1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition period from to
Commission File Number: 0-27598
IRIDEX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0210467
- - --------------------------------- ----------------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
1212 TERRA BELLA AVENUE
MOUNTAIN VIEW, CALIFORNIA 94043-1824
(Address of principal executive offices, including zip code)
(650) 940-4700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes [X] No [ ]; (2) Yes [X ] No [ ]
The number of shares of Common Stock, $.01 par value, issued and outstanding as
of November 10, 1998 was 6,506,010.
2
IRIDEX CORPORATION
Table of Contents
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of October 3, 1998 and
December 31, 1997 3
Condensed Consolidated Statements of Income for the three months and nine months
ended October 3, 1998 and September 30, 1997 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended October 3, 1998 and September 30, 1997 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 8
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 17
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 18
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS 18
ITEM 5. OTHER INFORMATION 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18
SIGNATURE 19
INDEX TO EXHIBITS 20
-2-
3
IRIDEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
OCTOBER 3, DECEMBER 31,
1998 1997
-------- --------
ASSETS (unaudited) *
Current assets:
Cash and cash equivalents $ 2,425 $ 9,900
Available-for-sale securities 7,695 3,588
Accounts receivable, net 7,503 6,057
Inventories 6,823 3,976
Prepaids and other current assets 409 451
Deferred income taxes 550 550
-------- --------
Total current assets 25,405 24,522
Property and equipment, net 2,350 2,133
Intangible assets 44 --
Deferred income taxes 31 31
-------- --------
Total assets $ 27,830 $ 26,686
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 923 $ 752
Accrued expenses 1,551 2,051
Capital lease obligations 2 3
-------- --------
Total current liabilities 2,476 2,806
-------- --------
Stockholders' equity:
Common Stock 65 65
Additional paid-in capital 21,794 21,552
Unrealized holding gains (losses) on available-for-sale securities 7 (2)
Retained earnings 3,488 2,265
-------- --------
Total stockholders' equity 25,354 23,880
-------- --------
Total liabilities and stockholders' equity $ 27,830 $ 26,686
======== ========
- - ----------------------
*Derived from the 1997 audited financial statements.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-3-
4
IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- ---------------------------
October 3, September 30, October 3, September 30,
1998 1997 1998 1997
-------- -------- -------- --------
Sales $ 5,200 $ 4,641 $ 17,074 $ 12,317
Cost of sales 2,650 1,987 7,627 5,267
-------- -------- -------- --------
Gross profit 2,550 2,654 9,447 7,050
-------- -------- -------- --------
Operating expenses:
Research and development 725 422 1,948 1,314
Selling, general and administrative 1,892 1,458 6,027 4,182
-------- -------- -------- --------
Total operating expenses 2,617 1,880 7,975 5,496
-------- -------- -------- --------
Income (loss) from operations (67) 774 1,472 1,554
Other income, net 132 157 380 472
-------- -------- -------- --------
Income before provision for
income taxes 65 931 1,852 2,026
Provision for income taxes (22) (335) (629) (731)
-------- -------- -------- --------
Net income $ 43 $ 596 $ 1,223 $ 1,295
======== ======== ======== ========
Net income per common share $ 0.01 $ 0.09 $ 0.19 $ 0.20
======== ======== ======== ========
Net income per common share -
assuming dilution $ 0.01 $ 0.09 $ 0.18 $ 0.19
======== ======== ======== ========
Shares used in per common share
calculation 6,485 6,427 6,473 6,390
======== ======== ======== ========
Shares used in per common share -
assuming dilution calculation 6,703 6,849 6,797 6,719
======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
5
IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
----------------------------
OCTOBER 3, SEPTEMBER 30,
----------- -------------
1998 1997
----------- -------------
Cash flows from operating activities:
Net income $ 1,223 $ 1,295
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 507 261
Provision for doubtful accounts (20) 10
Changes in operating assets and liabilities:
Accounts receivable (1,426) (108)
Inventories (2,847) (1,402)
Prepaids and other current assets 42 (361)
Accounts payable 171 491
Accrued expenses (500) (272)
-------- --------
Net cash used in operating activities (2,850) (86)
-------- --------
Cash flows from investing activities:
Purchases of available-for-sale securities (7,670) (4,790)
Proceeds from sale and maturity of available-for-sale securities 3,572 1,621
Purchase of intangible assets (44) --
Acquisition of property and equipment (724) (1,679)
-------- --------
Net cash used in investing activities (4,866) (4,848)
-------- --------
Cash flows from financing activities:
Payment on capital lease obligations (1) (5)
Issuance of common stock, net 242 237
-------- --------
Net cash provided by financing activities 241 232
-------- --------
Net (decrease) in cash and cash equivalents (7,475) (4,702)
Cash and cash equivalents at beginning of period 9,900 14,107
-------- --------
Cash and cash equivalents at end of period $ 2,425 $ 9,405
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-5-
6
IRIDEX CORPORATION
CONDENSED CONSOLIDATED
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements at October 3, 1998 and for the
three and nine month periods then ended are unaudited (except for the balance
sheet information as of December 31, 1997, which is derived from the Company's
audited financial statements) and reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for a fair presentation of the financial position and operating results for the
interim periods. The condensed consolidated financial statements should be read
in conjunction with the audited financial statements and notes thereto, together
with management's discussion and analysis of financial condition and results of
operations, contained in the Company's Annual Report on Form 10-K and Form 10-Q,
which were filed with the Securities and Exchange Commission on March 31, 1998
and August 17, 1998, respectively. The results of operations for the three and
nine month periods ended October 3, 1998 are not necessarily indicative of the
results for the year ending January 2, 1999, or any future interim period.
