e10vq
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the quarterly period ended July 1, 2006
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o |
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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)
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Delaware
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77-0210467 |
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(State or other jurisdiction of
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(I.R.S. employer |
incorporation or organization)
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identification No.) |
1212 Terra Bella Avenue
Mountain View, California 94043-1824
(Address of principal executive offices, including zip code)
(650) 940-4700
(Registrants 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. Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. (See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act).
Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
APPLICABLE TO CORPORATE ISSUERS:
The number
of shares of common stock, $.01 par value, issued and outstanding as
of December 15,
2006 was 7,829,948.
IRIDEX Corporation
Table of Contents
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39 |
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40 |
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2
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
IRIDEX Corporation
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
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July 1, |
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December 31, |
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2006 |
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2005 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
3,738 |
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$ |
12,655 |
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Available-for-sale securities |
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18,540 |
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8,779 |
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Accounts receivable, net |
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6,035 |
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6,589 |
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Inventories |
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8,877 |
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8,594 |
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Prepaids and other current assets |
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777 |
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885 |
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Current deferred income taxes |
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1,415 |
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1,415 |
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Total current assets |
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39,382 |
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38,917 |
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Property and equipment, net |
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1,048 |
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1,114 |
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Deferred income taxes and other long term assets |
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1,099 |
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1,073 |
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Total assets |
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$ |
41,529 |
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$ |
41,104 |
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Liabilities and Stockholders Equity |
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Current liabilities: |
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Accounts payable |
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$ |
1,356 |
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$ |
1,094 |
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Accrued expenses |
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3,304 |
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4,421 |
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Deferred revenue |
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1,224 |
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1,072 |
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Total liabilities |
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5,884 |
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6,587 |
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Contingencies
(Note 6) |
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Stockholders equity: |
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Common stock |
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78 |
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76 |
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Additional paid-in capital |
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28,275 |
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26,334 |
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Accumulated other comprehensive loss |
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(5 |
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(27 |
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Treasury stock |
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(430 |
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(430 |
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Retained earnings |
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7,727 |
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8,564 |
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Total stockholders equity |
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35,645 |
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34,517 |
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Total liabilities and stockholders equity |
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$ |
41,529 |
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$ |
41,104 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
IRIDEX Corporation
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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Six Months Ended |
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July 1, |
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July 2, |
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July 1, |
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July 2, |
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2006 |
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2005 |
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2006 |
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2005 |
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Sales |
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$ |
8,804 |
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$ |
9,387 |
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$ |
17,647 |
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$ |
17,532 |
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Cost of sales |
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4,145 |
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4,842 |
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8,726 |
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9,309 |
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Gross profit |
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4,659 |
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4,545 |
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8,921 |
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8,223 |
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Operating expenses: |
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Research and development |
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1,328 |
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922 |
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2,449 |
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1,961 |
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Sales, general and administrative |
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3,864 |
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3,065 |
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7,796 |
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5,862 |
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Total operating expenses |
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5,192 |
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3,987 |
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10,245 |
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7,823 |
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Income (loss) from operations |
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(533 |
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558 |
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(1,324 |
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400 |
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Interest and other income,
net |
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177 |
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130 |
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356 |
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256 |
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Income (loss) before income taxes |
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(356 |
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688 |
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(968 |
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656 |
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Benefit from (provision for) income taxes |
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(178 |
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(258 |
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131 |
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(246 |
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Net income (loss) |
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$ |
(534 |
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$ |
430 |
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$ |
(837 |
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$ |
410 |
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Net income (loss) per common share basic |
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($ |
0.07 |
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$ |
0.06 |
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($ |
0.11 |
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$ |
0.06 |
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Net income (loss) per common share diluted |
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($ |
0.07 |
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$ |
0.05 |
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($ |
0.11 |
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$ |
0.05 |
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Shares used in per common share basic
calculations |
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7,694 |
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7,362 |
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7,641 |
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7,339 |
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Shares used in per common share diluted
calculations |
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7,694 |
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7,955 |
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7,641 |
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7,778 |
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(A) Results for the three and six months ended July 1, 2006 and July 2, 2005 include stock-based
compensation expense as follows:
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Three Months Ended |
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Six Months Ended |
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July
1, 2006 |
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July
2, 2005 |
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July
1, 2006 |
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July
2, 2005 |
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(In thousands) |
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Cost of sales |
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$ |
31 |
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$ |
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$ |
67 |
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$ |
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Research and development |
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73 |
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121 |
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Selling, general and administrative |
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374 |
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747 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
IRIDEX Corporation
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
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Three Months Ended |
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Six Months Ended |
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July 1, |
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July 2, |
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July 1, |
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July 2, |
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2006 |
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2005 |
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2006 |
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2005 |
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Net income (loss) |
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$ |
(534 |
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$ |
430 |
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$ |
(837 |
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$ |
410 |
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Other comprehensive income (loss): |
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Change in unrealized gain (loss) on
available-for-sale
securities, net of
tax |
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5 |
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12 |
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14 |
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(13 |
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Comprehensive income (loss) |
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$ |
(529 |
) |
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$ |
442 |
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$ |
(823 |
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$ |
397 |
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The accompanying notes are an integral part of these condensed consolidated financial statements
5
IRIDEX Corporation
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
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Six Months Ended |
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July 1, |
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July 2, |
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2006 |
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2005 |
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Cash flows from operating activities: |
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Net income (loss) |
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$ |
(837 |
) |
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$ |
410 |
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Adjustments
to reconcile net income to net cash provided by (used in) operating activities: |
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Depreciation and amortization |
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251 |
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223 |
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Stock-based compensation |
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935 |
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Provision for (recoveries of) doubtful accounts |
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68 |
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36 |
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Provision
for excess and obsolete inventories |
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16 |
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134 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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486 |
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191 |
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Inventories |
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(299 |
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(173 |
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Prepaids and other current assets |
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108 |
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(160 |
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Other long term assets |
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(26 |
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Accounts payable |
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262 |
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(83 |
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Accrued expenses |
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(1,115 |
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(501 |
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Deferred revenue |
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152 |
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469 |
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Net cash
provided by operating activities |
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1 |
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546 |
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Cash flows from investing activities: |
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Purchases of available-for-sale securities |
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(18,519 |
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(3,593 |
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Proceeds from maturity of available-for-sale securities |
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8,778 |
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3,016 |
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Acquisition of property and equipment |
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(185 |
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(176 |
) |
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Net cash used in investing activities |
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(9,926 |
) |
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(753 |
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Cash flows from financing activities: |
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Issuance of common stock |
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1,008 |
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308 |
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Net cash provided by financing activities |
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1,008 |
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308 |
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Net increase (decrease) in cash and cash equivalents |
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(8,917 |
) |
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101 |
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Cash and cash equivalents at beginning of period |
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12,655 |
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|
10,381 |
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Cash and cash equivalents at end of period |
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$ |
3,738 |
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$ |
10,482 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
6
IRIDEX Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of IRIDEX Corporation
(the Company) have been prepared in accordance with generally accepted accounting principles in
the United States of America for interim financial information and pursuant to the instructions to
Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States
of America for complete financial statements. In the opinion of management, all adjustments,
consisting of normal recurring adjustments, considered necessary for a fair statement have been
included.
The condensed consolidated financial statements should be read in conjunction with the audited
financial statements and notes thereto, together with managements discussion and analysis of
financial condition and results of operations, contained in our Annual Report on Form 10-K, which
was filed with the Securities and Exchange Commission on April 3, 2006. The results of operations
for the three and six months period ended July 1, 2006 are not necessarily indicative of the
results for the year ending December 30, 2006 or any future interim period.
2. Restatement of Financial Results for the Quarter Ended April 1, 2006
As
disclosed in the Companys Current Report on Form 8-K dated
August 21, 2006, in August 2006,
the Audit Committee of the Board of Directors engaged outside counsel and initiated an independent
review of the Companys revenue recognition practices. This
review was initiated in response to an allegation made by a former
employee that the Company had recognized revenues prematurely in its
fourth fiscal quarter of 2004. The investigation concluded that the
Company had prematurely recognized revenue in 2004, but the error did
not arise from any wrongful intent to impact the Companys financial
reporting. In the course of this
review, other errors unrelated to the allegation were identified from the period
beginning in the fourth
quarter of 2003 through the first quarter of 2006. As it relates to the errors identified in the
first quarter of 2006, the Company determined that it was necessary to restate its financial
results for the quarter ended April 1, 2006 to reflect adjustments to the previously reported financial information.
While the review identified errors relating to
the periods from the fourth quarter of 2003 through December 31, 2005, the Audit Committee of the Board of Directors
concluded that
these errors were not material to the previously issued financial
statements. The six month results of 2006 includes adjustments to
reduce revenue, cost of sales and operating expenses by $81,000,
$43,000, and $5,000, respectively, related to the correction of
immaterial errors related to prior periods.
3. Changes to August 3, 2006 Press Release
On August 3, 2006, the Company issued a press release announcing results for the three and six
months ended July 1, 2006 which was furnished in a Current Report on Form 8-K dated August 3, 2006.
Those results differ from the results presented in this Form 10-Q as follows:
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Increase (decrease) in revenue of $94,000 and ($73,000) for the three and six months ended July 1,
2006, respectively, due to identified errors in revenue recognition in the first quarter
of 2006. |
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Increase (decrease) in cost of sales of $53,000 and ($30,000) and
operating expenses of $6,000
and $(4,000) for the three and six months ended July 1, 2006, respectively, due to
identified errors in revenue recognition in the first quarter of 2006. |
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Increase in operating expenses of $169,000 for the three and six months ended July 1,
2006 due to an increase in the estimated provision for bad debt expense based on updated
information available subsequent to the issuance of the press release. |
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Decrease in the income tax benefit of $448,000 and $414,000 for the three and six
months ended July 1, 2006, respectively, based on the changes identified above, as well as
to a change in the estimated tax rate based on updated forecast results for 2006. |
4. Summary of Significant Accounting Policies
The Companys significant accounting policies are disclosed in our Annual Report on Form 10-K
for the year ended December 31, 2005 which was filed with the Securities and Exchange Commission on
April 3, 2006. With the exception of the adoption of Statement of Financial Accounting Standards
No. 123(R), (SFAS 123(R)), the Company adopted on January 1, 2006, the Companys significant
accounting policies have not materially changed as of July 1, 2006.
Revenue
Recognition
Our
revenue arise
from the sale of consoles, delivery devices and service and support activities. Revenue from
product sales is recognized upon receipt of a purchase order and product shipment
provided that no significant obligations remain and collection of the receivables is reasonably
assured. Shipments are generally made with Free-On-Board (FOB) shipping point terms, whereby title
passes upon
shipment from our dock. Any shipments with FOB receiving point terms are recorded as revenue when
the shipment arrives at the receiving point. Up-front fees received in connection with product
sales are deferred
7
and recognized over the associated product shipments.
Revenue relating to
extended warranty contracts is recognized on a straight line basis over the period of the
applicable warranty contract. We recognize service repair revenue upon completion of the work.
Cost is recognized as product sales revenue is recognized. The Companys sales may include post-sale obligations for training
or other deliverables. When these obligations are fulfilled after product shipment, the Company
recognizes revenue in accordance with the multiple element accounting guidance set forth in
Emerging Issues Task Force No. 00-21, Revenue Arrangements with Multiple Deliverables. When the Company
has objective and reliable evidence of fair value of the undelivered elements, it defers revenue
attributable to the post-shipment obligations and recognizes such revenue when the obligation is
fulfilled. Otherwise, the Company defers all revenue related to the transaction until all elements
are delivered.
Deferred
Revenue
Deferred revenue related to warranty contracts is recognized on a straight line basis over the
period of the applicable contract. Cost is recognized as incurred. A reconciliation of changes in
the Companys deferred revenue balances for the six months ending July 1, 2006 and July 2, 2005
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
July 1, 2006 |
|
|
July 2, 2005 |
|
Balance, beginning of period |
|
$ |
1,072 |
|
|
$ |
910 |
|
|
Additions to deferred revenue |
|
|
822 |
|
|
|
1,185 |
|
|
Revenue recognized |
|
|
(670 |
) |
|
|
(716 |
) |
|
|
|
|
|
|
|
|
Balance, end of period |
|
$ |
1,224 |
|
|
$ |
1,379 |
|
|
|
|
|
|
|
|
Warranty
The Company accrues for an estimated warranty cost upon shipment of products in accordance
with Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies.
Actual warranty costs incurred have not materially differed from those accrued. The Companys
warranty policy is effective for shipped products which are considered defective or fail to meet
the product specifications. Warranty costs are reflected in the statement of operations as a cost
of sales. A reconciliation of the changes in the Companys warranty liability for the six months
ending July 1, 2006 and July 2, 2005 follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
July 1, 2006 |
|
|
July 2, 2005 |
|
Balance, beginning of period |
|
$ |
1,128 |
|
|
$ |
933 |
|
|
Accruals for warranties issued during the period |
|
|
335 |
|
|
|
679 |
|
|
Settlements made in kind during the period |
|
|
(534 |
) |
|
|
(474 |
) |
|
|
|
|
|
|
|
|
Balance, end of period |
|
$ |
929 |
|
|
$ |
1,138 |
|
|
|
|
|
|
|
|
8
5. Inventories
Inventories are
stated at the lower of cost or market. Cost is determined under a standard cost, which approximates
a first in, first out basis. The components of inventories consist of the following (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
July 1, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Raw materials and work in progress |
|
$ |
4,854 |
|
|
$ |
5,191 |
|
Finished goods |
|
|
4,023 |
|
|
|
3,403 |
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
8,877 |
|
|
$ |
8,594 |
|
|
|
|
|
|
|
|
6. Contingencies
From time to time, the
Company may be engaged in certain administrative proceedings, incidental to its normal business activities.
Management believes that liabilities resulting from such proceedings, or claims which are pending or known
to be threatened, are adequately covered by liability insurance and will not have a material adverse effect
on the Companys financial position, results of operations or cash flows.
In
October 2005, the Company filed a suit against Synergetics USA, Inc.
(Synergetics USA). The suit is entitled
IRIDEX Corporation v. Synergetics USA, Inc.,
Case No. 4:05CV1916CDP in the United States District Court for the
Eastern District of Missouri, Eastern Division, St. Louis for
infringement of our patent No. 5,085,492. The Company seeks
injunctive relief, monetary damages, treble damages, cost and
attorneys fees. Synergetics USA answered our complaint in November
2005, denied liability for patent infringement, and filed counterclaims seeking a
declaratory judgment that it did not infringe our patent. Synergetics USA also brought three additional
counterclaims for false advertising, commercial disparagement, trade libel, injurious falsehood, unfair
competition, disparagement of property, slander of goods and defamation, under state and federal law, based
upon allegations that we had raised safety issues involving Synergetics product with the Food and Drug
Administration and the public. Synergetics seeks monetary damages, costs and attorneys fees. Our response
to these counterclaims was a denial of any wrongdoing and a reference to the expiration of the statute of limitations
on those claims.
