business, results of operations and
financial condition. The Company's future success will depend on the successful
installation of these systems as well as on the ability of its current and
future executive officers to operate effectively, both independently and as a
group. There can be no assurance that the Company's personnel, systems,
procedures and controls will be adequate to support the Company's existing and
future operations. Any failure to implement and improve the Company's
operational, financial and management systems or to expand, train, motivate or
manage employees could have a material adverse effect on the Company's business,
results of operations and financial condition.
Dependence on Collaborative Relationships. The Company has entered into
collaborative relationships with academic medical centers and physicians in
connection with the research and development and clinical testing of its
products. The Company plans to collaborate with third parties to develop and
commercialize existing and new products. In May 1996, the Company executed an
agreement with Miravant Medical Technologies ("Miravant"), formerly known as
PDT, Inc.,a maker of photodynamic drugs, under which the Company and Miravant
have collaborated to develop a device that emits a laser beam to activate a
photodynamic drug developed by Miravant to achieve a desired therapeutic result
in the treatment of age-related macular degeneration. The development, clinical
testing and regulatory approval of this new photodynamic system will require
three to five years and significant financial and other resources. There can be
no assurance that this collaborative development effort will continue or that it
will result in the successful development and introduction of a photodynamic
system. The Company believes that these current and future relationships are
important because they may allow the Company greater access to funds, to
research, development and testing resources and to manufacturing, sales and
distribution resources. However, the amount and timing of resources to be
devoted to these activities are not within the Company's control. There can be
no assurance that such parties will perform their obligations as expected or
that the Company's reliance on others for clinical development, manufacturing
and distribution of its products will not result in unforeseen problems.
Further, there can be no assurance that the Company's collaborative partners
will not develop or pursue alternative technologies either on their own or in
collaboration with others, including the Company's competitors, as a means of
developing or marketing products for the diseases targeted by the collaborative
programs and by the Company's products. The failure of any current or future
collaboration efforts could have a material adverse effect on the Company's
ability to introduce new products or applications and
-14-
15
therefore could have a material adverse effect on the Company's business,
results of operations and financial condition.
Patents and Proprietary Rights. The Company's success and ability to
compete is dependent in part upon its proprietary information. The Company
relies on a combination of patents, trade secrets, copyright and trademark laws,
nondisclosure and other contractual agreements and technical measures to protect
its intellectual property rights. The Company files patent applications to
protect technology, inventions and improvements that are significant to the
development of its business. The Company has been issued six United States
patents on the technologies related to its products and processes. There can be
no assurance that any of the Company's patent applications will issue as
patents, that any patents now or hereafter held by the Company will offer any
degree of protection, or that the Company's patents or patent applications will
not be challenged, invalidated or circumvented in the future. Moreover, there
can be no assurance that the Company's competitors, many of which have
substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with the Company's ability to make, use or sell its products
either in the United States or in international markets.
In addition to patents, the Company relies on trade secrets and proprietary
know-how which it seeks to protect, in part, through proprietary information
agreements with employees, consultants and other parties. The Company's
proprietary information agreements with its employees and consultants contain
industry standard provisions requiring such individuals to assign to the Company
without additional consideration any inventions conceived or reduced to practice
by them while employed or retained by the Company, subject to customary
exceptions. There can be no assurance that proprietary information agreements
with employees, consultant and others will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known to or independently developed by competitors.
The laser and medical device industry is characterized by frequent
litigation regarding patent and other intellectual property rights and companies
in the medical device industry have employed intellectual property litigation to
gain a competitive advantage. Numerous patents are held by others, including
academic institutions and competitors of the Company. Because patent
applications are maintained in secrecy in the United States until patents are
issued and are maintained in secrecy for a period of time outside the United
States, the Company has not conducted any searches to determine whether the
Company's technology infringes any patents or patent applications. The Company
has from time to time been notified of, or has otherwise been made aware of
claims that it may be infringing upon patents or other proprietary intellectual
property owned by others. If it appears necessary or desirable, the Company may
seek licenses under such patents or proprietary intellectual property. Although
patent holders commonly offer such licenses, no assurance can be given that
licenses under such patents or intellectual property will be offered or that the
terms of any offered licenses will be reasonable or will not adversely impact
the Company's operating results. Recently, a company has challenged one of the
patents held by Light Solutions Corporation, a wholly-owned subsidiary of
IRIDEX. The Company believes that this dispute will be settled without a
material adverse effect to the Company's business and financial condition.