2. RECLASSIFICATIONS
Certain prior quarters and year amounts have been reclassified to conform with
the current year presentation. The reclassification had no impact on previously
reported income from operations or net income.
3. INVENTORIES COMPRISE: (IN THOUSANDS)
OCTOBER 3, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
Raw materials and work in progress $4,236 $2,579
Finished goods 2,587 1,397
------ ------
Total inventories $6,823 $3,976
====== ======
4. COMPUTATION OF NET INCOME PER COMMON SHARE AND PER COMMON SHARE - ASSUMING
DILUTION
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share," and the provisions of
the Securities and Exchange Commission Staff Accounting Bulletin No. 98 and,
accordingly, all prior periods have been restated. Net income per common share
is computed using the weighted average number of shares of common stock
outstanding. Net income per common share-assuming dilution is computed using the
weighted average number of shares of common stock and dilutive Common equivalent
shares from stock options. The Company has determined that no incremental shares
should be included in the computations of earnings per share in accordance with
Staff Accounting Bulletin No. 98.
-6-
7
In accordance with the disclosure requirements of SFAS No. 128, a reconciliation
of the numerator and denominator of net income per common share and net income
per common share-assuming dilution is provided as follows (in thousands, except
per share amounts):
Three Months Ended Nine Months Ended
--------------------------- -------------------------------
October 3, September 30, October 3, September 30,
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Numerator -- Net income per common share and per
common share -- assuming dilution
Net income ................................................. $ 43 $ 596 $1,223 $1,295
====== ====== ====== ======
Denominator -- Net income per common share
Weighted average common stock outstanding .............. 6,485 6,427 6,473 6,390
------ ------ ------ ------
Net income per common share ................................ $ .01 $ .09 $ .19 $ .20
====== ====== ====== ======
Denominator -- Net income per common share --
assuming dilution
Weighted average common stock outstanding ................ 6,485 6,427 6,473 6,390
Effect of dilutive securities
Weighted average common stock options .................... 218 422 324 329
Total weighted average stock and options outstanding ....... 6,703 6,849 6,797 6,719
====== ====== ====== ======
Net income per common share -- assuming dilution ........... $ .01 $ .09 $ .18 $ .19
====== ====== ====== ======
During the three months ended October 3, 1998 and September 30, 1997,
options to purchase 612,791 and 21,782 shares, respectively, at weighted average
exercise prices of $7.92 and $14.04 per share, respectively, were outstanding,
but were not included in the computations of net income per common
share-assuming dilution because the exercise price of the related options
exceeded the market price of the common shares. These options could dilute
earnings per share in future periods.
5. ADOPTED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 (SFAS 130), reporting comprehensive
income. This statement establishes requirements for disclosure of comprehensive
income, with reclassification of earlier financial statements for comparative
purposes. Comprehensive income generally represents all changes in stockholders'
equity except those resulting from investments or contributions by stockholders.
SFAS No. 130, which is effective for interim periods beginning after December
15, 1997, has been adopted by the Company. However, comprehensive income is
insignificant for all periods presented and, accordingly, no additional
disclosures have been presented in the accompanying financial statements.
-7-
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the factors set forth under "Factors
Affecting Operating Results" and other risks detailed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 and Form 10-Q filed
with the Securities and Exchange Commission and detailed from time to time in
the Company's reports filed with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales of certain
items in the Company's income statement for the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- --------------------------------
OCTOBER 3, SEPTEMBER 30, OCTOBER 3, SEPTEMBER 30,
1998 1997 1998 1997
------- ------- ------- -------
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 51.0 42.8 44.7 42.8
Gross profit 49.0 57.2 55.3 57.2
Operating expenses:
Research and development 13.9 9.1 11.4 10.7
Sales, general and administrative 36.4 31.4 35.3 33.9
------- ------- ------- -------
Total operating expenses 50.3 40.5 46.7 44.6
------- ------- ------- -------
Income (Loss) from operations (1.3) 16.7 8.6 12.6
Other income, net 2.5 3.4 2.2 3.8
------- ------- ------- -------
Income before provision for income taxes 1.2 20.1 10.8 16.4
Provision for income taxes (0.4) (7.3) (3.6) (5.9)
------- ------- ------- -------
Net income 0.8% 12.8% 7.2% 10.5%
======= ======= ======= =======
Sales. Sales increased 12% to $5.2 million for the three months ended
October 3, 1998 from $4.6 million for the three months ended September 30, 1997.