On July 7, 2006, the
United States District Court for the Eastern District of Missouri, Eastern Division, St. Louis issued a Claim
Construction Ruling, interpreting 14 disputed phrases within the Companys patent No. 5,085,492. The court
adopted the Companys position with respect to 13 of the 14 patent terms, and adopted a position between the
Companys and Synergetics positions with respect to the 14th term. On November 2, 2006, the Company
amended its complaint to add patent infringement claims against Synergetics USAs wholly owned subsidiary,
Synergetics Inc. On November 10, 2006, Synergetics Inc. and Synergetics USA answered the amended complaint,
denying liability for patent infringement and filing counterclaims seeking a declaratory judgment that they did not
infringe the Companys patent. Synergetics Inc. also re-filed the three additional counterclaims relating to
disparagement, thereby substituting Synergetics Inc. for Synergetics USA as the plaintiff on those counterclaims.
Discovery is scheduled to end on December 22, 2006, and trial is scheduled to begin on April 16, 2007. The Company
is confident that its patent claims have merit, and if the parties do not reach a settlement, the Company intends to
vigorously pursue its claims to judgment.
The
Company is involved in another suit with Synergetics Inc., entitled
Synergetics, Inc. v. Peregrine Surgical, Ltd., Innovatech Surgical, Inc., and
IRIDEX Corporation,
Case No. 06-CV-107 in the United States District Court for the Eastern District of Pennsylvania.
Synergetics filed suit against the Company on April 25, 2006, by adding the Company as a defendant
to a then-existing lawsuit against the other two defendants. Synergetics Inc. alleges that the Company
infringes its patent and seeks injunctive relief, monetary damages, treble damages, costs and attorneys
fees. On June 29, 2006, the Company filed its response to Synergetics Inc.s pleading, denying Synergetics Inc.s
claims and asserting counterclaims seeking a declaratory judgment that it does not infringe Synergetics Incs patent.
Synergetics Inc. responded to the Companys counterclaims on July 24, 2006, denying them. On August 10, 2006, the
case was reassigned to District Judge Thomas Golden.
On July 19, 2006,
Synergetics Inc. filed suit in the United States District Court
for the Eastern District of Missouri against the Company, seeking a declaratory judgment that a laser probe connector
system that it announced on July 10, 2006 does not infringe the Companys patent No. 5,085,492, and seeking a
declaratory judgment that the Companys patent is invalid and unenforceable. This suit is
entitled Synergetics, Inc. v. IRIDEX Corporation, Case No. 4:06CV1104CDP.
On August 15, 2006, the Company answered the Synergetics Inc. complaint, denying that Synergetics Inc. was entitled to
any relief, and filed crossclaims against Synergetics USA Inc. and counterclaims against Synergetics Inc., alleging that
they infringe the Companys patent No. 5,085,492 and seeking injunctive relief, monetary damages, treble damages,
costs and attorneys fees. On November 20, 2006, the Court ordered that this case (No. 4:06CV1104CDP) be
consolidated for all purposes with the case against Synergetics USA pending in the same court (No. 4:05CV1916CDP), that the amended pleadings in the earlier case shall be the
operative pleadings, and that this case be administratively closed.
Management believes that liabilities resulting from the proceedings described
above (collectively referred to hereafter in this Quarterly Report on Form 10-Q as the Synergetics Litigation Matters), or
claims which are pending or known to be threatened, will not have a material adverse effect on the Companys financial
position or results of operations and are adequately covered by the Companys liability insurance. However, it
is possible that cash flows or results of operations could be materially affected in any particular period by the
unfavorable resolution of one or more of these contingencies or because of the diversion of managements attention
and the incurrence of significant expenses.
9
7. Computations of Net Income (Loss) Per Common Share
Basic and diluted net income (loss) per share are computed by dividing net income (loss) for
the period by the weighted average number of shares of common stock outstanding during the period.
The calculation of diluted net income (loss) per share includes the dilutive effect of potentially
dilutive common stock provided the inclusion of such potential common stock is not antidilutive.
Potential common stock consists of incremental common shares issuable upon the exercise of stock
options and a warrant to purchase common shares.
During the three months ended July 1, 2006, options to purchase 15,500 shares of common stock
at a weighted average exercise price of $12.45 per share as well as warrants to purchase 25,000
shares at a weighted average exercise price of $6.07 were outstanding, but were not included in the
computations of diluted net income per common share because the exercise price of the related
options exceeded the average market price of the common shares. During the three months ended July
2, 2005, options to purchase 700,667 shares of common stock at a weighted average exercise price of
$8.28 per share were outstanding but were not included in the computations of diluted net income
per common share because the exercise price of the related options exceeded the average market
price of the common shares. During the six months ended July 2, 2005, options to purchase 855,781
shares at a weighted average exercise price of $7.84 were outstanding, but were not included in the
computations of diluted net income per share because the exercise price of the related options
exceeded the average market price of the common shares. During the six months ended July 1, 2006,
options to purchase 2,081,448 shares at a weighted average exercise
price of $5.80 as well as a
warrant to purchase 25,000 shares at a weighted average exercise price of $6.07 were outstanding,
but were not included in the computations of diluted net loss per share because their effect was
antidilutive. These options could dilute earnings per share in future periods.
8. Business Segments
We operate in two reportable segments: the ophthalmology medical device segment and the
dermatology medical device segment. In both segments, we develop, manufacture and market medical
devices. Our revenues arise from the sale of consoles, delivery devices, disposables and service
and support activities.
Information on reportable segments for the three and six months ended July 1, 2006 and July 2,
2005 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 1, 2006 |
|
|
Three Months Ended July 2, 2005 |
|
|
|
Ophthalmology |
|
|
Dermatology |
|
|
|
|
|
|
Ophthalmology |
|
|
Dermatology |
|
|
|
|
|
|
Medical |
|
|
Medical |
|
|
|
|
|
|
Medical |
|
|
Medical |
|
|
|
|
|
|
Devices |
|
|
Devices |
|
|
Total |
|
|
Devices |
|
|
Devices |
|
|
Total |
|
Sales |
|
$ |
7,681 |
|
|
$ |
1,123 |
|
|
$ |
8,804 |
|
|
$ |
7,687 |
|
|
$ |
1,700 |
|
|
$ |
9,387 |
|
|
Direct cost of goods
sold |
|
|
2,213 |
|
|
|
475 |
|
|
|
2,688 |
|
|
|
2,660 |
|
|
|
932 |
|
|
|
3,592 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct gross margin |
|
|
5,468 |
|
|
|
648 |
|
|
|
6,116 |
|
|
|
5,027 |
|
|
|
768 |
|
|
|
5,795 |
|
|
Total unallocated
costs |
|
|
|
|
|
|
|
|
|
|
(6,472 |
) |
|
|
|
|
|
|
|
|
|
|
(5,107 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax income (loss) |
|
|
|
|
|
|
|
|
|
|
(356 |
) |
|
|
|
|
|
|
|
|
|
|
688 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended July 1, 2006 |
|
|
Six Months Ended July 2, 2005 |
|
|
|
Ophthalmology |
|
|
Dermatology |
|
|
|
|
|
|
Ophthalmology |
|
|
Dermatology |
|
|
|
|
|
|
Medical |
|
|
Medical |
|
|
|
|
|
|
Medical |
|
|
Medical |
|
|
|
|
|
|
Devices |
|
|
Devices |
|
|
Total |
|
|
Devices |
|
|
Devices |
|
|
Total |
|
Sales |
|
$ |
15,221 |
|
|
$ |
2,426 |
|
|
$ |
17,647 |
|
|
$ |
13,880 |
|
|
$ |
3,652 |
|
|
$ |
17,532 |
|
|
Direct cost of goods sold |
|
|
4,742 |
|
|
|
1,158 |
|
|
|
5,900 |
|
|
|
4,759 |
|
|
|
1,927 |
|
|
|
6,686 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct gross margin |
|
|
10,479 |
|
|
|
1,268 |
|
|
|
11,747 |
|
|
|
9,121 |
|
|
|
1,725 |
|
|
|
10,846 |
|
|
Total unallocated costs |
|
|
|
|
|
|
|
|
|
|
(12,715 |
) |
|
|
|
|
|
|
|
|
|
|
(10,190 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax income (loss) |
|
|
|
|
|
|
|
|
|
|
(968 |
) |
|
|
|
|
|
|
|
|
|
|
656 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect costs of manufacturing, research and development, and selling, general and
administrative costs are not allocated to the segments.
The Companys assets and liabilities are not evaluated on a segment basis. Accordingly, no
disclosure of segment assets and liabilities is provided.
9. Stockbased Compensation
Employee Stock Purchase Plan
The IRIDEX 2005 Stock Purchase Plan (the Purchase Plan) permits eligible employees
(including officers) to purchase Common Stock through payroll deductions, which may not exceed 10%
of an employees compensation. No employee may purchase more than $25,000 worth of stock in any
calendar year or more than 2,000 shares of Common Stock in any twelve-month period. The price of
shares purchased under the Purchase Plan is 85% of the lower of the fair market value of the Common
Stock at the beginning of the offering period or the end of the offering period.
Stock Option Plans
Amended and Restated 1989 Incentive Stock Plan
The Amended and Restated 1989 Plan (the 1989 Plan) provided for the grant of options and
stock purchase rights to purchase shares of our Common Stock to employees and consultants. The
terms of the 1989 Plan, which expired in August 1999, are substantially the same as the 1998 Plan
described below.
11
1998 Stock Plan
The 1998 Stock Plan (the 1998 Plan), as amended, provides for the granting to employees
(including officers and employee directors) of incentive stock options and for the granting to
employees (including officers and employee directors) and consultants of nonstatutory stock
options, stock purchase rights (SPRs), restricted stock, restricted stock units, performance
shares, performance units and stock appreciation rights. The 1998 Plan is administered by the
Companys Board of Directors (the Administrator).
The exercise price of incentive stock
options and stock appreciation rights granted under the 1998 Plan must be at least equal to the
fair market value of the shares at the time of grant. With respect to any recipient who owns stock
possessing more than 10% of the voting power of our outstanding capital stock, the exercise price
of any option or SPR granted must be at least equal to 110% of the fair market value at the time of
grant. Options granted under the 1998 Plan are exercisable at such times and under such conditions
as determined by the Administrator; generally over a four year period. The maximum term of
incentive stock options granted to any recipient must not exceed ten years; provided, however, that
the maximum term of an incentive stock option granted to any recipient possessing more than 10% of
the voting power of our outstanding capital stock must not exceed five years. In the case of SPRs,
unless the Administrator determines otherwise, the Company has a repurchase option exercisable upon
the voluntary or involuntary termination of the purchasers employment with the Company for any
reason (including death or disability). Such repurchase option lapses at a rate determined by the
Administrator. The purchase price for shares repurchased by the Company is the original price paid
by the purchaser. As of July 1, 2006 and July 2, 2005, no shares were subject to repurchase. The
form of consideration for exercising an option or stock purchase right, including the method of
payment, is determined by the Administrator. The 1998 Plan expires in June 2008.
1995 Director Option Plan
In October 1995, the Company adopted the 1995 Director Option Plan (the Director Plan),
under which members of the Board of Directors were granted options to purchase 11,250 shares upon
the first to occur of their appointment or the adoption of the Director Plan (First Option) and
an option to purchase 3,750 shares (Subsequent Option) on July 1 of each year thereafter provided
that he or she has served on the Board of Directors for at least the preceding six months. The
options granted had exercise prices equal to the fair market value on the date of grant. The First
Option becomes exercisable as to one-twelfth (1/12) of the shares subject to the First Option for
each quarter over a three-year period. Each Subsequent Option becomes exercisable as to one-fourth
(1/4) of the shares subject to the Subsequent Option for each quarter, commencing one quarter after
the First Option and any previously granted Subsequent Options have become fully exercisable.
Options granted under the Director Plan have a term of 10 years.
In the event of our merger with or into another corporation, resulting in a change of control,
or the sale of substantially all of our assets, each Director Plan options become exercisable in
full and shall be exercisable for 30 days after written notice to the holder of the event causing
the change in control.
The Director Plan terminated in 2005. Directors are now granted options under the 1998 Plan.
Stand-Alone Options and Warrants
In July 2005, in connection with the employment of Barry G. Caldwell as the Companys Chief
Executive Officer, the Companys Board of Directors granted a stand alone option, outside of the
Companys existing
12
stock plans, to the Chief Executive Officer. The option entitles Mr. Caldwell to
purchase up to 234,104 shares of the Companys common stock at an exercise price of $6.07 per
share.
In conjunction with the employment of the Companys Chief Executive Officer in July 2005, in
consideration of services performed under a recruiting contract, the Company issued a warrant to
purchase 25,000 shares of the Companys common stock at an exercise price of $6.07 per share. The
warrant is exercisable at any time and expires on July 5, 2008. The fair value of the warrants of
$87,000 was recorded as an expense for the twelve month period ended December 31, 2005. The fair
value of the warrant was calculated using the Black-Scholes pricing model with the following
assumptions: dividend yield of 0 percent, contractual life of 3 years, risk free rates of 4.04
percent and volatility of 83 percent. At July 1, 2006, the warrant remained outstanding.
In March 2006, in connection with the employment of the Companys Vice President of Product
Innovation, the Companys Board of Directors granted a stand alone option, outside of the Companys
existing stock plans, to Deborah Tomasco, the Companys Vice President of Product Innovation. The
option entitles Ms. Tomasco to purchase up to 50,000 shares of the Companys common stock at an
exercise price of $8.26 per share.
Stock-Based Compensation
The Company adopted SFAS 123(R) using the modified prospective method, which requires the
application of the accounting standard as of January 1, 2006, the first day of the Companys fiscal
year. The Companys financial statements as of and for the six months ended July 1, 2006 reflect
the impact of SFAS 123(R). In accordance with the modified prospective method, the Companys
financial statements for prior periods have not been restated to reflect, and do not include the
impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the six
months ended July 1, 2006 was $0.9 million, which consisted of stock-based compensation expense
related to stock options and employee stock purchases. There was no stock-based compensation
expense related to employee stock options and employee stock purchases recognized during the six
months ended July 2, 2005.
We
estimate the fair value of stock options granted using the Black-Scholes option-pricing
formula. In conjunction with the adoption of SFAS 123(R) on January 1, 2006, the Company changed
its method of attributing the value of stock-based compensation from the multiple award (graded vesting) method to the straight-line single option method for options granted following
the adoption of SFAS 123(R).
The determination of fair value of all options granted by the Company is computed based on the
Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Option |
|
Employee Stock |
|
Employee Stock Option |
|
Employee Stock |
|
|
Plan |
|
Purchase Plan |
|
Plan |
|
Purchase Plan |
|
|
Three Months Ended |
|
Three Months Ended |
|
Six Months Ended |
|
Six Months Ended |
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Average risk free
interest rate |
|
|
5.13 |
% |
|
|
3.63 |
% |
|
|
5.11 |
% |
|
|
3.22 |
% |
|
|
4.80 |
% |
|
|
3.50 |
% |
|
|
5.11 |
% |
|
|
2.50 |
% |
|
Expected life (in
years) |
|
|
3.8 |
|
|
|
3 |
|
|
|
0.5 |
|
|
|
0.5 |
|
|
|
3.7 |
|
|
|
3.0 |
|
|
|
0.5 |
|
|
|
0.5 |
|
|
Dividend yield |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average volatility |
|
|
50.0 |
% |
|
|
85.0 |
% |
|
|
35.0 |
% |
|
|
85.0 |
% |
|
|
50.0 |
% |
|
|
85.0 |
% |
|
|
47.0 |
% |
|
|
85.0 |
% |
13
Option-pricing models require the input of various subjective assumptions, including the
options expected life and the price volatility of the underlying stock. The expected stock price
volatility is based on analysis of the Companys stock price history over a period commensurate
with the expected term of the options, trading volume of the Companys stock, look-back
volatilities and Company specific events that affected volatility in a prior period. The expected
term of options granted is based on an analysis of historical exercise and post-vesting employment
termination behavior. The risk-free interest rate is based on the U.S. Treasury yield curve in
effect at the time of grant. No dividend yield is included as the Company has not issued any
dividends and does not anticipate issuing any dividends in the future.