Any claims, with or without merit, could be time-consuming, result in
costly litigation and diversion of technical and management personnel, cause
shipment delays or require the Company to develop noninfringing technology or to
enter into royalty or licensing agreements. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. An adverse determination in
a judicial or administrative proceeding or failure to obtain necessary licenses
could prevent the Company from manufacturing and selling its products, which
would have a material adverse effect on the Company's business, results of
operations and financial condition. Conversely, litigation may be necessary to
enforce patents issued to the
-15-
16
Company, to protect trade secrets or know-how owned by the Company or to
determine the enforceability, scope and validity of the proprietary rights of
others. Both the defense and prosecution of intellectual property suits or
interference proceedings are costly and time consuming.
Government Regulation. The medical devices marketed and manufactured by the
Company are subject to extensive regulation by the Food and Drug Administration
("FDA") and by foreign and state governments. Pursuant to the FDA Act and the
regulations promulgated thereunder, the FDA regulates the design, development,
clinical testing, manufacture, labeling, sale, distribution and promotion of
medical devices. Before a new device can be introduced into the market, the
manufacturer must obtain market clearance through either the 510(k) premarket
notification process or the lengthier premarket approval ("PMA") application
process. Obtaining these approvals can take a long time and delay the
introduction of a product. For example, the introduction of the OcuLight GL in
the United States was delayed about three months from the Company's expectations
due to the longer than expected time period required to obtain FDA premarket
clearance. Noncompliance with applicable requirements, including QSR, can result
in, among other things, fines, injunctions, civil penalties, recall or seizure
of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing approvals, and criminal prosecution. The FDA also has
the authority to request repair, replacement or refund of the cost of any device
manufactured or distributed by the Company. The failure of the Company to obtain
government approvals or any delays in receipt of such approvals would have a
material adverse effect on the Company's business, results of operations and
financial condition.
Product Liability and Insurance. The Company may be subject to product
liability claims in the future. The Company's products are highly complex and
are used to treat extremely delicate eye tissue as well as to treat skin
conditions primarily on the face. The Company's products are often used in
situations where there is a high risk of serious injury or adverse side effects.
In addition, although the Company recommends that its disposable products only
be used once and so prominently labels these products, the Company believes that
certain customers may nevertheless reuse these disposable products. Were such a
disposable product not adequately sterilized by the customer between such uses,
a patient could suffer serious consequences, possibly resulting in a suit
against the Company for damages. Accordingly, the manufacture and sale of
medical products entails significant risk of product liability claims. Although
the Company maintains product liability insurance with coverage limits of $6.0
million per occurrence and an annual aggregate maximum of $7.0 million, there
can be no assurance that the coverage of the Company's insurance policies will
be adequate. Such insurance is expensive and in the future may not be available
on acceptable terms, if at all. A successful claim brought against the Company
in excess of its insurance coverage could have a material adverse effect on the
Company's business, results of operations and financial condition. To date, the
Company has not experienced any product liability claims.
Volatility of Stock Price. The trading price of the Company's Common Stock
has been subject to wide fluctuations in response to a variety of factors since
the Company's initial public offering in February 1996, including quarterly
variations in operating results, announcements of technological innovations or
new products by the Company or its competitors, developments in patents or other
intellectual property rights, general conditions in the ophthalmic laser
industry, revised earning estimates, comments or recommendations issued by
analysts who follow the Company, its competitors or the ophthalmic laser
industry and general economic and market conditions. Additionally, the stock
market in general, and the market for technology stocks in particular, have
experienced extreme price volatility in recent years. Volatility in price and
volume has had a substantial effect on the market prices of many technology
companies for reasons unrelated or disproportionate to the operating performance
of such companies. These broad market fluctuations could have a significant
impact on the market price of the Common Stock.
-16-
17
Year 2000 Compliance. The Company uses a significant number of computer
software programs and operating systems in its internal operations, including
applications for various financial, business and administrative functions. In
addition, many of the Company's suppliers use similar applications. These
applications may contain source code that is unable to properly interpret
calendar years beginning with the upcoming year 2000. Systems that do not
properly recognize such date-sensitive information may fail or create erroneous
results. Because there are no internal calendars embedded in any of the
Company's products, the Company does not anticipate any problems with its
products related to the Year 2000 problem will develop. The Company is currently
installing a new ERP system which it believes will be fully Year 2000 compliant.