Sales increased 39% to $17.1 million for the nine months ended October 3, 1998
from $12.3 million for the nine months ended September 30, 1997. The growth in
sales was primarily attributable to increased unit volume as the Company
expanded its product offerings and broadened its customer base. Domestic sales
of $3.4 million accounted for 65% of sales for the three months ended October 3,
1998 compared to $1.9 million or 40% of sales in the comparable 1997 period. The
increase in domestic sales was attributable primarily to sales of ophthalmology
products. In addition, increased domestic sales resulted in higher average
selling prices as domestic sales are primarily sold by employee sales
representatives at higher average selling prices than to the Company's
international distributors. International sales of $1.8 million in the three
months ended October 3, 1998 decreased from $2.8 million in the comparable 1997
period. The decrease in international sales was primarily attributable to a
reduction in sales to many Asian region countries which continue to experience
economic uncertainty. The Company expects lower sales from
-8-
9
many countries in the Asia region to continue through the end of 1998 and next
year. The Company expects revenues from international sales to continue to
account for a substantial portion of its sales. There can be no assurance that
further economic uncertainty in the Asia region and other factors discussed
above will not have a material adverse effect on the Company's business,
financial condition or results of operations.
Gross Profit. The Company's gross profit decreased 4% to $2.6 million
for the three months ended October 3, 1998 from $2.7 million for the three
months ended September 30, 1997. For the nine months ended October 3, 1998, the
Company's gross profit increased 34% to $9.4 million as compared to $7.1 million
for the comparable period in 1997. Gross profit as a percentage of net sales for
the three months ended October 3, 1998 decreased to 49.0%, compared to 57.2% for
the three months ended September 30, 1997, due primarily to proportionately
higher overhead costs of production. In addition, ongoing competitive pressure
on the prices of the Company's products resulted in a decline in average selling
prices. The Company's newer products such as the OcuLight GLx will cost more to
build due to advances in technology but are expected to be sold with higher
average selling prices. The Company expects to begin shipping the OcuLight GLx
in the fourth quarter of 1998. The Company intends to continue its efforts to
reduce the cost of components and the costs associated with new product
introductions, and expects its gross profit to continue to fluctuate due to
changes in the relative proportions of domestic and international sales, costs
associated with additional new product introductions, pricing, volumes and a
variety of other factors.
Research and Development. Research and development expenses increased by
72% to $0.7 million for the three months ended October 3, 1998 from $0.4 million
for the three months ended September 30, 1997, and increased as a percentage of
net sales to 14% for the three months ended October 3, 1998 from 9% of net sales
for the comparable prior year three-month period ended September 30, 1997. For
the nine months ended October 3, 1998, research and development expenses
increased 48% to $2.0 million as compared to $1.3 million for the nine months
ended September 30, 1997. The increase in absolute dollars in research and
development expenses during this period was primarily attributable to an
increase in personnel as the Company continued to strengthen its product
development efforts. The Company expects these expenses for research and
development to continue to increase in absolute dollars during the remainder of
1998 in connection with new product development activities.
Sales, General and Administrative. Sales, general and administrative
expenses increased by 30% to $1.9 million for the three months ended October 3,
1998 from $1.5 million for the three months ended September 30, 1997, and
increased as a percentage of net sales to 36% for the three months ended October
3, 1998 from 31% for the comparable prior year three-month period. For the nine
months ended October 3, 1998, sales, general and administrative expenses
increased by 44% to $6.0 million from $4.2 million for the nine months ended
September 30, 1997. The increase in absolute dollars in sales, general and
administrative expenses was primarily due to the hiring of additional sales,
marketing and administrative employees to address new opportunities and support
expanding unit volumes. Furthermore, the increase in domestic sales caused an
associated increase in direct selling expenses due to certain selling costs that
vary directly with the level of sales. In addition, during the three months
ended October 3, 1998, the Company completed full scale implementation of a new
company-wide enterprise resource planning ("ERP") system. The Company expects
sales, general and administrative expenses to continue to increase during the
balance of 1998 to support the increasing unit shipment volumes, additional
sales employees and promotional activities.
Income Taxes. The Company's effective tax rate for the three and nine
months ended October 3, 1998 was 34%. This rate differs from the federal
statutory rate primarily due to state income taxes, offset by the utilization of
tax credits, non-taxable available-for-sale security investments and tax
benefits from the Company's foreign sales corporation.
-9-
10
LIQUIDITY AND CAPITAL RESOURCES
At October 3, 1998, the Company's primary sources of liquidity included
cash and cash equivalents and available-for-sale securities of $10.1 million.
During the nine months ended October 3, 1998, the Company used $2.9 million in
operating activities. Uses of cash included increases in inventories of $2.8
million and accounts receivables of $1.4 million, and decreases in accrued
expenses of $0.5 million offset by net income of $1.2 million, depreciation of
$0.5 million and increases in accounts payable of $0.2 million. The increase in
inventory is primarily due to increased finished goods inventory and raw
materials for newer products such as the OcuLight GLx. The Company used $4.9
million in investing activities during the nine months ended October 3, 1998,
primarily from the net purchase of $4.1 million of available-for-sale securities
and by the acquisition of $0.8 million of property and equipment and intangible
assets. Net cash provided by financing activities during the nine months ended
October 3, 1998 was $0.2 million, which consisted primarily of proceeds from the
issuance of stock. The Company believes that, based on current estimates, its
current cash and cash equivalents, and available-for-sale securities will be
sufficient to meet its anticipated cash requirements through 1999.