The following table shows stock-based compensation expense included in the condensed
consolidated statements of operations for the three and six months ended July 1, 2006 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
July 1, 2006 |
|
|
July 1, 2006 |
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
31 |
|
|
$ |
67 |
|
|
Research and development |
|
|
73 |
|
|
|
121 |
|
|
Sales, general and administrative |
|
|
374 |
|
|
|
747 |
|
|
|
|
|
|
|
|
|
|
$ |
478 |
|
|
$ |
935 |
|
|
|
|
|
|
|
|
Stock-based compensation capitalized as part of inventory for the three and six months
ended July 1, 2006 was insignificant.
The modified prospective transition method of SFAS 123(R) requires the presentation of
pro-forma information for periods presented prior to the adoption of SFAS 123(R) regarding net
income (loss) and net income (loss) per share as if the Company had accounted for the Companys
stock options under the fair value method of SFAS 123. If compensation expense had been determined
based upon the fair value at grant date for employee compensation arrangements, consistent with the
methodology prescribed under SFAS 123, the Companys pro forma net income and net income per common
share under SFAS 123 for the six months ended July 2, 2005 would have been as follows (in
thousands except per share data).
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
July 2, 2005 |
|
|
July 2, 2005 |
|
Net income, as reported for prior periods |
|
$ |
430 |
|
|
$ |
410 |
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense related
to employee stock options and employee
stock purchases |
|
|
(190 |
) |
|
|
(315 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net income |
|
$ |
240 |
|
|
$ |
95 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.06 |
|
|
$ |
0.06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.03 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.05 |
|
|
$ |
0.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.03 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
14
Pro Forma disclosures for the three and six months ended July 1, 2006 are not presented
because stock-based employee compensation was accounted for under SFAS 123(R)s fair value method
during this period.
Information with respect to activity under these option plans are set forth below (in thousand
except per share and per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
Aggregate Intrinsic |
|
|
|
Shares |
|
|
Exercise Price |
|
|
Value |
|
Outstanding at December 31, 2005 |
|
|
2,154,003 |
|
|
$ |
5.50 |
|
|
$ |
14,518 |
|
|
Options granted |
|
|
146,800 |
|
|
|
8.80 |
|
|
|
145 |
|
|
Options exercised |
|
|
(194,913 |
) |
|
|
4.55 |
|
|
|
(1,021 |
) |
|
Options forfeited/cancelled/expired |
|
|
(24,442 |
) |
|
|
7.08 |
|
|
|
(66 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at July 1, 2006 |
|
|
2,081,448 |
|
|
$ |
5.80 |
|
|
$ |
13,576 |
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average grant date fair value of options granted during the six months ended
July 1, 2006 was $8.80 per share.
The aggregate intrinsic value in the table above represents the total pretax intrinsic value
(the difference between the Companys closing stock price on the last trading day of the second
quarter of fiscal 2006 and the exercise price, multiplied by the number of in-the-money options)
that would have been received by the option holders had all option holders exercised their options
on July 1, 2006. This amount changes based on the fair market value of the Companys stock. Total
intrinsic value of options exercised for the six months ended July 1, 2006 was $1.0 million. Total
fair value of options vested and expensed was $0.8 million, net of tax, for the six months ended
July 1, 2006.
As a result of adopting the fair value recognition provisions of SFAS 123(R), the impact to
the condensed consolidated financial statements for the six months ended July 1, 2006 from
stock-based compensation is as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Six Months |
|
|
|
Ended July 1, |
|
|
Ended July 1, |
|
|
|
2006 |
|
|
2006 |
|
Stock-based compensation expense by award type: |
|
|
|
|
|
|
|
|
|
Employee stock options granted |
|
$ |
471 |
|
|
$ |
918 |
|
|
Employee stock purchase plan |
|
|
7 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
Total stock-based compensation |
|
|
478 |
|
|
|
935 |
|
|
Total effect on stock-based compensation at
the Companys marginal tax rate |
|
|
(88 |
) |
|
|
(162 |
) |
|
|
|
|
|
|
|
|
Effect on net income (loss) |
|
$ |
390 |
|
|
$ |
773 |
|
|
Effect on net income (loss) per share: |
|
|
|
|
|
|
|
|
|
Basic and diluted |
|
$ |
(0.05 |
) |
|
$ |
(0.10 |
) |
15
A
summary of the status of the Companys non-vested options as of July 1, 2006 and changes
during the period ended July 1, 2006 is presented below (in thousands, except per share
data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
Grant Dated Fair |
|
|
Number of Shares |
|
Value |
Non-vested at December 31, 2005 |
|
|
893,119 |
|
|
$ |
5.72 |
|
|
Granted |
|
|
146,800 |
|
|
|
8.80 |
|
|
Vested |
|
|
(107,491 |
) |
|
|
4.35 |
|
|
Cancelled/forfeited |
|
|
(24,442 |
) |
|
|
7.08 |
|
|
Non-vested at July 1, 2006 |
|
|
907,986 |
|
|
|
6.38 |
|
As of July 1, 2006, there were $2.2 million of total unrecognized compensation cost related to
non-vested share-based compensation arrangements under both of the plans. The cost is expected to
be recognized over a weighted average period of 3 years.
The following table summarizes information with respect to stock options outstanding at July
1, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Options Vested and Exercisable |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
Number of |
|
|
Average |
|
|
Weighted |
|
|
Number of |
|
|
Weighted |
|
|
Average |
|
|
|
Shares |
|
|
Remaining |
|
|
Average |
|
|
Shares |
|
|
Average |
|
|
Remaining |
|
Range of |
|
Outstanding at |
|
|
Contractual |
|
|
Exercise |
|
|
Exercisable at |
|
|
Exercise |
|
|
Contractual |
|
Exercise Prices |
|
July 1, 2006 |
|
|
Life (Years) |
|
|
Price |
|
|
July 1, 2006 |
|
|
Price |
|
|
Life (Years) |
|
$2.94 - $3.50 |
|
|
248,680 |
|
|
|
6.69 |
|
|
$ |
3.36 |
|
|
|
198,105 |
|
|
$ |
3.37 |
|
|
|
6.64 |
|
|
$3.52 - $4.00 |
|
|
315,013 |
|
|
|
3.43 |
|
|
$ |
3.86 |
|
|
|
299,059 |
|
|
$ |
3.87 |
|
|
|
3.25 |
|
|
$4.01- $5.00 |
|
|
214,177 |
|
|
|
4.90 |
|
|
$ |
4.43 |
|
|
|
182,469 |
|
|
$ |
4.41 |
|
|
|
4.34 |
|
|
$5.08 - $5.50 |
|
|
221,713 |
|
|
|
6.52 |
|
|
$ |
5.24 |
|
|
|
91,603 |
|
|
$ |
5.27 |
|
|
|
4.29 |
|
|
$5.56 - $6.00 |
|
|
113,000 |
|
|
|
8.07 |
|
|
$ |
5.61 |
|
|
|
52,587 |
|
|
$ |
5.61 |
|
|
|
7.21 |
|
|
$6.07 - $6.07 |
|
|
325,000 |
|
|
|
9.01 |
|
|
$ |
6.07 |
|
|
|
25,000 |
|
|
$ |
6.07 |
|
|
|
9.01 |
|
|
$6.19 - $7.63 |
|
|
212,315 |
|
|
|
6.76 |
|
|
$ |
6.83 |
|
|
|
107,981 |
|
|
$ |
7.00 |
|
|
|
5.12 |
|
|
$7.98 - $8.88 |
|
|
262,750 |
|
|
|
5.92 |
|
|
$ |
8.40 |
|
|
|
95,908 |
|
|
$ |
8.72 |
|
|
|
2.04 |
|
|
$9.00 - $12.19 |
|
|
161,300 |
|
|
|
4.91 |
|
|
$ |
9.69 |
|
|
|
113,250 |
|
|
$ |
9.49 |
|
|
|
4.00 |
|
|
$12.75 - $12.75 |
|
|
7,500 |
|
|
|
4.01 |
|
|
$ |
12.75 |
|
|
|
7,500 |
|
|
$ |
12.75 |
|
|
|
4.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$2.94 - $12.75 |
|
|
2,081,448 |
|
|
|
6.16 |
|
|
$ |
5.80 |
|
|
|
1,173,462 |
|
|
$ |
5.39 |
|
|
|
|
|
As
of July 1, 2006, the aggregate intrinsic value of fully vested and
exercisable options was $4.0 million.
10. Subsequent Event
On November 30, 2006 the Company signed a definitive agreement with American Medical Systems, Inc.
and Laserscope, a wholly owned subsidiary of American Medical Systems, Inc., (AMS) under which we
intend to acquire the laser aesthetics business of Laserscope. Under the terms of the definitive
agreement, we will acquire certain assets and liabilities of Laserscope, for approximately $26
million in cash and $2 million in unregistered shares of IRIDEX common stock subject to post
closing adjustments. AMS will be supplying aesthetics laser products to the Company for a period
of up to nine months. At the end of this period, the Company will purchase from AMS any remaining
raw material, work in process and finished goods inventory for no more than $9.0 million. The
Company plans to use a combination of cash and bank financing to finance the transaction. The
Board of Directors for IRIDEX has unanimously approved the terms of the transaction, which is
expected to close by early January 2007, subject to certain closing conditions.
11. Recent Accounting Pronouncements
In September 2006, the SEC issued SAB No. 108 regarding the process of quantifying financial
statement misstatements. SAB No. 108 states that registrants should use both a balance sheet
approach and an income statement approach when quantifying and evaluating the materiality of a
misstatement. The interpretations in SAB No. 108 contain
guidance on correcting errors under the
dual approach as well as provide transition guidance for correcting errors. This interpretation
does not change the requirements within SFAS No. 154, Accounting Changes and Error Corrections
a replacement of APB No. 20 and Financial Accounting Standards
Board (FASB) Statement No. 3,
for the correction of an error on financial statements. SAB No. 108 is effective for annual
financial statements covering the first fiscal years ending after November 15, 2006. The Company
will be required to adopt this interpretation by December 31, 2006. Management is currently
evaluating the requirements of SAB No. 108 and the impact this interpretation may have on the
consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This standard defines
fair value, establishes a framework for measuring fair value in accounting principles generally
accepted in the United States of America, and expands disclosure about fair value measurements.
This pronouncement applies under other accounting standards that require or permit fair value
measurements. Accordingly, this statement does not require any new fair value measurements. This
statement is effective for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company will be required to adopt SFAS No. 157 in the first quarter
of fiscal year 2008. Management is currently evaluating the requirements of SFAS No. 157 and has
not yet determined the impact on the consolidated financial statements.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes
effective for fiscal years beginning after December 15, 2006. The Interpretation prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The Interpretation
also provides guidance on derecognition, classification, interest and penalties, accounting for
interim periods, disclosure, and transition. The Company will decide on its policy
for interest and penalty classification by the end of 2006 and adopt the Interpretation beginning
with the fiscal year ending 2007. Upon adoption, it is not expected that the Interpretation will
have a material effect on the Companys financial position or results of operation.
16
Item 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report
on Form 10-Q 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, such as statements relating to levels of
future sales and operating results, actual order rate and market acceptance of our products;
expectations for future sales growth, generally, including expectations of additional sales from
our new products and new applications of our existing products; the potential for production cost
decreases and higher gross margins; our ability to develop and introduce new products through
strategic alliances; favorable Center for Medicare and Medicaid coverage decisions regarding AMD
procedures that use our products; results of clinical studies and risks associated with bringing
new products to market; general economic conditions; and levels of international sales. In some
cases, forward-looking statements can be identified by terminology, such as may, will,
should, expects, plans, anticipates, believes,
estimates, predicts, intends,
potential, continue, or the negative of such terms or other comparable terminology. These
statements involve known and unknown risks, uncertainties and other factors which may cause our
actual results, performance or achievements to differ materially from those expressed or implied by
such forward-looking statements, including as a result of the factors set forth under Factors That
May Affect Future Operating Results and other risks detailed in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on April 3, 2006 and detailed from time to time
in our reports filed with the Securities and Exchange Commission. The reader is cautioned not to
place undue reliance on these forward-looking statements, which reflect managements analysis only
as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update such
forward-looking
statements to reflect events or circumstances occurring after the date of this report.
Restatement of Financial Results for the Quarter
Ended April 1, 2006
As
disclosed in the Companys Current Report on Form 8-K dated
August 21, 2006, in August 2006,
the Audit Committee of the Board of Directors engaged outside counsel and initiated an independent
review of the Companys revenue recognition practices. This
review was initiated in response to an allegation made by a former
employee that the Company had recognized revenues prematurely in its
fourth fiscal quarter of 2004. The investigation concluded that the
Company had prematurely recognized revenue in 2004, but the error did
not arise from any wrongful intent to impact the Companys financial
reporting. In the course of this
review, other errors unrelated to the allegation were identified from the period
beginning in the fourth
quarter of 2003 through the first quarter of 2006. As it relates to the errors identified in the
first quarter of 2006, the Company determined that it was necessary to restate its financial
results for the quarter ended April 1, 2006 to reflect adjustments to the previously reported financial information.
While the review identified errors relating to
the periods from the fourth quarter of 2003 through December 31, 2005, the Audit Committee of
the Board of Directors
concluded that
these errors were not material to the previously issued financial
statements. The six month results of 2006 includes adjustments to
reduce revenue, cost of sales and operating expenses by $81,000,
$43,000 and $5,000, respectively, related to the correction of
immaterial errors related to prior periods.
Changes to August 3, 2006 Press Release
On August 3, 2006, the Company issued a press release announcing results for the three and six
months ended July 1, 2006 which was furnished in Current Report
on Form 8-K dated August 3, 2006. Those results differ from the results presented in this Form 10-Q as
follows:
|
|
|
Increase (decrease) in revenue of $94,000 and ($73,000) for the three and six months ended July 1,
2006, respectively, due to identified errors in revenue recognition in the first quarter
of 2006. |
|
|
|
|
Increase (decrease) in cost of goods sold of $53,000 and ($30,000) and operating expenses of
$6,000 and $(4,000) for the three and six months ended July 1, 2006, respectively, due
to identified errors in revenue recognition in the first quarter of 2006. |
|
|
|
|
Increase in operating expenses of $169,000 for the three and six months ended July 1, 2006 due
to an increase in the estimated provision for bad debt expense based on updated
information available subsequent to the issuance of the press release. |
|
|
|
|
decrease in the income tax benefit of $448,000 and $414,000 for the three and six
months ended July 1, 2006, respectively, based on the changes identified above as well as
to a change in the estimated tax rate based on updated forecast results for 2006. |
Overview
IRIDEX Corporation is a leading provider of therapeutic based laser systems and delivery
devices used to treat eye diseases in ophthalmology and skin conditions in dermatology
(aesthetics). Our products are sold in the United States predominantly through a direct sales
force and internationally through 73 independent distributors into 107 countries. Our revenues
arise primarily from the sale of our OcuLight Systems, IQ810 lasers, VariLite, DioLite 532 systems,
delivery devices, disposables and service and support activities. Our business includes a
recurring revenue component which includes the sale of our disposable single use laser probes,
EndoProbes, combined with the repair, servicing and extended warranty protection for our laser
systems. Cost of sales consists primarily of the cost of purchasing components and sub-systems,
assembling, packaging, shipping and testing components at our facility, and the direct labor and
associated overhead. Research and development expenses consist primarily of personnel costs,
materials and research
17
support provided to clinicians at medical institutions developing new
applications which utilize our products. Research and development costs have been expensed as
incurred. Sales, general and administrative expenses consist primarily of costs of personnel,
sales commissions, travel expenses, advertising and promotional expenses, facilities, legal and
accounting, insurance and other expenses which are not allocated to other departments.
Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based
Payment, which requires us to measure all employee stock-based compensation awards using a fair
value method and record such expense in our consolidated financial statements. Prior to January 1,
2006, we had accounted for stock-based compensation awards in accordance with Accounting Principles
Board (APB) Opinion No. 25. We have chosen to implement SFAS No. 123(R) using the modified
prospective method. Under this method, periods prior to January 1, 2006 are not restated to
reflect stock-based compensation using the fair value method.
Results of Operations
The following table sets forth certain operating data as a percentage of sales for the periods
indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of sales |
|
|
47.1 |
% |
|
|
51.6 |
% |
|
|
49.4 |
% |
|
|
53.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
52.9 |
% |
|
|
48.4 |
% |
|
|
50.6 |
% |
|
|
46.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development |
|
|
15.1 |
% |
|
|
9.8 |
% |
|
|
13.9 |
% |
|
|
11.2 |
% |
Sales, general and administrative |
|
|
43.9 |
% |
|
|
32.6 |
% |
|
|
44.2 |
% |
|
|
33.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
59.0 |
% |
|
|
42.4 |
% |
|
|
58.1 |
% |
|
|
44.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
|
(6.1 |
)% |
|
|
6.0 |
% |
|
|
(7.5 |
)% |
|
|
2.3 |
% |
Interest and other income, net |
|
|
2.0 |
% |
|
|
1.3 |
% |
|
|
2.0 |
% |
|
|
1.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income(loss) before income taxes |
|
|
(4.1 |
)% |
|
|
7.3 |
% |
|
|
(5.5 |
)% |
|
|
3.7 |
% |
Benefit from (provision for) income taxes |
|
|
(2.0 |
)% |
|
|
(2.7 |
)% |
|
|
0.8 |
% |
|
|
(1.4 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
(6.1 |
)% |
|
|
4.6 |
% |
|
|
(4.7 |
)% |
|
|
2.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
The following table sets forth for the periods indicated the amount of sales for our
operating segments and sales as a percentage of total sales.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
July 1, 2006 |
|
|
July 2, 2005 |
|
|
July 1, 2006 |
|
|
July 2, 2005 |
|
|
|
|
|
|
|
Percentage |
|
|
|
|
|
|
Percentage |
|
|
|
|
|
|
Percentage |
|
|
|
|
|
|
Percentage |
|
|
|
|
|
|
|
of total |
|
|
|
|
|
|
of total |
|
|
|
|
|
|
of total |
|
|
|
|
|
|
of total |
|
|
|
Amount |
|
|
sales |
|
|
Amount |
|
|
sales |
|
|
Amount |
|
|
sales |
|
|
Amount |
|
|
sales |
|
Domestic |
|
$ |
5,296 |
|
|
|
60.2 |
% |
|
$ |
5,725 |
|
|
|
61.0 |
% |
|
$ |
10,426 |
|
|
|
59.1 |
% |
|
$ |
10,650 |
|
|
|
60.8 |
% |
|
International |
|
|
3,508 |
|
|
|
39.8 |
% |
|
|
3,662 |
|
|
|
39.0 |
% |
|
|
7,221 |
|
|
|
40.9 |
% |
|
|
6,882 |
|
|
|
39.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
8,804 |
|
|
|
100.0 |
% |
|
|
9,387 |
|
|
|
100.0 |
% |
|
|
17,647 |
|
|
|
100.0 |
% |
|
|
17,532 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ophthalmology: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic |
|
|
4,544 |
|
|
|
51.6 |
% |
|
|
4,333 |
|
|
|
46.2 |
% |
|
|
8,637 |
|
|
|
49.0 |
% |
|
|
7,746 |
|
|
|
44.2 |
% |
|
International |
|
|
3,137 |
|
|
|
35.6 |
% |
|
|
3,354 |
|
|
|
35.7 |
% |
|
|
6,584 |
|
|
|
37.3 |
% |
|
|
6,134 |
|
|
|
35.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
7,681 |
|
|
|
87.2 |
% |
|
|
7,687 |
|
|
|
81.9 |
% |
|
|
15,221 |
|
|
|
86.3 |
% |
|
|
13,880 |
|
|
|
79.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dermatology: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic |
|
|
753 |
|
|
|
8.6 |
% |
|
|
1,392 |
|
|
|
14.8 |
% |
|
|
1,789 |
|
|
|
10.1 |
% |
|
|
2,904 |
|
|
|
16.6 |
% |
|
International |
|
|
370 |
|
|
|
4.2 |
% |
|
|
308 |
|
|
|
3.3 |
% |
|
|
637 |
|
|
|
3.6 |
% |
|
|
748 |
|
|
|
4.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,123 |
|
|
|
12.8 |
% |
|
$ |
1,700 |
|
|
|
18.1 |
% |
|
$ |
2,426 |
|
|
|
13.7 |
% |
|
$ |
3,652 |
|
|
|
20.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total recurring
revenue |
|
$ |
3,932 |
|
|
|
44.7 |
% |
|
$ |
3,333 |
|
|
|
35.5 |
% |
|
$ |
7,712 |
|
|
|
43.7 |
% |
|
$ |
6,429 |
|
|
|
36.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-recurring
revenue |
|
$ |
4,872 |
|
|
|
55.3 |
% |
|
$ |
6,054 |
|
|
|
64.5 |
% |
|
$ |
9,935 |
|
|
|
56.3 |
% |
|
$ |
11,103 |
|
|
|
63.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ophthalmology and Dermatology Sales Overview
We manage and evaluate our business in two segments ophthalmology and dermatology. We then
further break down these major segments by geography Domestic (United States) and International
(the rest of the world). In addition, within ophthalmology, we review trends by laser system sales
(laser boxes and delivery devices) and recurring sales (single use disposable probes, EndoProbes,
combined with the repair, servicing and extended warranty protection for our laser systems).
Within the dermatology segment we review overall trends surrounding our laser systems, which
include our newly introduced DioLite XP and VariLite laser systems and the DioLite laser system.
Total sales decreased by 6.2% to $8.8 million for the three months ended July 1, 2006 from
$9.4 million for the three months ended July 2, 2005. Domestic sales which represented 60.2% of
total sales, decreased by 7.5% to $5.3 million from $5.7 million. The decrease in domestic sales
was a result of a $0.7 million decrease in domestic dermatology sales offset by a $0.2 million
increase in domestic ophthalmology revenue. The decrease in domestic dermatology sales was driven
primarily by unfilled dermatology sales positions in the second quarter of 2006. International
sales, which were 39.8% of total sales, decreased by 4.2% to $3.5 million from $3.7 million. The
decrease in international sales was a result of a $0.2 million
19
decrease in international ophthalmology revenue offset by a $0.1 million increase in
international dermatology revenue. The decrease in international ophthalmology sales was due
largely to administrative delays in finalizing sales transactions related to a letter of credit and
to shipments into a new country.
For the six months ended July 1, 2006, total sales increased 0.7% to $17.6 million for the six
months ended July 1, 2006 from $17.5 million for the six months ended July 2, 2005. Domestic
sales, which were 59.1% of total sales, decreased by 2.1% to $10.4 million for the six months ended
July 1, 2006 from $10.7 million for the six months ended July 2, 2005. The decrease in domestic
sales was a result of a $1.1 million decrease in domestic dermatology sales offset by a $0.9
million increase in domestic ophthalmology revenue. International sales, which represented 40.9%
of total sales, increased by 4.9% to $7.2 million for the six months ended July 1, 2006 from $6.9
million for the six months ended July 2, 2005. The increase in international sales was a result of
a $0.4 million increase in international ophthalmology sales offset by a $0.1 million decrease in
international dermatology revenue.
Ophthalmology Sales
Ophthalmology sales remained constant at $7.7 million for the three months ended July 1, 2006
and July 2, 2005. Domestic ophthalmology sales increased 4.9% to $4.5 million for the three months
ended July 1, 2006 from $4.3 million for the three months ended July 2, 2005. The increase in
domestic ophthalmology sales was due, in large part, to increased sales of disposable products,
including new disposables introduced in the last eighteen months. International ophthalmology
sales decreased 6.5% to $3.1 million for the three months ended July 1, 2006 from $3.4 million for
the three months ended July 2, 2005. The decrease in international ophthalmology sales was due, in
large part, to administrative delays in finalizing sales transactions related to a letter of credit
and shipment into a new country, Sudan.
For the six months ended July 1, 2006, ophthalmology sales increased 9.7% to $15.2 million
from $13.9 million for the six months ended July 2, 2005. Domestic ophthalmology sales increased
11.5% for the six months ended July 1, 2006 to $8.6 million from $7.7 million for the six months
ended July 2, 2005. For the six months ended July 1, 2006, international ophthalmology sales
increased 7.3% to $6.6 million from $6.1 million for the six months ended July 2, 2005. The
increases in sales for domestic and international ophthalmology for the six month period ended July
1, 2006 was due mainly to increased sales of disposable products.
We anticipate that with the continued focus on our direct ophthalmic business that the
disposable business will continue to grow at greater than historical rates. The second half of the
year is historically the highest revenue period, with the fourth quarter being the highest.
Dermatology Sales
Dermatology sales decreased 33.9% to $1.1 million for the three months ended July 1, 2006 from
$1.7 million for the three months ended July 2, 2005. Domestic dermatology sales decreased 45.9%
to $0.8 million for the three month period ended July 1, 2006 from $1.4 million for the comparable
period in 2005. The decrease in domestic dermatology sales was driven primarily by unfilled
dermatology sales positions. International dermatology sales increased 20.1% to $0.4 million for
the three months ended July 1, 2006 from $0.3 million for the three months ended July 2, 2005.
For the six months ended July 1, 2006 dermatology sales decreased 33.6% to $2.4 million from
$3.7 million for the six months ended July 2, 2005. Domestic dermatology sales decreased 38.4% to
$1.8 million for the six months ended July 1, 2006 from $2.9 million for the six months ended July
2, 2005. The decrease in domestic dermatology sales was driven mainly by unfilled sales positions
on the dermatology sales team in the second quarter of 2006. We have since hired an additional
dermatology sales representative and have revised our marketing programs. International
dermatology sales decreased 14.8% to $0.6 million for the six months ended July 1, 2006 from $0.7
million for the comparable period in 2005.
20
The company has increased the domestic sales force and added additional management in order to increase
productivity levels. Two new area sales managers have been hired and a third is in process. The
company believes that these changes will enhance the level of dermatology revenues the second half
of the year.
Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of sales |
|
|
47.1 |
% |
|
|
51.6 |
% |
|
|
49.4 |
% |
|
|
53.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
52.9 |
% |
|
|
48.4 |
% |
|
|
50.6 |
% |
|
|
46.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our gross profit increased by $0.1 million to $4.7 million for the three month periods
ended July 1, 2006 compared to $4.5 million for the three months ended July 2, 2005. Gross profit
as a percentage of sales for the three months ended July 1, 2006 increased to 52.9% from 48.4% for
the comparable prior year three month period. The total 4.5% increase in gross profit as a
percentage of sales during this period included an increase of 4.1% relating to lower product costs
including product mix, the change in inventory reserves and warranty charges, and an increase of
1.1% related to lower overhead costs offset by a 0.6% decrease due to reduced average selling
prices.
For the six months ended July 1, 2006, gross profit increased by $0.7 million to $8.9 million
from $8.2 million for the six months ended July 2, 2005. Gross profit as a percentage of sales for
the six months ended July 1, 2006 increased to 50.6% from 46.9%. The total 3.7% increase in gross
profit as a percentage of sales during this period included an increase of 4.5% relating to lower
product costs including product mix, the change in inventory reserves and warranty charges and an
increase of 0.2% related to lower overhead costs offset by a 1.0% decrease due to reduced average
selling prices. Although increasing competition has continued to result in a downward trend in
average selling prices for some products, we intend to continue our efforts to reduce the cost of
components and manufacturing and thereby mitigate the impact of price reductions on our gross
profit. In addition, as we evaluate gross margins on each of our product lines, we may choose to
place greater focus on product lines with better margins. See -Factors That May Affect Future
Results If We Cannot Increase Our Sales Volumes, Reduce Our Costs or Introduce Higher Margin
Products to Offset Anticipated Reductions in the Average Unit Selling Price of our Products, Our
Operating Results May Suffer. We expect our gross profit margins to continue to fluctuate due to
changes in the relative proportions of domestic and international sales, mix of sales of existing
products, pricing, product costs and a variety of other factors. See -Factors That May Affect
Future Results Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Research and
development
expense as a
percentage of
total revenue
|
|
|
15.1 |
% |
|
|
9.8 |
% |
|
|
13.9 |
% |
|
|
11.2 |
% |
21
Our research and development expenses increased by 44.0% to $1.3 million for the three
months ended July 1, 2006 from $0.9 million for the three months ended July 2, 2005 and included
the expensing of a patent application from Innovatech. Research and development expenses increased
as a percentage of sales to 15.1% for the three months ended July 1, 2006 from 9.8% for the
comparable prior year three-month period. The increase in research and development expenses in
absolute dollars and as a percentage of sales for the three month period ended July 1, 2006 was due
to $0.1 million in increased project spending for new development projects, $0.1 million in
increased salaries and recruiting and relocation expenses associated with new hires in 2006, $0.1
million in stock compensation expenses and $0.1 million in other research and development expenses.
For the six months ended July 1, 2006 research and development expenses increased 24.9% to
$2.4 million from $2.0 million for the six months ended July 2, 2005 and included the expensing of
a patent application purchased from Innovatech. As a percentage of sales, research and development
expense increased to 13.9% for the six months ended July 1, 2006 from 11.2% for the six months
ended July 2, 2005. The increase in research and development expense in absolute dollars and as a
percentage of sales for the six month period ended July 1, 2006 was due primarily to $0.2 million
in increased salaries, benefits and recruiting and relocation expenses associated with new hires in
2006, $0.1 million in increased project spending and $0.1 million in stock compensation expenses.
The companys research and development expenses have been higher than normal levels as two
major laser consoles and several new disposable products are in development. The company
anticipates that future research and development levels will be 10% to 12% as a percentage of total
revenue.