Based on this and other information currently available to the Company, the
Company believes that its internal systems currently are, or will be by such
time as is necessary to avoid a material adverse impact on the Company, Year
2000 compliant. Also based on information thus far available to the Company, the
Company does not believe that it will incur expenditures in dealing with Year
2000 issues that will have a material adverse effect on the financial condition
of the Company. In addition to the risks from failure of the Company's own
internal systems, the Company may also be exposed to risks from computer systems
of parties with whom the Company transacts business. For example, if the
internal systems of one of the Company's key suppliers developed problems such
that the supplier could not deliver parts to the Company on a timely basis, the
Company's financial condition could be materially adversely affected. The
Company intends to work with its suppliers to ascertain what actions, if any,
are needed. To date, the Company has spent approximately $250,000 on the ERP
system and does not expect additional costs for the ERP system and other
potential problems related to the Year 2000 problem to exceed $200,000.
There can be no assurances, however, that unknown costs necessary to update the
Company's systems or address potential system interruptions of the Company's or
its suppliers' systems will not have a material adverse effect on the Company's
business, financial condition or results of operations.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
On June 8, 1998, the Annual Meeting of Stockholders of the Company was held
in Mountain View, California. An election of Directors was held with a slate of
seven candidates, Theodore Bontacoff, James Donovan, Milton Chang, Donald
Hammond, William Boeger, Joshua Makower and John Nehra being elected to the
Board of Directors of the Company. The slate of candidates received
approximately 5,504,739 affirmative votes of shares represented and voting and
approximately 4,480 shares voted against the slate. Votes withheld from any
nominee and broker non-votes were counted for purposes of determining the
presence or absence of a quorum.
The stockholders also approved the adoption of the 1998 Stock Plan and the
reservation of 250,000 shares of Common Stock for issuance thereunder. There
were 3,097,629 shares voted for adoption, 1,042,334 shares voted against the
adoption, 8,180 shares abstained and there were 1,361,076 broker non-votes. The
stockholders also approved an amendment of the Company's 1995 Employee Stock
Purchase Plan to increase the number of shares of Common Stock reserved for
issuance thereunder by 75,000 shares from 100,000 shares to 175,000. There were
4,079,143 shares voted in favor of the amendment, 58,820 shares voted against
the amendment, 10,180 shares abstained and there were 1,361,076 broker
non-votes. The stockholders also approved an amendment of the Company's 1995
Director Option Plan to increase the number of shares of Common Stock thereunder
by 60,000 shares from 100,000 shares to 160,000 shares. There were 4,051,076
shares voted in favor of the amendment, 87,587 shares voted against the
amendment, 9,480 shares abstained and there were 1,361,076 broker non-votes.
Additionally, the stockholders ratified the appointment of
PricewaterhouseCoopers LLP as independent accountants of the Company for the
fiscal year ending December 31, 1998. There were 5,501,864 shares voted in favor
of the ratification, 1,300 shares voted against the ratification and 6,055
shares abstained. The affirmative vote of the holders of a majority of the
Common Stock represented in person or by proxy and entitled to vote at the
Annual Meeting ("Votes Cast") was needed in order to approve the foregoing
proposals. Votes Cast against the proposals
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18
were counted for purposes of determining (i) the presence or absence of a quorum
for the transaction of business and (ii) the number of Votes Cast with respect
to each such proposal. An abstention had the same effect as a vote against the
proposal. Broker non-votes were counted for purposes of determining the presence
or absence of a quorum, but were not counted as Votes Cast.
ITEM 5. OTHER INFORMATION
A Stockholder may notify the Company of its intent to raise a matter at the
1999 Annual Meeting and eliminate the Company's discretionary proxy authority
over that issue by submitting a request to the Company at least 45 days prior to
the month and day that the Company's prior year's proxy was mailed.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
A Report on Form 8-K was filed on June 19, 1998 to disclose that a change
in the Company's fiscal year end.
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19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IRIDEX CORPORATION
(Registrant)
Date: August 17, 1998 By: /s/ Robert Kamenski
-----------------------------
Robert Kamenski
Chief Financial Officer
(Principal Financial and
Principal Accounting Officer)
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20
INDEX TO EXHIBITS
EXHIBIT PAGE
- ------- ----
27.1 Financial Data Schedule 22
-20-
5
1,000
6-MOS
JAN-02-1999
JAN-01-1998
JUL-04-1998
5,794
5,226
7,858
(285)
6,096
25,553
3,534
(1,258)
27,904
2,741
0
0
0
21,719
3,444
27,904
11,874
11,874
4,977
4,977
5,358
0
0
1,787
(607)
0
0
0
0
1,180
0.18
0.17