YEAR 2000 COMPLIANCE
The Company uses a significant number of computer software programs and
operating systems in its internal operations, including applications for various
financial, business and administrative functions. In addition, many of the
Company's suppliers use similar applications. These applications may contain
source code that is unable to properly interpret calendar years beginning with
the upcoming year 2000. Systems that do not properly recognize such
date-sensitive information may fail or create erroneous results. Because there
are no internal calendars embedded in any of the Company's products, the Company
does not anticipate any problems with its products related to the Year 2000
problem. Based on information currently available to the Company, the Company
believes that its internal systems currently are, or will be by such time as is
necessary to avoid a material adverse impact on the Company, Year 2000
compliant. Also based on information thus far available to the Company, the
Company does not believe that it will incur expenditures in dealing with Year
2000 issues that will have a material adverse effect on the financial condition
of the Company. In addition to the risks from failure of the Company's own
internal systems, the Company may also be exposed to risks from computer systems
of parties with whom the Company transacts business. For example, if the
internal systems of one of the Company's key suppliers developed problems such
that the supplier could not deliver parts to the Company on a timely basis, the
Company's financial condition could be materially adversely affected. The
Company intends to work with its suppliers to ascertain what actions, if any,
are needed. The Company does not expect additional costs for problems related to
the Year 2000 problem to exceed $100,000. There can be no assurances, however,
that unknown costs necessary to update the Company's systems or address
potential system interruptions of the Company's or its suppliers' systems will
not have a material adverse effect on the Company's business, financial
condition or results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, The Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments
of an Enterprise and Related Information. This statement establishes standards
for disclosure about operating segments in annual financial statements and
selected information in interim financial reports. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting Standards
No. 14, Financial Reporting for Segments of a Business Enterprise. The new
standard
-10-
11
becomes effective for fiscal years beginning after December 15, 1997, and
requires that comparative information from earlier years be restated to conform
to the requirements of this standard. The Company is evaluating the requirements
of SFAS 131 and the effects, if any, on the Company's current reporting and
disclosures.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Continued Market Acceptance of the Company's Products. The Company
currently markets visible and invisible light semiconductor-based
photocoagulator medical laser systems to the ophthalmic market and a visible
light semiconductor-based photocoagulator medical laser system to the
dermatological market. The Company believes that continued and increased sales,
if any, of these medical laser systems is dependent upon the continued market
acceptance of these products. Medical equipment purchasing decisions and
continued market acceptance of the Company's products may in turn depend on
opinions of medical professionals, performance and price, product and treatment
familiarity, procedure reimbursement economics and other factors. The Company
believes that recommendations by ophthalmologists and dermatologists as to the
use of semiconductor-based laser systems is essential for the continued market
acceptance of the Company's products. Such medical professionals may not
recommend these laser systems or related treatments unless they conclude, based
on clinical data and other factors, that the performance of these laser systems
and treatments are a beneficial alternative to competing technologies and
treatments. Favorable recommendations from such medical professionals is
particularly important to the Company because the ophthalmic and dermatological
communities historically have used more established visible light, argon gas or
other ion-based photocoagulation laser systems. The Company's
semiconductor-based laser systems are relatively new to the marketplace. The
Company's infrared laser systems deliver invisible light to provide additional
and, in some instances, improved treatments. Because many ophthalmologists and
dermatologists have been trained in medical school using visible argon gas or
other ion-based laser systems, they may be reluctant or unwilling to convert to
semiconductor-based or infrared laser systems. In addition, ophthalmic
procedures are typically reimbursed by third party payers who are increasingly
scrutinizing the level of reimbursement for treatment procedures. Furthermore,
changes in government legislation or regulation could effect reimbursement
levels. A reduction in the level of reimbursement for treatments administered
with the Company's ophthalmic products would negatively impact the saleability
of such products. Dermatological procedures are typically paid for by the
treated patient. Any reduction in the perceived value of such treatments would
reduce the price level that dermatologists can charge and would negatively
impact the saleability of such products. There can be no assurance that the
Company's medical laser systems will continue to be accepted by the market. The
failure of medical professionals to recommend the Company's laser systems, the
introduction of improved alternative technologies or treatments, the reluctance
or unwillingness of ophthalmologists or dermatologists to convert to
semiconductor-based laser systems or to infrared laser systems, or reductions in
treatment reimbursements would negatively impact the market acceptance of the
Company's products. Any significant decline in market acceptance of the
Company's products would have a material adverse effect on the Company's
business, results of operations and financial condition.
Competition. Competition in the market for devices used for ophthalmic
and dermatological treatments is intense and may increase. This market is also
characterized by rapid technological innovation and change, and the Company's
products could be rendered obsolete as a result of future innovations. The
Company's competitive position depends on a number of factors including product
performance, characteristics and functionality, ease of use, scalability,
durability and cost. In addition to other companies that manufacture
photocoagulators, the Company's products compete with pharmaceutical treatments,
other technologies and other surgical techniques. The Company's principal
competitors in ophthalmology are Coherent, Inc., Nidek, Inc. ("Nidek"), Carl
Zeiss, Inc. ("Zeiss"), Alcon International ("Alcon"), Keeler Instruments, Inc.