Selling, General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Selling,
general and
administrative
expense as a
percentage of
total revenue |
|
|
43.9 |
% |
|
|
32.6 |
% |
|
|
44.2 |
% |
|
|
33.4 |
% |
Our sales, general and administrative expenses increased by 26.1% to $3.9 million for the
three months ended July 1, 2006 from $3.1 million for the three months ended July 2, 2005. As a
percentage of sales, sales, general and administrative expenses increased to 43.9% for the three
months ended July 1, 2006 from 32.6% for the comparable prior year three-month period. The
increase in sales, general and administrative expense in absolute dollars and as a percentage of
sales for the three month period ended July 1, 2006 as compared to the three month period ended
July 2, 2005 was due primarily to $0.4 million in stock compensation expense, $0.3 million in
increased legal spending which was associated mainly with litigation, $0.1 million in other
general and administrative costs offset by decreased general and administrative recruiting costs of
$0.2 million in 2005 for the Chief Executive Officer.
For the six months ended July 1, 2006 sales, general and administrative expense increased
33.0% to $7.8 million from $5.9 million for the six months ended July 2, 2005. As a percentage of
sales, sales, general and administrative expense increased to 44.2% for the six months ended July
1, 2006 from 33.4% for the six months ended July 2, 2005. The increase in sales, general and
administrative expense in absolute dollars and as a percentage of sales for the six month period
ended July 1, 2006 was due primarily to $0.7 million in stock compensation expense, $0.5 million in
increased legal spending, which was associated mainly with litigation, $0.2 million in increased
general and administrative salaries associated with hiring of a Chief Executive Officer in July
2005, $0.3 million in increased sales and marketing salaries and relocation expenses associated
with new hires, $0.2 million in increased sales and marketing spending associated with increased
activity offset by a decrease of $0.2 million in general and administrative recruiting costs from
2005 associated with hiring of a Chief Executive Officer.
22
The companys selling, general and administrative expenses have been running at higher than
historical levels. This has been due to some unusual expenses particularly relating to
recruitment, relocation and legal expenses. The company expects these unusual expenses to decline
and return back to historical levels.
Interest and Other
Income, net. For the three months ended July 1, 2006 we recorded net other
income of $0.2 million as compared with net other income of $0.1 million for the three months ended
July 2, 2005. For the six months ended July 1, 2006, net other income was $0.4 million as compared
with $0.3 million for the six months ended July 2, 2005. The change in net other income for both
the three and six month periods was due primarily to increased interest rates and to increased
cash, cash equivalents and available for sale securities.
Income Taxes. The effective income tax rate for the three month period ending July 1, 2006 was 50%
as compared with 37.5% for the three month period ending July 2, 2005. For the six month period
ending July 1, 2006 the effective income tax rate was 13.5% as compared with 37.5% for the six
month period ending July 2, 2005. The change in the effective tax rate was driven primarily by the
accounting for certain tax benefits associated with stock compensation expense commencing in 2006.
This impact is magnified for the six month period ending July 1, 2006 based on our updated
forecasted loss position for 2006.
Liquidity and Capital Resources
At July 1, 2006, our primary sources of liquidity included cash and cash equivalents and
available-for-sale securities in the aggregate amount of $22.3 million. In addition, we have
available $4 million under our unsecured line of credit which bears interest at the banks prime
rate and expires in October 2006. As of July 1, 2006, no borrowings were outstanding under this
credit facility. We expect to renew the line of credit in October 2006, assuming that the terms
continue to be acceptable.
During the six months ended July 1, 2006, operating activities provided $1,000 of cash. The
primary uses of cash from operating activities included a net loss of $0.8 million, a decrease in
accrued expenses of $1.1 million and an increase in net inventory of $0.3 million, offset by
sources of cash which included stock compensation expense of $0.9 million, a decrease in net
accounts receivable of $0.6 million, an increase in accounts payable of $0.3 million, depreciation
of $0.3 million and a decrease in prepaid expenses of $0.1 million. The decrease in accrued
expenses related primarily to a $0.4 million decrease in tax payable, a $0.4 million decrease in
accrued salaries associated with payment of the 2005 bonus, a $0.2 million in decreased warranty
reserves and a $0.1 million decrease in overall accrued liabilities. Net inventory increased by
$0.3 million as a result of the associated decrease in revenue. Net accounts receivable decreased
by $0.3 million as a result of continued focus on collection efforts.
Investing activities used $9.9 million in cash and cash equivalents during the six months
ended July 1, 2006, primarily due to net purchases of available for sale securities of $9.7 million
and purchases of fixed assets of $0.2 million.
Net cash provided by financing activities during the six months ended July 1, 2006 was $1.0
million which consisted of the issuance of common stock under employee option plans and the
employee stock purchase plan.
As noted in Note 10 to
the condensed and consolidated financial statements, on November
30, 2006, we signed a definitive agreement with American Medical
Systems, Inc. and Laserscope, a
wholly-owned subsidiary of American Medical Systems, Inc.
(AMS) under which we intend to acquire the
laser aesthetics business of Laserscope. Under the terms of the definitive agreement, we will
acquire certain assets and liabilities of Laserscope, for approximately $26 million in cash and $2 million in
unregistered shares of IRIDEX common stock, subject to post closing
adjustments. AMS will be supplying aesthetics laser products to the Company for a period of up to nine months. At the end of this period, we will purchase from
AMS any remaining raw materials, work in process and finished goods
inventory for no more than $9 million. We plan
to use a combination of cash and bank financing to finance the transaction. Our Board of Directors
has unanimously approved the terms of the transaction, which is expected to close by early
January 2007, subject to certain closing conditions.
We believe that,
based on current estimates, our cash, cash equivalents and available-for-sale
securities together with cash generated from operations and the bank financing to be obtained in
connection with its acquisition of Laserscope will be sufficient to meet our anticipated cash
requirements for the 12 month period following the acquisition of Laserscope which is expected to
close by early January 2007. Our liquidity could be negatively affected by a decline in demand for our
products, the need to invest in new product development or reductions in spending by our customers as well
as the increased working capital requirement of our business following completion of our pending acquisition
of the Laserscope laser aesthetics business.
There can be no assurance that additional debt or equity financing will be available when required
or, if available, can be secured on terms satisfactory to us. See -Factors That May Affect Future
Results We May Need Additional Capital, which May Not Be Available, and Our Ability to Grow May
Be Limited as a Result.
23
Accounting Policies
The Companys significant accounting policies are disclosed in our Annual Report on Form 10-K
for the year ended December 31, 2005 which was filed with the Securities and Exchange Commission on
April 3, 2006; however, they have been updated below to reflect
the adoption of SFAS 123(R) on January 1, 2006.
The Company adopted SFAS 123(R) using the modified prospective method, which requires the
application of the accounting standard as of January 1, 2006, the first day of the Companys fiscal
year. The Companys financial statements as of and for the six months ended July 1, 2006 reflect
the impact of SFAS 123(R). In accordance with the modified prospective method, the Companys
financial statements for prior periods have not been restated to reflect, and do not include the
impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the six
months ended July 1, 2006 was $0.9 million, which consisted of stock-based compensation expense
related to stock options and employee stock purchases. There was no stock-based compensation
expense related to employee stock options and employee stock purchases recognized during the six
months ended July 2, 2005. See Note 7 for additional information.
We estimate the fair value of stock options granted using the Black-Scholes option-pricing
formula. In conjunction with the adoption of SFAS 123(R) on January 1, 2006, the Company changed
its method of attributing the value of stock-based compensation from
the multiple award (graded vesting) method to the straight-line single option method.
Recent Accounting Pronouncements
In September 2006, the SEC issued SAB No. 108 regarding the process of quantifying financial
statement misstatements. SAB No. 108 states that registrants should use both a balance sheet
approach and an income statement approach when quantifying and evaluating the materiality of a
misstatement. The interpretations in SAB No. 108 contain guidance on correcting errors under the
dual approach as well as provide transition guidance for correcting errors. This interpretation
does not change the requirements within SFAS No. 154, Accounting Changes and Error Corrections
a replacement of APB No. 20 and Financial Accounting Standards Board (FASB) Statement No. 3,
for the correction of an error on financial statements. SAB No. 108 is effective for annual
financial statements covering the first fiscal years ending after November 15, 2006. The Company
will be required to adopt this interpretation by December 31, 2006. Management is currently
evaluating the requirements of SAB No. 108 and the impact this interpretation may have on the
consolidated financial statements.
In September 2006,
the FASB issued SFAS No. 157, Fair Value Measurements. This standard
defines fair value, establishes a framework for measuring fair value in accounting principles
generally accepted in the United States of America, and expands disclosure about fair value
measurements. This pronouncement applies under other accounting standards that require or permit
fair value measurements. Accordingly, this statement does not require any new fair value
measurements. This statement is effective for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company will be required to adopt SFAS No. 157 in
the first quarter of fiscal year 2008. Management is currently evaluating the requirements of SFAS
No. 157 and has not yet determined the impact on the consolidated financial statements.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes effective for fiscal years beginning after December 15, 2006. The Interpretation prescribes
a recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The Interpretation
also provides guidance on derecognition, classification, interest and penalties, accounting for
interim periods, disclosure, and transition. The Company will decide on its policy for interest
and penalty classification by the end of 2006 and adopt the Interpretation beginning with the
fiscal year ending 2007. Upon adoption, it is not expected that the Interpretation will have a
material effect on the Companys financial position or results of operation.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Quantitative Disclosures
We are exposed to market risks inherent in our operations, primarily related to interest rate
risk and currency risk. These risks arise from transactions and operations entered into in the
normal course of business. We do not use derivatives to alter the interest characteristics of our
marketable securities or our debt instruments. We have no holdings of derivative or commodity
instruments.
Interest Rate Risk. We are subject to interest rate risks on cash and cash equivalents,
available-for-sale marketable securities and any future financing requirements. Interest rate
risks related to marketable securities are managed by managing maturities in our marketable
securities portfolio. We have no long-term debt as of July 1, 2006.
The fair value of our investment portfolio or related income would not be significantly
impacted by changes in interest rates since the marketable securities maturities do not exceed a
term of 12 14 months.
Qualitative Disclosures
Interest Rate Risk. Our primary interest rate risk exposures relate to:
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the fall in value of available-for-sale securities if market interest rates
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the impact of interest rate movements on our ability to obtain adequate financing
to fund future operations. |
Our exposure to interest rate risk at July 1, 2006 is related primarily to our investment
portfolio. Our investment portfolio includes fixed rate debt instruments of high quality corporate
issuers, asset-backed securities and variable-rate municipal bonds. A change in prevailing
interest rates may cause the fair value of our investments to fluctuate. For example, if we hold a
security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing
rate rises, the fair value of the principal amount of our investment will probably decline. To
minimize this risk, investments are generally held to maturity and the weighted average duration of
our investments is 12 months or less. Due to the short-term nature of these investments, we
believe we have no material exposure to interest rate risk arising from our investments. As of
July 1, 2006, the carrying value of these investments approximates fair market value. We do not
believe any of our investments are other than temporarily impaired at July 1, 2006.
Management evaluates our financial position on an ongoing basis.
24
Currency
Rate Risk. As all of our sales transactions and the majority of
our expenses are denominated
in U.S. currency, we do not hedge any balance sheet exposures against future movements in foreign
exchange rates. The exposure related to currency rate movements would not have a material impact
on future net income or cash flows.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
a) Evaluation of disclosure controls and procedures.
Our management evaluated, with the participation of its Chief Executive Officer (CEO) and its
Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13A-15(e) and Rule 15d-15(e) of the Securities Exchange
Act of 1934 (the 34 Act), as of the end of the period covered by this report.
Disclosure controls and procedures are designed with the objective of ensuring that (i)
information required to be disclosed in our reports filed under the 34 Act is recorded, processed,
summarized and reported within the time periods specified in the SECs rules and forms and (ii)
information is accumulated and communicated to management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal control procedures,
which are designed with the objective of providing reasonable assurance that our transactions are
properly authorized, our assets are safeguarded against unauthorized or improper use and its
transactions are properly recorded and reported, are intended to permit the preparation of our
financial statements in conformity with generally accepted accounting principles. To the extent
that elements of our internal controls over financial reporting are included within our disclosure
controls and procedures, they are included in the scope of our quarterly controls evaluation.
Based on that evaluation, and as a result of the material weakness in our internal controls
over financial reporting discussed below, the CEO and CFO concluded that as of the end of the
period covered by this report, the Companys disclosure controls and procedures were not effective.
A material weakness is a control deficiency, or a combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. Management determined that the following
control deficiencies constitute a material weakness in our internal control over financial
reporting at July 1, 2006.
In connection with the annual audit of our financial statements as of December 31, 2005, our
independent registered public accounting firm communicated to our management and the Audit
Committee of the Board of Directors that they had identified a control deficiency that existed in
the design or operation of our internal controls over financial reporting that they considered to
be a material weakness, because the control deficiency resulted in more than a remote likelihood
that a material misstatement could occur in our annual financial statements and not be prevented or
detected. Specifically, the material weakness identified by our independent accountants relates to
a failure to maintain adequate period-end review procedures to ensure the completeness and accuracy
of certain journal entries impacting general ledger accounts. As a result, an error in a system
generated custom inventory report and errors in two key spreadsheets related to warranty and
deferred revenue resulted in incorrect entries being recorded to the financial statements which
were not identified and corrected by management in a timely manner.
In addition, as disclosed in our Current Report on Form 8-K dated August 21, 2006, in August
2006, the Audit Committee of the Board of Directors engaged outside counsel and initiated an
independent review of our revenue recognition practices. This review was initiated in response to
an allegation made by a former employee. In the course of this review, errors in revenue
recognition were identified from the period beginning in 2003 through the first quarter of 2006.
As a result of these errors, the Audit Committee of the Board of Directors determined that it was
necessary to restate our financial results for the quarter ended April 1, 2006 to reflect
adjustments to the previously reported financial information. While errors were identified in
prior years, we concluded that the errors were not material to the previously issued financial
statements.
During the course of its review, subsequent to the three month period covered by this
Quarterly Report on Form 10-Q, management, with the participation of the CEO and CFO, determined
the Company did not maintain effective controls over the accounting for revenue because of the
following material weakness.
The Company did not maintain effective controls over the completeness and accuracy of the
revenue recognition process. Specifically, effective controls were not designed and in place to
ensure that all terms and conditions relating to revenue agreements, including verbal and written
side arrangements, non standard terms and multiple element arrangements, were identified to ensure
revenue was accurately recorded in accordance with generally accepted accounting principles.
Additionally, effective controls were not designed and in place to ensure that sales personnel did
not enter into unauthorized side arrangements with customers, including rights of return. This
control deficiency resulted in restatements of the Companys consolidated financial statements for
the first quarter of 2006 and adjustments to the second quarter of 2006, affecting revenue, cost of
goods sold, operating expenses and inventory. These control deficiencies could result in the
misstatement of the aforementioned accounts that would result in a material misstatement of the
annual or interim consolidated financial statements that would not be prevented or detected.
Accordingly, management has determined that these control deficiencies constitute a material
weakness at July 1, 2006.