("Keeler") and HGM Medical Laser Systems, Inc. ("HGM"). Of these companies, most
currently offer a semiconductor-based laser system in
-11-
12
ophthalmology. The Company's principal competitors in dermatology are Laserscope
and HGM, neither of which currently offers a semiconductor-based laser system in
dermatology. Other competitors have substantially greater financial,
engineering, product development, manufacturing, marketing and technical
resources than the Company. Such companies may also have greater name
recognition than the Company, broader product offerings and long-standing
customer relationships. In addition, there can be no assurance that other
medical companies, academic and research institutions or others will not develop
new technologies or therapies, including medical devices, surgical procedures or
pharmacological treatments and obtain regulatory approval for products utilizing
such techniques that are more effective in treating the ophthalmic and
dermatological conditions targeted by the Company or are less expensive than the
Company's current or future products. Moreover, there can be no assurance that
the Company's technologies and products would not be rendered obsolete by such
developments. Any such developments could have a material adverse effect on the
business, financial condition and results of operations of the Company.
Risks of Manufacturing and Dependence on Key Manufacturers and
Suppliers. The manufacture of the Company's infrared and visible light
semiconductor-based photocoagulator medical laser systems and the related
delivery devices is a highly complex and precise process which requires the
integration of components with unique characteristics. Accordingly, problems may
occur in the manufacture of the Company's products which could prevent shipping
of some products or could result in reduced bookings, manufacturing rework
costs, delays in collecting accounts receivable, additional service and warranty
costs and a decline in the Company's competitive position. There can be no
assurance that the Company will be able to continue to manufacture its existing
products or future products on a cost-effective and timely basis. Although the
Company assembles critical subassemblies as well as the final product at its
facility in Mountain View, California, the Company relies on third parties to
manufacture substantially all of the components used in its products. There are
risks associated with the use of independent manufacturers, availability of or
delays in obtaining adequate supplies of components such as optics and laser
diodes and potentially reduced control of quality, production costs and the
timing of delivery. The Company has qualified two or more sources for most of
the components used in its products. However, certain of the Company's products
remain significantly dependent on sole source suppliers. Certain diodes
purchased from SDL, Inc. ("SDL") were not readily available from other suppliers
until the second quarter of 1997. During 1996 and the first quarter of 1997, the
Company experienced delays in its manufacturing of the OcuLight GL because of
the inability of SDL to deliver components in volume and on a timely basis. The
Company continues to work with this supplier to ensure such difficulties do not
recur. During the first quarter of 1997, the Company qualified Opto Power as a
second source of this diode component. Because laser diode components are
extremely complex and difficult to manufacture, there can be no assurance that
the Company's suppliers of such components will be able to deliver components in
sufficient quantities to meet the Company's requirements on a timely basis.
Similar manufacturing issues or delays in the delivery of other key components
of the Company's products could also have a material adverse impact on the
Company. The Company does not have long-term or volume purchase agreements with
any of its suppliers and currently purchases components on a purchase order
basis. No assurance can be given that these components will be available in the
quantities required by the Company, on reasonable terms, or at all. Establishing
its own capabilities to manufacture these components would require significant
scale-up expenses and additions to facilities and personnel and could
significantly decrease the Company's profit margins. The Company's inability to
obtain components as required at a reasonable cost, or at all, would have a
material adverse affect on the Company's business, results of operations and
financial condition.
Dependence on International Sales. The Company derives, and expects to
continue to derive, a large portion of its revenue from international sales. In
1997 and 1996, the Company's international sales were $9.4 million and $6.1
million, representing 52% and 50%, respectively, of total sales. In addition,
for the three months ended October 3, 1998 and September 30, 1997, the Company's
international sales were $1.8 million and
-12-
13
$2.8 million, representing 35% and 60% respectively, of total sales. A large
portion of the Company's revenues will continue to be subject to the risks
associated with international sales, including fluctuations in foreign currency
exchange rates, shipping delays, generally longer receivables collection
periods, changes in applicable regulatory policies, international monetary
conditions, domestic and foreign tax policies, trade restrictions, duties and
tariffs, and economic and political instability. The recent currency devaluation
in many Asian countries has had the effect of significantly increasing the
purchase price of the Company's products to the Company's distributors and their
customers in that region. Conversely, because certain of the Company's
competitors are based in Asia, the currency devaluations may put additional
downward pressures on the average selling prices of the Company's products.
Product sales were lower for the affected Asian region during the first nine
months of 1998 and the fourth quarter of 1997 primarily as a result of the
currency devaluation problem. The Company expects lower sales to the Asian
region to continue into 1999. However, the Company also expects revenues from
international sales to continue to account for a substantial portion of its
sales. Accordingly, if the Asian economic difficulties are prolonged, worsen or
otherwise negatively impact the salability of the Company's product or if other
government certifications become required, these difficulties could negatively
impact the Company's business, results of operations, and financial condition.
While these currency and government approval factors and other factors listed
above have been mitigated by product sales in other regions and in the United
States, there can be no assurance that continuance or reoccurrence of the
factors discussed above will not have a material adverse effect on the Company's
business, financial condition or results of operations.