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Plan for remediation of material weaknesses
To address the material weaknesses in our internal control over financial reporting identified
above, management has designed a remediation plan which will supplement the existing controls of
the Company. The remediation plan addresses the following
Related to our period-end review procedures:
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implementation of additional controls over the preparation and review of key
spreadsheets; |
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implementation of automated general ledger reports to replace existing key spreadsheets
where possible; |
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correction of a system generated custom report to include additional information
necessary to prepare accurate financial information; |
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implementation of additional review procedures; and |
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enhancement of the current capabilities of the finance function. |
Related to our revenue recognition practices:
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reassignment of responsibilities for oversight of the sales function and
responsibilities for internal control over sales transactions; |
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provision of additional training on a recurring basis for all domestic sales personnel
on revenue recognition policies and procedures; |
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establishment of annual formal training for our customer service group on revenue
recognition policies and procedures; |
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establishment of a checklist for use by our customer service group in processing
revenue transactions to verify proper recognition and establishment of a policy by which
this checklist is signed off by the preparer and at least one
reviewer; |
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establishment of internal audit procedures over all domestic laser sale transactions;
and |
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formalization over our sales returns process to include more thorough documentation,
review and approval for all returns. |
We began implementing
certain corrective actions relating to our revenue recognition practices
subsequent to the three month period covered by this Quarterly Report on Form 10-Q.
We believe that once all of these corrective actions
are implemented, including the enhancement of the capabilities of the finance function, the
material weaknesses that were identified will be mitigated.
Even if we are to successfully remediate each of the material weaknesses described above,
because of inherent limitations, our disclosure controls and procedures may not prevent or detect
misstatements or material omissions. Projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
(b) Changes in internal control over financial reporting
We have implemented
most of the corrective actions related to the material weaknesses related
to our period-end review procedures identified above in the three-month period covered by this
Quarterly Report on Form 10-Q. We continue to implement automated general ledger reports to
replace key spreadsheets where possible and we are in the process of enhancing the current
capabilities of the finance function. No other change has occurred in our internal controls over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the 34 Act) during the quarter
ended July 1, 2006, that has materially affected, or is reasonably likely to materially
affect, our internal controls over financial reporting. As discussed above, management
has designed a plan for remediation and is implementing changes in our internal control over
financial reporting to remediate the material weaknesses identified above.
26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In
October 2005, the Company filed a suit against Synergetics USA, Inc.
(Synergetics USA).
The suit is entitled IRIDEX Corporation v. Synergetics USA, Inc.,
Case No. 4:05CV1916CDP in the United States District Court for the
Eastern District of Missouri, Eastern Division, St. Louis for
infringement of our patent No. 5,085,492. The Company seeks
injunctive relief, monetary damages, treble damages, cost and
attorneys fees. Synergetics USA answered our complaint in November 2005,
denied liability for patent infringement, and filed counterclaims seeking a declaratory
judgment that it did not infringe our patent. Synergetics also brought three additional counterclaims
for false advertising, commercial disparagement, trade libel, injurious falsehood, unfair competition,
disparagement of property, slander of goods and defamation, under state and federal law, based upon
allegations that we had raised safety issues involving Synergetics product with the Food and
Drug Administration and the public. Synergetics seeks monetary damages, costs and attorneys fees.
Our response to these counterclaims was a denial of any wrongdoing and a reference to the expiration of
the statute of limitations on those claims.
On July 7, 2006, the United States District Court for the Eastern District of Missouri, Eastern Division, St. Louis issued a Claim Construction Ruling, interpreting 14 disputed phrases within the Companys patent No. 5,085,492. The Court adopted the Companys position with respect to 13 of the 14 patent terms, and adopted a position between the Companys and Synergetics positions with respect to the 14th term. On November 2, 2006, the Company amended its complaint to add patent infringement claims against Synergetics USAs wholly owned subsidiary, Synergetics Inc. On November 10, 2006, Synergetics Inc. and Synergetics USA, Inc. answered the amended complaint, denying liability for patent infringement and filing counterclaims seeking a declaratory judgment that they did not infringe the Companys patent. Synergetics Inc. also re-filed the three additional counterclaims relating to dispa
ragement, thereby substituting Synergetics Inc. for Synergetics USA as the plaintiff on those counterclaims. Discovery is scheduled to end on December 22, 2006, and trial is scheduled to begin on April 16, 2007. The Company is confident that its patent claims have merit, and if the parties do not reach a settlement, the Company intends to vigorously pursue its claims to judgment.
The Company is involved in another suit with Synergetics Inc., entitled
Synergetics, Inc. v. Peregrine Surgical, Ltd., Innovatech
Surgical, Inc., and IRIDEX Corporation,
Case No. 06-CV-107 in the United States District Court for the Eastern District of Pennsylvania. Synergetics filed suit against the Company on April 25, 2006, by adding the Company as a defendant to a then-existing lawsuit against the other two defendants. Synergetics alleges that the Company infringes its patent and seeks injunctive relief, monetary damages, treble damages, costs and attorneys fees. On June 29, 2006, the Company filed its response to Synergetics pleading, denying Synergetics claims and asserting counterclaims seeking a declaratory judgment that it does not infringe Synergetics patent. Synergetics responded to the Companys counterclaims on July 24, 2006, denying them. On August 10, 2006, the case was reassigned to District Judge Thomas Golden.
On July 19, 2006, Synergetics Inc.
(a wholly owned subsidiary of Synergetics USA, Inc.) filed suit in the United States District Court for the Eastern
District of Missouri against the Company, seeking a declaratory judgment that a laser probe connector system that it
announced on July 10, 2006 does not infringe the Companys patent No. 5,085,492, and seeking a declaratory
judgment that the Companys patent is invalid and unenforceable. This suit is entitled
Synergetics, Inc. v. IRIDEX Corporation,
Case No. 4:06CV1104CDP. On August 15, 2006, the Company answered the Synergetics Inc. complaint, denying that
Synergetics Inc. was entitled to any relief, and filed crossclaims against Synergetics USA Inc. and counterclaims
against Synergetics Inc., alleging that they infringe the Companys patent No. 5,085,492 and seeking injunctive
relief, monetary damages, treble damages, costs and attorneys fees. On November 20, 2006, the Court ordered that
this case (No. 4:06CV1104CDP) be consolidated for all purposes with
the case against Synergetics USA, Inc. pending in the same court
(No. 4:05CV1916CDP), that the amended pleadings in the earlier case shall be the operative pleadings, and that this
case be administratively closed.
Management believes that liabilities resulting from the proceedings described above (collectively referred to hereafter in this Quarterly Report on Form 10-Q as the Synergetics Litigation Matters), or claims which are pending or known to be threatened, will not have a material adverse effect on the Companys financial position or results of operations and are adequately covered by the Companys liability insurance. However, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of managements attention and the incurrence of significant expenses.
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Item 1A. Risk Factors
Factors That May Affect Future Results
In addition to the other information contained in this quarterly report Form 10-Q, we have
identified the following risks and uncertainties that may have a material adverse effect on our
business, financial condition or results of operation. You should carefully consider the risks
described below before making an investment decision.
We Rely on Continued Market Acceptance of Our Existing Products and Any Decline in Sales of
Our Existing Products Would Adversely Affect Our Business and Results of Operations. We currently
market visible and infrared light therapeutic-based photocoagulator medical laser systems and
delivery devices to the ophthalmology and dermatology markets. We believe that continued and
increased sales, if any, of these medical laser systems is dependent upon a number of factors
including the following:
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acceptance of product performance, features, ease of use, scalability and durability; |
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acceptance of the companys new marketing programs; |
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recommendations and opinions by ophthalmologists, dermatologists, other
clinicians, plastic surgeons and their associated opinion leaders, including study
outcomes; |
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price of our products and prices of competing products and technologies; |
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availability of competing products, technologies and alternative treatments; and |
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level of reimbursement for treatments administered with our products. |
In addition, we derive a meaningful portion of our sales from recurring revenues including
disposable laser probes, EndoProbes and service. Our ability to increase recurring revenues from
the sale of EndoProbes will depend primarily upon the features of our current products and product
innovation, ease of use and prices of our products, including the relationship to prices of
competing delivery devices. The level of service revenues will depend on our quality of care,
responsiveness and the willingness of our customers to request our services rather than purchase
competing products or services. Any significant decline in market acceptance of our products or
our revenues derived from the sales of laser consoles, delivery devices or services may have a
material adverse effect on our business, results of operations and financial condition.
Our Future Success Depends on Our Ability to Develop and Successfully Introduce New Products
and New Applications. Our future success is dependent upon, among other factors, our ability to
develop, obtain regulatory approval or clearance of, manufacture and market new products.
Successful commercialization of new products and new applications will require that we effectively
transfer production processes from research and development to manufacturing and effectively
coordinate with our suppliers. In addition, we must 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, which include, among other things, price, safety, efficacy,
reliability, marketing and sales efforts, the development of new applications for these products,
the availability of third-party reimbursement of procedures using our new products, the existence
of competing products and general economic conditions affecting purchasing patterns. Our ability
to market and sell new products may also be subject to government regulation, including approval or
clearance by the United States Food and Drug Administration, or FDA, and foreign government
agencies. Any failure in our ability to successfully develop and introduce new products or enhanced
versions of existing products and achieve market acceptance of new products and new applications
could have a material adverse effect on our operating results and would cause our net revenues to
decline.
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We Face Strong Competition in Our Markets and Expect the Level of Competition to Grow in the
Foreseeable Future. Competition in the market for devices used for ophthalmic and dermatology
treatment procedures is intense and is expected to increase. Our competitive position depends on a
number of factors including product performance, characteristics and functionality, ease of use,
scalability, durability and cost. Our principal competitors in ophthalmology are Lumenis Ltd.,
Nidek, Carl Zeiss, Inc., Alcon, and Synergetics, Inc. Most of these companies currently offer a
competitive semiconductor-based laser system in ophthalmology. Also
within ophthalmology,
pharmaceutical alternative treatments for AMD such as Visudyne (Novartis), Macugen (OSI
Pharmaceuticals) and Lucentis (Genentech) compete rigorously with traditional laser procedures. Our
principal competitors in dermatology are Palomar Technologies, Candela Corporation, Syneron,
Lumenis Ltd. and Laserscope (which was recently acquired). Some competitors have substantially
greater financial, engineering, product development, manufacturing, marketing and technical
resources than we do. Some companies also have greater name recognition than we do and
long-standing customer relationships. In addition to other companies that manufacture
photocoagulators, we compete with pharmaceuticals, other technologies and other surgical
techniques. Some medical companies, academic and research institutions, or others, may develop new
technologies or therapies that are more effective in treating conditions targeted by us or are less
expensive than our current or future products. Any such developments could have a material adverse
effect on our business, financial condition and results of operations.
If We Cannot Increase Our Sales Volumes, Reduce Our Costs or Introduce Higher Margin Products
to Offset Anticipated Reductions in the Average Unit Price of Our Products, Our Operating Results
May Suffer. We have experienced some declines in the average unit price of our products and expect
to continue to
suffer from declines in the future. The average unit price of our products may decrease in
the future in response to changes in product mix, competitive pricing pressures, new product
introductions by our competitors or other factors. If we are unable to offset the anticipated
decrease in our average selling prices by increasing our sales volumes or through new product
introductions, our net revenues will decline. In addition, to maintain our gross margins we must
continue to reduce the manufacturing cost of our products. If we cannot maintain our gross margins
our business could be seriously harmed, particularly if the average selling price of our products
decreases significantly without a corresponding increase in sales.
We Depend on Sales of Our Ophthalmology Products for a Significant Portion of Our Operating
Results. We derive, and expect to continue to derive, a large portion of our revenue and profits
from sales of our ophthalmology products. For the three months ended July 1, 2006, our
ophthalmology sales were $7.7 million or 87.2% of total sales. For the six months ended July 1,
2006, our ophthalmology sales were $15.2 million or 86.3% of total sales. We anticipate that sales
of our ophthalmology products will continue to account for a significant portion of our revenues in
the foreseeable future.
We Depend on International Sales for a Significant Portion of Our Operating Results. We
derive, and expect to continue to derive, a large portion of our revenue from international sales.
For the three months ended July 1, 2006, our international sales were $3.5 million or 39.8% of
total sales. For the six months ended July 1, 2006, our international sales were $7.2 million or
40.9% of total sales. We anticipate that international sales will continue to account for a
significant portion of our revenues, particularly ophthalmology, in the foreseeable future. None
of our international revenues and costs has been denominated in foreign currencies. As a result,
an increase in the value of the U.S. dollar relative to foreign currencies makes our products more
expensive and thus less competitive in foreign markets. The factors stated above could have a
material adverse effect on our business, financial condition or results of operations. Our
international operations and sales are subject to a number of other risks including:
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impact of recessions in economies outside of the United States; |
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performance of our international channel of distributors; |
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foreign certification requirements, including continued ability to use the
CE mark in Europe; |
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reduced or limited protections of intellectual property rights in
jurisdictions outside the United States; |
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longer accounts receivable collection periods; |
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potentially adverse tax consequences; and |
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multiple protectionist, adverse and changing foreign governmental laws and
regulations. |
Any one or more of these factors stated above could have a material adverse effect on our business,
financial condition or results of operations.
We Rely on Our Direct Sales Force and Network of International Distributors to Sell Our
Products and any Failure to Maintain Our Direct Sales Force and Distributor Relationships Could
Harm Our Business. Our ability to sell our products and generate revenue depends upon our direct
sales force within the United States and relationships with independent distributors outside the
United States. Currently our direct sales force consists of 16 employees and we maintain
relationships with 73 independent distributors internationally selling our products into 107
countries through four direct Area Sales Managers. We generally grant our distributors exclusive
territories for the sale of our products in specified countries. The amount and timing of
resources dedicated by our distributors to the sales of our products is not within our control.
Our international sales are entirely dependent on the efforts of these third parties. If any
distributor breaches terms of its distribution agreement or fails to generate sales of our
products, we may be forced to replace the distributor and our ability to sell our products into
that exclusive sales territory would be adversely affected.
We do not have any long-term employment contracts with the members of our direct sales force.
We may be unable to replace our direct sales force personnel with individuals of equivalent
technical expertise and qualifications, which may limit our revenues and our ability to maintain
market share. The loss of the services of these key personnel would harm our business. Similarly,
our distributionship agreements are generally terminable at will by either party and distributors
may terminate their relationships with us, which would affect our international sales and results
of operations.
Failure to Remediate the Material Weaknesses in Our Disclosure Controls and Procedures in a
Timely Manner, or At All, Could Harm Our Operating Results or Cause Us to Fail to Meet Our
Regulatory or Reporting Obligations. We evaluated the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report and, based on this evaluation, management concluded that our
disclosure controls and procedures were not effective because of the material weaknesses detailed
in Part II (Controls and Procedures), Item 9A of our annual report on Form 10-K for the year ended
December 31, 2005, which was filed with the SEC on April 3,
2006 and in Item 4 of this Quarterly Report on Form 10-Q.
In
particular, the material weaknesses identified related to the
Companys period-end review procedures and revenue recognition
practices. We are taking a number of remedial actions designed to remedy the material weaknesses summarized
above. However, if despite our efforts, we fail to
remediate our material weaknesses,
we could be subject to regulatory scrutiny and a loss of public confidence in our disclosure
controls and procedures. These remediation efforts will likely increase our general and
administrative expenses and could, therefore, have an adverse effect on our reported net income.
Even if we are to successfully remediate such material weaknesses, because of inherent
limitations, our disclosure controls and procedures may not prevent or detect misstatements or
material omissions.