Quarterly Fluctuations in Operating Results. Although the Company has
been profitable on an annual and quarterly basis for the last five years, the
Company's sales and operating results have varied substantially on a quarterly
basis, and such fluctuations are expected to continue in future periods. The
Company's operating results are affected by a number of factors, many of which
are beyond the Company's control. Factors contributing to these fluctuations
include the timing of the introduction and market acceptance of new products or
product enhancements by the Company and its competitors, the timing of receiving
government approvals or certification, the cost and availability of components
and subassemblies, changes in pricing by the Company and its competitors, the
timing of the development and market acceptance of new applications for the
Company's products, the relatively long and highly variable sales cycle for the
Company's products to hospitals, other health care institutions and
governmental agencies, fluctuations in economic and financial market conditions,
such as the recent currency devaluation in Asia, and resulting changes in
customers' or potential customers' budgets and increased product development
costs. For example, the Company's gross profits as a percentage of sales have
generally declined in part as a result of increased competition which has led to
decreases in average selling prices, particularly with respect to the Company's
older products. Any inability to obtain adequate quantities of the critical
components used in the system products would adversely impact the Company's
ability to ship the OcuLight SL, SLx, GL and GLx and the DioLite 532. In
addition to these factors, the Company's quarterly results have been and are
expected to continue to be affected by seasonal factors. For example, domestic
sales often decline slightly prior to the meeting of the American Academy of
Ophthalmology in the fourth quarter of the year. The Company manufactures its
products to forecast rather than to outstanding purchase orders, and products
are typically shipped shortly after receipt of a purchase order. While backlog
increased in 1997, it decreased during the nine months ending October 3, 1998.
The Company does not expect significant backlog in the future and the amount of
backlog at any particular date is generally not indicative of its future level
of sales. Although the Company's manufacturing procedures are designed to assure
rapid response to customer orders, they may in certain instances create a risk
of excess or inadequate inventory levels if orders do not match forecasts. The
Company's expense levels are based, in part, on expected future sales. If sales
levels in a particular quarter do not meet expectations, the Company may be
unable to adjust operating expenses quickly enough to compensate for the
shortfall, and the Company's results of operations may be adversely affected. In
addition, the Company has historically made a significant portion of each
quarter's product shipments near the end of the quarter. If that pattern
continues, even short delays in shipment of products at the end of a quarter
could have a material adverse effect on results
-13-
14
of operations for such quarter. As a result of the above factors, sales for any
future quarter are not predictable with any significant degree of accuracy and
operating results in any period should not be considered indicative of the
results to be expected for any future period. There can be no assurance that the
Company will remain profitable in the future or that operating results will not
vary significantly.
Dependence on Development of New Products and New Applications. The
Company's future success is dependent upon, among other factors, its ability to
develop, obtain regulatory approval, manufacture and introduce on a timely and
cost-effective basis as well as successfully sell and achieve market acceptance
of new products and applications and enhanced versions of existing products. The
extent of, and rate at which, market acceptance and penetration are achieved by
future products, is a function of many variables, including price, safety,
efficacy, reliability, marketing and sales efforts, the development of new
applications for these products and general economic conditions affecting
purchasing patterns. Even if the Company's products achieve clinical acceptance,
there can be no assurance that the Company can successfully manage the
introduction of such products into the ophthalmic, dermatological or other
markets. The Company expects to begin shipping the OcuLight GLx in the fourth
quarter of 1998. The failure of the Company to successfully develop and
introduce new products or enhanced versions of existing products could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company is seeking to expand the market for its
existing and new products by working with clinicians and third parties to
identify new applications for its products, validating new procedures which
utilize its products and responding more effectively to new procedures. There
can be no assurance that the Company's efforts to develop new applications for
its products will be successful, that it can obtain regulatory approvals to use
its products in new clinical applications in a timely manner, or at all, or gain
satisfactory market acceptance for such new applications. Failure to develop and
achieve market acceptance of new applications or new products would have a
material adverse effect on the Company's business, results of operations and
financial condition.
Management of Growth. With the introduction of new products, the Company
has recently experienced, and may continue to experience growth in production,
the number of employees, the scope of its business, its operating and financial
systems and the geographic area of its operations. This growth has resulted in
new and increased responsibilities for management personnel and has placed and
continues to place a significant strain upon the Company's management,
operating, inventory and financial systems and resources. To accommodate recent
growth and to compete effectively and manage future growth, if any, the Company
has been required to continue to implement and improve operational, financial
and management information systems, procedures and controls and to expand,
train, motivate and manage its work force. The Company implemented a new
enterprise resource planning ("ERP") system to run the Company's business
transaction processes. The installation and implementation of this new system
was completed in the third quarter of 1998. The transition to the ERP system is
a highly complex and technical process, and it is not uncommon for companies
engaged in such a transition to experience unexpected delays and technical
problems. There can be no assurance that the Company has successfully
implemented the ERP system, and difficulties encountered after the
implementation process could have a material adverse effect on the Company's
business, results of operations and financial condition. The Company's future
success will depend on the successful implementation of these systems as well as
on the ability of its current and future executive officers to operate
effectively, both independently and as a group. There can be no assurance that
the Company's personnel, systems, procedures and controls will be adequate to
support the Company's existing and future operations. Any failure to implement
and improve the Company's operational, financial and management systems or to
expand, train, motivate or manage employees could have a material adverse effect
on the Company's business, results of operations and financial condition.