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Projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
If We Lose Key Personnel or Fail to Integrate Replacement Personnel Successfully, Our Ability
to Manage Our Business Could Be Impaired. Our future success depends upon the continued service of
our key management, technical, sales, and other critical personnel. Our officers and other key
personnel are employees-at-will, and we cannot assure you that we will be able to retain them. Key
personnel have left our company in the past and there likely will be additional departures of key
personnel from time to time in the future. The loss of any key employee could result in significant
disruptions to our operations, including adversely affecting the timeliness of product releases,
the successful implementation and completion of company initiatives, and the results of our
operations. Competition for these individuals is intense, and we may not be able to attract,
assimilate or retain highly qualified personnel. Competition for qualified personnel in our
industry and the San Francisco Bay Area, as well as other geographic markets in which we recruit,
is intense and characterized by increasing salaries, which may increase our operating expenses or
hinder our ability to recruit qualified candidates. In addition, the integration of replacement
personnel could be time consuming, may cause additional disruptions to our operations, and may be
unsuccessful.
If We Fail to Accurately Forecast Demand For Our Product and Component Requirements For the
Manufacture of Our Product, We Could Incur Additional Costs or Experience Manufacturing Delays and
May Experience Lost Sales or Significant Inventory Carrying Costs. We use quarterly and annual
forecasts based primarily on our anticipated product orders to plan our manufacturing efforts and
determine our requirements for components and materials. It is very important that we accurately
predict both the demand for our product and the lead times required to obtain the necessary
components and materials. Lead times for components vary significantly and depend on numerous
factors, including the specific supplier, the size of the order, contract terms and current market
demand for such components. If we overestimate the demand for our product, we may have excess
inventory, which would increase our costs. Over the past several quarters, we have placed a high
priority on our asset management efforts to, among other things, reduce overall inventory levels
and increase our cash position. If we underestimate demand for our product and, consequently, our
component and materials requirements, we may have inadequate inventory, which could interrupt our
manufacturing, delay delivery of our product to our customers and result in the loss of customer
sales. Any of these occurrences would negatively impact our business and operating results.
We Depend on Sole Source or Limited Source Suppliers. We rely on third parties to manufacture
substantially all of the components used in our products, including optics, laser diodes and
crystals. We have some long term or volume purchase agreements with our suppliers and currently
purchase components on a purchase order basis. Some of our suppliers and manufacturers are sole or
limited sources. In addition, some of these suppliers are relatively small private companies that
may discontinue their operations at any time. There are risks associated with the use of
independent manufacturers, including the following:
|
§ |
|
unavailability of, shortages or limitations on the ability to obtain supplies of
components in the quantities that we require; |
|
|
§ |
|
delays in delivery or failure of suppliers to deliver critical components on the
dates we require; |
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§ |
|
failure of suppliers to manufacture components to our specifications, and
potentially reduced quality; and |
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§ |
|
inability to obtain components at acceptable prices. |
Our business and operating results may suffer from the lack of alternative sources of supply
for critical sole and limited source components. The process of qualifying suppliers is complex,
requires extensive testing with our products, and may be lengthy, particularly as new products are
introduced. New suppliers would have to be educated in our production processes. In addition, the
use of alternate components may
31
require design alterations to our products and additional product
testing under FDA and relevant foreign regulatory agency guidelines, which may delay sales and
increase product costs. Any failures by our vendors to adequately supply limited and sole source
components may impair our ability to offer our existing products, delay the submission of new
products for regulatory approval and market introduction, materially harm our business and
financial condition and cause our stock price to decline. Establishing our own capabilities to
manufacture these components would be expensive and could significantly decrease our profit
margins. Our business, results of operations and financial condition would be adversely affected
if we are unable to continue to obtain components in the quantity and quality desired and at the
prices we have budgeted.
We Face Risks Associated with our Collaborative and OEM Relationships. Our collaborators may
not pursue further development and commercialization of products resulting from collaborations with
us or may not devote sufficient resources to the marketing and sale of such products. For example,
in 2005 we developed and sold a laser system on an OEM basis for a third party which positively
impacted the revenues and gross margins during the second half of 2005. We cannot provide assurance
that these types of relationships will continue over a longer period. Our reliance on others for
clinical development, manufacturing and distribution of our products may result in unforeseen
problems. Further, our collaborative
partners may develop or pursue alternative technologies either on their own or in
collaboration with others. If a collaborator elects to terminate its agreement with us, our
ability to develop, introduce, market and sell the product may be significantly impaired and we may
be forced to discontinue altogether the product resulting from the collaboration. We may not be
able to negotiate alternative collaboration agreements on acceptable terms, if at all. The failure
of any current or future collaboration efforts could have a material adverse effect on our ability
to introduce new products or applications and therefore could have a material adverse effect on our
business, results of operations and financial condition.
We Face Manufacturing Risks. The manufacture of our infrared and visible light
photocoagulators and the related delivery devices is a highly complex and precise process. We
assemble critical subassemblies and all of our final products at our facility in Mountain View,
California. We may experience manufacturing difficulties, quality control issues or assembly
constraints, particularly with regard to new products that we may introduce. We may not be able to
manufacture sufficient quantities of our products, which may require that we qualify other
manufacturers for our products. Furthermore, we may experience delays, disruptions, capacity
constraints or quality control problems in our manufacturing operations and, as a result, product
shipments to our customers could be delayed, which would negatively impact our net revenues.
We Depend on Collaborative Relationships to Develop, Introduce and Market New Products,
Product Enhancements and New Applications. We depend on both clinical and commercial collaborative
relationships. We have entered into collaborative relationships with academic medical centers and
physicians in connection with the research and innovation and clinical testing of our products.
Commercially, we currently collaborate with Bausch & Lomb to design and manufacture a solid-state
green wavelength (532nm) laser photocoagulator module, called the Millennium Endolase module. The
Millennium Endolase module is designed to be a component of Bausch & Lombs ophthalmic surgical
suite product offering and is not expected to be sold as a stand-alone product. Sales of the
Millennium Endolase module are dependent upon the actual order rate from and shipment rate to
Bausch & Lomb, which depends on the efforts of our partner and is beyond our control. We cannot
assure you that our relationship with Bausch & Lomb will result in further sales of our Millennium
Endolase module. The failure to obtain any additional future clinical or commercial
collaborations and the resulting failure or success of such arrangements of any current or future
clinical or commercial collaboration relationships could have a material adverse effect on our
ability to introduce new products or applications and therefore could have a material adverse
effect on our business, results of operations and financial condition.
32
Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year. Our sales and
operating results may vary significantly from quarter to quarter and from year to year in the
future. Our operating results are affected by a number of factors, many of which are beyond our
control. Factors contributing to these fluctuations include the following:
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general economic uncertainties and political concerns; |
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|
the timing of the introduction and market acceptance of new products, product
enhancements and new applications; |
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changes in demand for our existing line of dermatology and ophthalmic products; |
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|
the cost and availability of components and subassemblies, including the ability of our
sole or limited source suppliers to deliver components at the times and prices that we have
planned; |
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|
our ability to maintain sales volumes at a level sufficient to cover fixed manufacturing
and operating costs; |
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fluctuations in our product mix between dermatology and ophthalmic products and foreign
and domestic sales; |
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the effect of regulatory approvals and changes in domestic and foreign regulatory
requirements; |
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|
introduction of new products, product enhancements and new applications by our
competitors, entry of new competitors into our markets, pricing pressures and other
competitive factors; |
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our long and highly variable sales cycle; |
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changes in the prices at which we can sell our products; |
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|
changes in customers or potential customers budgets as a result of, among other
things, reimbursement policies of government programs and private insurers for treatments
that use our products; and |
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|
increased product innovation costs. |
In addition to these factors, our quarterly results have been, and are expected to continue to
be, affected by seasonal factors.
Our expense levels are based, in part, on expected future sales. If sales levels in a
particular quarter do not meet expectations, we may be unable to adjust operating expenses quickly
enough to compensate for the shortfall of sales, and our results of operations may be adversely
affected. In addition, we have historically made a significant portion of each quarters product
shipments near the end of the quarter. If that pattern continues, any delays in shipment of
products could have a material adverse effect on results of operations for such quarter. Due to
these and other factors, we believe that quarter to quarter and year to year comparisons of our
past operating results may not be meaningful. You should not rely on our results for any quarter
or year as an indication of our future performance. Our operating results in future quarters and
years may be below expectations, which would likely cause the price of our common stock to fall.
We entered into a definitive asset purchase agreement with American Medical Systems, Inc.
and Laserscope, a California corporation and a wholly owned subsidiary of American Medical Systems,
Inc. on November 30, 2006 and we may experience unexpected difficulties closing this transaction or
integrating the aesthetics business which we agreed to purchase in this transaction. On November
30, 2006, we signed a definitive agreement with American Medical Systems Holdings, Inc. and
Laserscope, a wholly-owned subsidiary of American Medical Systems, Inc. under which we intend to
acquire the laser aesthetics business of Laserscope. Under the terms of the definitive agreement,
we will acquire certain assets and liabilities of Laserscope, for approximately $26 million in cash
and $2 million in unregistered shares of IRIDEX common stock, subject to post closing adjustments.
We intend to use a combination of cash and bank financing to finance this transaction. The Board
of Directors of IRIDEX has unanimously approved the terms of the transaction, which is expected to
close by early January 2007, subject to certain closing conditions. However, there can be no
assurance that the transaction will close on a timely basis, or at all.
Integrating the aesthetics business of Laserscope may be expensive and time-consuming and we
may not be able to successfully do so. Integration efforts often take a significant amount of time,
place a significant strain on managerial, operational and financial resources and could prove to be
more difficult or expensive than predicted. The diversion of our managements attention and any
delay or difficulties encountered in connection with the pending acquisition of the aesthetics
business of Laserscope could result in the disruption of our on-going business or inconsistencies
in standards, controls, procedures and policies that could negatively affect our ability to
maintain relationships with customers, suppliers, collaborators, employees and others with whom we
have business dealings. Moreover, we may need to raise additional funds through public or private
debt or equity financing to cover the costs of this transaction, which may result in dilution for
stockholders or the incurrence of indebtedness. If our efforts to close the transactions
contemplated by the definitive agreement or to integrate the aesthetics business are unsuccessful
or are more difficult, time consuming or expensive than originally planned, we may incur unexpected
disruptions to our on-going business. These disruptions could harm our operating results. Further,
the following specific factors may adversely affect our ability to integrate the aesthetics
business of Laserscope:
|
|
|
we may experience unexpected losses of employees or customers we expected
to gain in connection with this transaction; |
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we may not achieve expected levels of revenue growth; |
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|
we may not be able to coordinate our current product and process
development efforts with those of the aesthetics business in a way which permits us to
bring future new products to the market in a timely and cost-effective manner; and |
|
|
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|
we may discover that liabilities that we assumed are greater than
anticipated. |
In addition, as part of our pending acquisition, we intend to enter into agreements with
Laserscope to obtain certain manufacturing support, administrative services and future intellectual
property rights. In the event that Laserscope fails to provide this support and service, or
provides such support and service at a level of quality and timeliness inconsistent with the
historical delivery of such support and service, or fails to grant us the intellectual property rights we expected, our ability to integrate the
aesthetics business will be hampered and our operating results may be harmed.
Our Stock Price Has Been and May Continue to be Volatile and an Investment in Our Common Stock
Could Suffer a Decline in Value. The trading price of our common stock has been subject to wide
fluctuations in response to a variety of factors, some of which are beyond our control, including
quarterly variations in our operating results, announcements by us or our competitors of new
products or of significant clinical achievements, changes in market valuations of other similar
companies in our industry and general market conditions. From time to time, we meet with investors
and potential investors. In addition, we
33
receive attention by securities analysts and present at
analyst meetings when invited. Our common stock may experience an imbalance between supply and
demand resulting from low trading volumes. These broad market fluctuations could have a
significant impact on the market price of our common stock regardless of our performance.
We Are Subject To Government Regulation Which May Cause Us to Delay or Withdraw the
Introduction of New Products or New Applications for Our Products. The medical devices that we
market and manufacture are subject to extensive regulation by the FDA and by foreign and state
governments. Under the Federal Food, Drug and Cosmetic Act and the related regulations, 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 product
must undergo rigorous testing and an extensive regulatory review process implemented by the FDA
under federal law. Unless otherwise exempt, a device manufacturer must obtain market clearance
through either the 510(k) premarket notification process or the lengthier premarket approval
application (PMA) process. Depending upon the type, complexity and
novelty of the device and the nature of the disease or disorder to be treated, the FDA process
can take several years, require extensive clinical testing and result in significant expenditures.
Even if regulatory approval is obtained, later discovery of previously unknown safety issues may
result in restrictions on the product, including withdrawal of the product from the market. Other
countries also have extensive regulations regarding clinical trials and testing prior to new
product introductions. Our failure to obtain government approvals or any delays in receipt of such
approvals would have a material adverse effect on our business, results of operations and financial
condition.
The FDA imposes additional regulations on manufacturers of approved medical devices. We are
required to comply with the applicable Quality System regulations and our manufacturing facilities
are subject to ongoing periodic inspections by the FDA and corresponding state agencies, including
unannounced inspections, and must be licensed as part of the product approval process before being
utilized for commercial manufacturing. Noncompliance with the applicable requirements can result
in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total
or partial suspension of production, 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
we manufacture or distribute. Any of these actions by the FDA would materially and adversely
affect our ability to continue operating our business and the results of our operations.
In addition, we are also subject to varying product standards, packaging requirements,
labeling requirements, tariff regulations, duties and tax requirements. As a result of our sales
in Europe, we are required to have all products CE marked, an international symbol affixed to all
products demonstrating compliance with the European Medical Device Directive and all applicable
standards. While currently all of our released products are CE marked, continued certification is
based on the successful review of our quality system by our European Registrar during their annual
audit. Any loss of certification would have a material adverse effect on our business, results of
operations and financial condition.
We Rely on Patents and Proprietary Rights to Protect our Intellectual Property and Business.
Our success and ability to compete is dependent in part upon our proprietary information. We rely
on a combination of patents, trade secrets, copyright and trademark laws, nondisclosure and other
contractual agreements and technical measures to protect our intellectual property rights. We file
patent applications to protect technology, inventions and improvements that are significant to the
development of our business. We have been issued fifteen United States patents and five foreign
patents on the technologies related to our products and processes. We have approximately five
pending patent applications in the United States and six foreign pending patent applications that
have been filed. Our patent applications may not be approved. Any patents granted now or in the
future may offer only limited protection against potential infringement and development by our
competitors of competing products. Moreover, our competitors, many of which have substantial
resources and have made substantial investments in competing technologies, may seek to apply for
and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our
products either in the United States or in international markets.
34
In addition to patents, we rely on trade secrets and proprietary know-how which we seek to
protect, in part, through proprietary information agreements with employees, consultants and other
parties. Our proprietary information agreements with our employees and consultants contain
industry standard provisions requiring such individuals to assign to us without additional
consideration any inventions conceived or reduced to practice by them while employed or retained by
us, subject to customary exceptions. Proprietary information agreements with employees,
consultants and others may be breached, and we may not have adequate remedies for any breach.
Also, our trade secrets may 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. 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 our competitors. Until recently patent applications
were maintained in secrecy in the United States until the patents issued. Patent applications
filed in the United States after November 2000 generally will be published eighteen months after
the filing date. However, since patent applications continue to be maintained in secrecy for at
least some period of time, both within the United States and with regards to international patent
applications, we cannot assure you that our technology does not infringe any patents or patent
applications held by third parties. We have, from time to time, been notified of, or have
otherwise been made aware of, claims that we may be infringing upon patents or other proprietary
intellectual property owned by others. If it appears necessary or desirable, we may seek licenses
under such patents or proprietary intellectual property. Although patent holders commonly offer
such licenses, licenses under such patents or intellectual property may not be offered or the terms
of any offered licenses may not be reasonable.