Dependence on Collaborative Relationships. The Company has entered into
collaborative relationships with academic medical centers and physicians in
connection with the research and development and clinical testing of its
products. The Company plans to collaborate with third parties to develop and
commercialize
-14-
15
existing and new products. In May 1996, the Company executed an agreement with
Miravant Medical Technologies ("Miravant"), formerly known as PDT, Inc.,a maker
of photodynamic drugs, under which the Company and Miravant have collaborated to
develop a device that emits a laser beam to activate a photodynamic drug
developed by Miravant to achieve a desired therapeutic result in the treatment
of age-related macular degeneration. The development, clinical testing and
regulatory approval of this new photodynamic system will require three to five
years and significant financial and other resources. There can be no assurance
that this collaborative development effort will continue or that it will result
in the successful development and introduction of a photodynamic system. The
Company believes that these current and future relationships are important
because they may allow the Company greater access to funds, to research,
development and testing resources and to manufacturing, sales and distribution
resources. However, the amount and timing of resources to be devoted to these
activities are not within the Company's control. There can be no assurance that
such parties will perform their obligations as expected or that the Company's
reliance on others for clinical development, manufacturing and distribution of
its products will not result in unforeseen problems. Further, there can be no
assurance that the Company's collaborative partners will not develop or pursue
alternative technologies either on their own or in collaboration with others,
including the Company's competitors, as a means of developing or marketing
products for the diseases targeted by the collaborative programs and by the
Company's products. The failure of any current or future collaboration efforts
could have a material adverse effect on the Company's ability to introduce new
products or applications and therefore could have a material adverse effect on
the Company's business, results of operations and financial condition.
Patents and Proprietary Rights. The Company's success and ability to
compete is dependent in part upon its proprietary information. The Company
relies on a combination of patents, trade secrets, copyright and trademark laws,
nondisclosure and other contractual agreements and technical measures to protect
its intellectual property rights. The Company files patent applications to
protect technology, inventions and improvements that are significant to the
development of its business. The Company has been issued six United States
patents on the technologies related to its products and processes. There can be
no assurance that any of the Company's patent applications will issue as
patents, that any patents now or hereafter held by the Company will offer any
degree of protection, or that the Company's patents or patent applications will
not be challenged, invalidated or circumvented in the future. Moreover, there
can be no assurance that the Company's competitors, many of which have
substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with the Company's ability to make, use or sell its products
either in the United States or in international markets.
In addition to patents, the Company relies on trade secrets and
proprietary know-how which it seeks to protect, in part, through proprietary
information agreements with employees, consultants and other parties. The
Company's proprietary information agreements with its employees and consultants
contain industry standard provisions requiring such individuals to assign to the
Company without additional consideration any inventions conceived or reduced to
practice by them while employed or retained by the Company, subject to customary
exceptions. There can be no assurance that proprietary information agreements
with employees, consultant and others will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known to or independently developed by competitors.
The laser and medical device industry is characterized by frequent
litigation regarding patent and other intellectual property rights and companies
in the medical device industry have employed intellectual property litigation to
gain a competitive advantage. Numerous patents are held by others, including
academic institutions and competitors of the Company. Because patent
applications are maintained in secrecy in the United States until patents are
issued and are maintained in secrecy for a period of time outside the United
States, the Company has not conducted any searches to determine whether the
Company's technology infringes any patents or patent
-15-
16
applications. The Company has from time to time been notified of, or has
otherwise been made aware of claims that it may be infringing upon patents or
other proprietary intellectual property owned by others. If it appears necessary
or desirable, the Company may seek licenses under such patents or proprietary
intellectual property. Although patent holders commonly offer such licenses, no
assurance can be given that licenses under such patents or intellectual property
will be offered or that the terms of any offered licenses will be reasonable or
will not adversely impact the Company's operating results.
Any claims, with or without merit, could be time-consuming, result in
costly litigation and diversion of technical and management personnel, cause
shipment delays or require the Company to develop noninfringing technology or to
enter into royalty or licensing agreements. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. An adverse determination in
a judicial or administrative proceeding or failure to obtain necessary licenses
could prevent the Company from manufacturing and selling its products, which
would have a material adverse effect on the Company's business, results of
operations and financial condition. Conversely, litigation may be necessary to
enforce patents issued to the Company, to protect trade secrets or know-how
owned by the Company or to determine the enforceability, scope and validity of
the proprietary rights of others. Both the defense and prosecution of
intellectual property suits or interference proceedings are costly and time
consuming.