Any claims, with or without merit, and regardless of whether we are successful on the merits,
would be time-consuming, result in costly litigation and diversion of technical and management
personnel, cause shipment delays or require us to develop noninfringing technology or to enter
into royalty or licensing agreements. An adverse determination in a judicial or administrative
proceeding and failure to obtain necessary licenses or develop alternate technologies could
prevent us from manufacturing and selling our products, which would have a material adverse
effect on our business, results of operations and financial condition.
Management believes that liabilities resulting from the Synergetics Litigation Matters described
in Part II, Item 4 , or other claims which are pending or known to be threatened, will not have
a material adverse effect on the Companys financial position or results of operations.
However, it is possible that cash flows or results or operations could be materially affected in
any particular period by the unfavorable resolution of one or more of these contingencies or
because of the diversion of managements attention and the incurrence of significant expenses.
35
The Requirements of Complying with the Sarbanes-Oxley Act of 2002 Might Strain Our Resources,
Which May Adversely Affect Our Business and Financial Condition. We are subject to a number of
requirements, including the reporting requirements of the Securities Exchange Act of 1934, as
amended, and the Sarbanes-Oxley Act of 2002. These requirements might place a strain on our systems
and resources. The Sarbanes-Oxley Act requires, among other things, that we maintain effective
disclosure controls and procedures and internal control over financial reporting. In order to
maintain and improve the effectiveness of our disclosure controls and procedures and internal
control over financial reporting, significant resources and management oversight will be required.
As a result, our managements attention might be diverted from other business concerns, which could
have a material adverse effect on our business, financial condition, and operating results. In
addition, we might need to hire additional accounting and financial staff with appropriate public
company experience and technical accounting knowledge, and we might not be able to do so in a
timely fashion.
Our products could be subject to recalls even after receiving FDA approval or clearance. A
recall would harm our reputation and adversely affect our operating results. The FDA and similar
governmental authorities in other countries in which we market and sell our products have the
authority to require the recall of our products in the event of material deficiencies or defects in
design or manufacture. A government mandated recall, or a voluntary recall by us, could occur as a
result of component failures, manufacturing errors or design defects, including defects in
labeling. A recall could divert managements attention, cause us to incur significant expenses,
harm our reputation with customers and negatively affect our future sales.
If we modify one of our FDA approved or cleared devices, we may need to seek new approvals or
clearances which, if not granted, would prevent us from selling our modified products.
Any modifications to an FDA-approved or cleared device that would significantly affect its
safety or effectiveness or that would constitute a major change in its intended use would require a
new 510(k) clearance or possibly a PMA approval. We may not be able to obtain additional 510(k)
clearances or PMA approvals for new products or for modifications to, or additional intended uses
or indications for, our existing products in a timely fashion, or at all. Delays in obtaining
future clearances would adversely affect our ability to introduce new or enhanced products in a
timely manner, which in turn would harm our revenue and future profitability. We have made
modifications to our devices and the labeling of our devices in the past and may make additional
modifications in the future that we believe do not or will not require additional clearances or
approvals. If the FDA disagrees and requires new clearances or approvals for the modifications, we
may be required to recall and stop marketing the modified devices, which could harm our operating
results and require us to redesign or relabel our products.
If We Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could Harm Our
Operating Results. We have experienced and may continue to experience growth in our business. We
have made and expect to continue to make significant investments to enable our future growth
through, among other things, new product innovation and clinical trials for new applications and
products. We must also be prepared to expand our work force and to train, motivate and manage
additional employees as the need for
36
additional personnel arises. Our personnel, systems,
procedures and controls may not be adequate to support our future operations. Any failure to
effectively manage future growth could have a material adverse effect on our business, results of
operations and financial condition.
If Product Liability Claims are Successfully Asserted Against Us, We may Incur Substantial
Liabilities That May Adversely Affect Our Business or Results of Operations. We may be subject to
product liability claims from time to time. Our products are highly complex and some are used to
treat extremely delicate eye tissue and skin conditions on and near a patients face. Although we
maintain product liability insurance with coverage limits of $10.0 million per occurrence and an
annual aggregate maximum of $10.0 million, our coverage from our insurance policies may not be
adequate. Product liability insurance is expensive. We
might not be able to obtain product liability insurance in the future on acceptable terms or
in sufficient amounts to protect us, if at all. A successful claim brought against us in excess of
our insurance coverage could have a material adverse effect on our business, results of operations
and financial condition.
Our Operating Results May be Adversely Affected by Changes in Third Party Coverage and
Reimbursement Policies and any Uncertainty Regarding Healthcare Reform Measures. Our ophthalmology
products are typically purchased by doctors, clinics, hospitals and other users, which bill various
third-party payers, such as governmental programs and private insurance plans, for the health care
services provided to their patients. Third-party payers are increasingly scrutinizing and
challenging the coverage of new products and the level of reimbursement for covered products.
Doctors, clinics, hospitals and other users of our products may not obtain adequate reimbursement
for use of our products from third-party payers. While we believe that the laser procedures using
our products have generally been reimbursed, payers may deny coverage and reimbursement for our
products if they determine that the device was not reasonable and necessary for the purpose used,
was investigational or was not cost-effective. In addition, third party payers may not initiate
coverage of new procedures using our products for a significant period. In September 2000, the
Center for Medicare and Medicaid Services, or CMS, advised that claims for reimbursement for
certain age related macular degeneration, or AMD, procedures which use our OcuLight SLx laser
system, could be submitted for reimbursement, with coverage and payment to be determined by the
local medical carriers at their discretion. To date five carriers representing 17 states have
written reimbursement coverage statements or local policies on Transpupillary Thermotherapy, or TTT. The states
reimbursing for TTT are Alaska, Arizona, California, Colorado, Hawaii, Iowa, Idaho, Mississippi,
North Carolina, North Dakota, Nevada, Oregon, Pennsylvania, South Dakota, Tennessee, Washington and
Wyoming. Domestic sales of the OcuLight SLx laser system may continue to be limited until more
local medical carriers reimburse for performing such AMD procedures or until CMS advises that
claims for these procedures may be submitted directly to CMS at the national level. The clinical
results of the TTT4CNV trial and other clinical trials may influence the individual state or CMS
decision to reimburse for certain laser procedures. In November 2005, we filed a CPT (Current
Procedural Terminology) Change Request Form seeking the extension of Category III (Emerging
Technology) codes 0016T and 0017T for wet and dry forms of AMD. We learned in early May that the
panel had voted to retain the Category III codes 0016T and 0017T on reporting Transpupillary
Thermotherapy/Ablation of macular drusen for an extension of five years or until codes have been
accepted for placement in the Category I section of CPT.
Changes in government legislation or regulation or in private third-party payers policies
toward reimbursement for procedures employing our products may prohibit adequate reimbursement.
There have been a number of legislative and regulatory proposals to change the healthcare system,
reduce the costs of healthcare and change medical reimbursement policies. Doctors, clinics,
hospitals and other users of our products may decline to purchase our products to the extent there
is uncertainty regarding reimbursement of medical procedures using our products and any healthcare
reform measures. Further proposed legislation, regulation and policy changes affecting third party
reimbursement are likely. We are unable to predict what legislation or regulation, if any,
relating to the health care industry or third-party coverage and reimbursement may be enacted in
the future, or what effect such legislation or regulation may have on us. However, denial of
coverage and reimbursement of our products would have a material adverse effect on our business,
results of operations and financial condition.
37
The Successful Outcome of Clinical Trials and the Development of New Applications Using
Certain of Our Products will Accelerate Future Revenue Growth Rates. The Companys ability to
generate incremental revenue growth will depend, in part, on the successful outcome of clinical
trials that lead to the development of new applications using our products. Clinical trials are
long, expensive and uncertain processes. If the future results of any of our clinical trials fail
to demonstrate improved patient outcomes and/or the development of new product applications, our
ability to generate incremental revenue growth would be adversely affected. We have supported
several clinical trials, including, for example, the TTT4CNV and the PTAMD clinical trials.
We May Need Additional Capital, which May Not Be Available, and Our Ability to Grow May be
Limited as a Result. We believe that our existing cash balances, available-for-sale securities,
bank financing associated with our acquisition of Laserscope and cash flow expected to be generated from future operations will be sufficient
to meet our capital requirements at least through the next 12 months. However, we may be required,
or could elect, to seek additional funding prior to that time. The development and marketing of
new products and associated support personnel requires a significant commitment of resources. If
cash from available sources is insufficient, we may need additional capital, which may not be
available on favorable terms, if at all. If we cannot raise funds on acceptable terms, we may not
be able to develop or enhance our products, take advantage of future opportunities, fund potential
acquisitions or respond to competitive pressures or unanticipated requirements. Any inability to
raise additional capital when we require it would seriously harm our business.
If Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be Seriously
Harmed. Our facilities could be subject to catastrophic loss such as fire, flood or earthquake.
All of our research and product innovation activities, manufacturing, our corporate headquarters
and other critical business operations are located near major earthquake faults in Mountain View,
California. Any such loss at any of our facilities could disrupt our operations, delay production,
shipments and revenue and result in large expense to repair and replace our facilities.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4.
Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on June 8, 2006 in Mountain View, California. Of the
7,765,829 shares outstanding as of the record date, 7,051,749 were present or represented by proxy
at the meeting. The results of the voting on the matters submitted to the stockholders are as
follows:
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1. |
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To elect seven (7) directors to serve for the ensuing year or until their
successors are duly elected and qualified. |
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|
Name |
|
Votes For |
|
Votes Withheld |
Theodore Boutacoff |
|
|
7,021,925 |
|
|
|
29,824 |
|
Barry G. Caldwell |
|
|
6,316,977 |
|
|
|
734,772 |
|
James L. Donovan |
|
|
6,959,325 |
|
|
|
92,424 |
|
Donald L. Hammond |
|
|
6,944,804 |
|
|
|
106,945 |
|
Garrett A. Garrettson |
|
|
6,945,004 |
|
|
|
106,745 |
|
Robert K. Anderson |
|
|
6,929,004 |
|
|
|
122,745 |
|
Sanford Fitch |
|
|
6,975,175 |
|
|
|
76,574 |
|
38
|
2. |
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To approve the amendment and restatement of the Companys 1998 Stock Plan. |
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|
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|
|
Votes for:
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|
|
3,956,818 |
|
Votes against:
|
|
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231,149 |
|
Votes abstaining:
|
|
|
37,921 |
|
No-Vote:
|
|
|
2,825,861 |
|
|
3. |
|
To ratify the appointment of PricewaterhouseCoopers LLP as the independent
registered public accounting firm of the Company for the fiscal year ending December
30, 2006. |
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|
|
|
|
Votes for:
|
|
|
7,033,596 |
|
Votes against:
|
|
|
12,260 |
|
Votes abstaining:
|
|
|
5,893 |
|
Item 5. Other Information
None.
Item 6. Exhibits
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
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|
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
|
|
32.1
|
|
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2
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Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Trademark Acknowledgments
IRIDEX, the IRIDEX logo, IRIS Medical, OcuLight, SmartKey, EndoProbe and Apex are our registered
trademarks. IRIDERM, G-Probe, DioPexy, DioVet, TruFocus, TrueCW, UltraView, DioLite 532, Long
Pulse, MicroPulse, ScanLite, ColdTip (Handpiece), VariSpot (Handpiece), TruView and EasyFit product
names are our trademarks. All other trademarks or trade names
appearing in this Quarterly Report on Form 10-Q are the
property of their respective owners.
39
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.
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IRIDEX Corporation
(Registrant)
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Date: December 22, 2006 |
By: |
/s/ Larry Tannenbaum
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Larry Tannenbaum |
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Chief Financial Officer and Vice President, Administration
(Principal Financial, Principal Accounting Officer and
Authorized Signatory) |
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40
Exhibit Index
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. |
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. |
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32.1
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Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2
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Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
exv31w1
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 13(a) OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 AS
ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Barry G. Caldwell, certify that:
1. |
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I have reviewed this Quarterly Report on Form 10-Q of IRIDEX Corporation; |
2. |
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Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report; |
3. |
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Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the periods
presented in this report; |
4. |
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The registrants other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) for the registrant and have: |
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a. |
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Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared; |
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b. |
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Evaluated the effectiveness of the registrants disclosure controls and
procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and |
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c. |
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Disclosed in this report any changes in the registrants internal
control over financial reporting that occurred during the registrants most recent
fiscal quarter (the registrants
fourth fiscal quarter in the case of the annual report) that has materially affected,
or is reasonably likely to materially affect the registrants internal control over
financial reporting; and |
5. |
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The registrants other certifying officer(s) and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors (or persons performing
the equivalent functions): |
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a. |
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All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrants ability to record, process, summarize and
report financial information; and |
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b. |
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Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting. |
Date:
December 22, 2006
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By: |
/s/ BARRY G. CALDWELL
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Name: |
Barry G. Caldwell |
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Title: |
President and Chief Executive Officer
(Principal Executive Officer) |
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exv31w2
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 13(a) OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 AS
ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Larry Tannenbaum, certify that:
1. |
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I have reviewed this Quarterly Report on Form 10-Q of IRIDEX Corporation; |
2. |
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Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report; |
3. |
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Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the periods
presented in this report; |
4. |
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The registrants other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) for the registrant and have: |
|
a. |
|
Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared; |
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b. |
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Evaluated the effectiveness of the registrants disclosure controls and
procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and |
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c. |
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Disclosed in this report any changes in the registrants internal
control over financial reporting that occurred during the registrants most recent
fiscal quarter (the registrants fourth fiscal quarter in the case of the annual
report) that has materially affected, or is
reasonably likely to materially affect the registrants internal control over
financial reporting; and |
5. |
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The registrants other certifying officer(s) and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors (or persons performing
the equivalent functions): |
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a. |
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All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrants ability to record, process, summarize and
report financial information; and |
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b. |
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Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting. |
Date:
December 22, 2006
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By: |
/s/ LARRY TANNENBAUM
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Name: |
Larry Tannenbaum |
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Title: |
Chief Financial Officer and Vice President,
Administration
(Principal Financial and Accounting Officer) |
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exv32w1
EXHIBIT 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Barry G. Caldwell, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of IRIDEX Corporation on Form 10-Q
for the three months ended July 1, 2006 (i) fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 and (ii) that information contained in such
Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition
and results of operations of IRIDEX Corporation.
Date:
December 22, 2006
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By: |
/s/ BARRY G. CALDWELL
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Name: |
Barry G. Caldwell |
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Title: |
President and Chief Executive Officer
(Principal Executive Officer) |
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exv32w2
EXHIBIT 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Larry Tannenbaum, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of IRIDEX Corporation on Form 10-Q
for the three months ended July 1, 2006 (i) fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 and (ii) that information contained in such
Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition
and results of operations of IRIDEX Corporation.
Date:
December 22, 2006
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By: |
/s/ LARRY TANNENBAUM
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Name: |
Larry Tannenbaum |
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Title: |
Chief Financial Officer and Vice President, Administration
(Principal Financial and Accounting Officer) |
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