Government Regulation. The medical devices marketed and manufactured by
the Company are subject to extensive regulation by the Food and Drug
Administration ("FDA") and by foreign and state governments. Pursuant to the FDA
Act and the regulations promulgated thereunder, the FDA regulates the design,
development, clinical testing, manufacture, labeling, sale, distribution and
promotion of medical devices. Before a new device can be introduced into the
market, the manufacturer must obtain market clearance through either the 510(k)
premarket notification process or the lengthier premarket approval ("PMA")
application process. Obtaining these approvals can take a long time and delay
the introduction of a product. For example, the introduction of the OcuLight GL
in the United States was delayed about three months from the Company's
expectations due to the longer than expected time period required to obtain FDA
premarket clearance. In addition, the Company's products must comply with the
regulatory requirements of each country in which the Company's products are
sold. Noncompliance with applicable requirements, including the FDA's quality
System Regulations, can result in, among other things, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, failure of the government to grant premarket clearance or premarket
approval for devices, withdrawal of marketing approvals, and criminal
prosecution. The FDA also has the authority to request repair, replacement or
refund of the cost of any device manufactured or distributed by the Company. The
failure of the Company to obtain government approvals or any delays in receipt
of such approvals would have a material adverse effect on the Company's
business, results of operations and financial condition.
Product Liability and Insurance. The Company may be subject to product
liability claims in the future. The Company's products are highly complex and
are used to treat extremely delicate eye tissue as well as to treat skin
conditions primarily on the face. The Company's products are often used in
situations where there is a high risk of serious injury or adverse side effects.
In addition, although the Company recommends that its disposable products only
be used once and so prominently labels these products, the Company believes that
certain customers may nevertheless reuse these disposable products. Were such a
disposable product not adequately sterilized by the customer between such uses,
a patient could suffer serious consequences, possibly resulting in a suit
against the Company for damages. Accordingly, the manufacture and sale of
medical products entails significant risk of product liability claims. Although
the Company maintains product liability insurance with coverage limits of $6.0
million per occurrence and an annual aggregate maximum of $7.0 million, there
can be
-16-
17
no assurance that the coverage of the Company's insurance policies will be
adequate. Such insurance is expensive and in the future may not be available on
acceptable terms, if at all. A successful claim brought against the Company in
excess of its insurance coverage could have a material adverse effect on the
Company's business, results of operations and financial condition. To date, the
Company has not experienced any product liability claims.
Volatility of Stock Price. The trading price of the Company's Common
Stock has been subject to wide fluctuations in response to a variety of factors
since the Company's initial public offering in February 1996, including
quarterly variations in operating results, announcements of technological
innovations or new products by the Company or its competitors, developments in
patents or other intellectual property rights, general conditions in the
ophthalmic laser industry, revised earning estimates, comments or
recommendations issued by analysts who follow the Company, its competitors or
the ophthalmic laser industry and general economic and market conditions.
Additionally, the stock market in general, and the market for technology stocks
in particular, have experienced extreme price volatility in recent years.
Volatility in price and volume has had a substantial effect on the market prices
of many technology companies for reasons unrelated or disproportionate to the
operating performance of such companies. These broad market fluctuations could
have a significant impact on the market price of the Common Stock.
Year 2000 Compliance. The Company uses a significant number of computer
software programs and operating systems in its internal operations, including
applications for various financial, business and administrative functions. In
addition, many of the Company's suppliers use similar applications. These
applications may contain source code that is unable to properly interpret
calendar years beginning with the upcoming year 2000. Systems that do not
properly recognize such date-sensitive information may fail or create erroneous
results. Because there are no internal calendars embedded in any of the
Company's products, the Company does not anticipate any problems with its
products related to the Year 2000 problem. Based on information currently
available to the Company, the Company believes that its internal systems
currently are, or will be by such time as is necessary to avoid a material
adverse impact on the Company, Year 2000 compliant. Also based on information
thus far available to the Company, the Company does not believe that it will
incur expenditures in dealing with Year 2000 issues that will have a material
adverse effect on the financial condition of the Company. In addition to the
risks from failure of the Company's own internal systems, the Company may also
be exposed to risks from computer systems of parties with whom the Company
transacts business. For example, if the internal systems of one of the Company's
key suppliers developed problems such that the supplier could not deliver parts
to the Company on a timely basis, the Company's financial condition could be
materially adversely affected. The Company intends to work with its suppliers to
ascertain what actions, if any, are needed. The Company does not expect
additional costs for problems related to the Year 2000 problem to exceed
$100,000. There can be no assurances, however, that unknown costs necessary to
update the Company's systems or address potential system interruptions of the
Company's or its suppliers' systems will not have a material adverse effect on
the Company's business, financial condition or results of operations.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
-17-
18
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On October 27, 1998 the Board of Directors approved an amendment to the
Company's Bylaws (i) to add an "advance notice" bylaw governing the requirement
of prior notice for stockholder proposals being submitted for Annual and Special
meeting and (ii) to eliminate the ability of stockholders holding an aggregate
of not less than 10% of the Company's stock to call special stockholder
meetings. The "advance notice" provision reflects recent amendments to Rules
14a-4 and 14a-8 under the Securities Exchange Act of 1934. The amended and
restated Bylaws are attached hereto as Exhibit 3.1.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Bylaws
27.1 Financial Data Schedule
(b) Reports on Form 8-K
-18-
19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IRIDEX CORPORATION
(Registrant)
Date: November 16, 1998 By: /s/ Robert Kamenski
-------------------------
Robert Kamenski
Chief Financial Officer
(Principal Financial and
Principal Accounting Officer)
-19-
20
INDEX TO EXHIBITS
EXHIBIT PAGE
3.1 Amended and Restated Bylaws
27.1 Financial Data Schedule
-20-