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 March 29, 2003
[ ] 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [X]
The number of shares of common stock, $.01 par value, issued and outstanding as
of May 6, 2003 was 6,919,285.
IRIDEX CORPORATION
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Condensed Consolidated Balance Sheets as of March 29, 2003
and December 28, 2002 3
Condensed Consolidated Statements of Operations for the three months
ended March 29, 2003 and March 30, 2002 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 29, 2003 and March 30, 2002 5
Condensed Consolidated Statements of Comprehensive Income (Loss) for the
three months ended March 29, 2003 and March 30, 2002 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26
ITEM 4. CONTROLS AND PROCEDURES 27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 28
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 28
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 28
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS 28
ITEM 5. OTHER INFORMATION 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 28
SIGNATURE 29
CERTIFICATION UNDER SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002 29
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
- --------------------------------------------------------
IRIDEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
MARCH 29, DECEMBER 28,
------------ --------------
2003 2002
------------ --------------
(unaudited)
ASSETS
------
Current assets:
Cash and cash equivalents. . . . . . . . . . .$ 11,888 $ 9,186
Available-for-sale securities. . . . . . . . . 1,418 2,356
Accounts receivable, net . . . . . . . . . . . 6,385 8,037
Inventories. . . . . . . . . . . . . . . . . . 10,616 10,725
Prepaids and other current assets. . . . . . . 1,130 751
------------ --------------
Total current assets . . . . . . . . . . . . 31,437 31,055
Property and equipment, net. . . . . . . . . . 828 950
Deferred income taxes. . . . . . . . . . . . . 2,267 2,267
------------ --------------
Total assets . . . . . . . . . . . . . . . .$ 34,532 $ 34,272
============ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable . . . . . . . . . . . . . . .$ 996 $ 657
Accrued expenses . . . . . . . . . . . . . . 3,401 3,417
------------ --------------
Total liabilities. . . . . . . . . . . . . 4,397 4,074
------------ --------------
Stockholders' equity:
Common stock . . . . . . . . . . . . . . . . . . . 70 70
Additional paid-in capital. . . . . . . . . . 23,652 23,631
Accumulated other comprehensive income. . . . 1 3
Treasury stock. . . . . . . . . . . . . . . . (430) (430)
Retained earnings . . . . . . . . . . . . . . 6,842 6,924
------------ --------------
Total stockholders' equity . . . . . . . . 30,135 30,198
------------ --------------
Total liabilities and stockholders' equity $ 34,532 $ 34,272
============ ==============
<FN>
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)
THREE MONTHS ENDED
MARCH 29, MARCH 30,
2003 2002
----------- -----------
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,226 $ 6,963
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . 3,988 3,878
----------- -----------
Gross Profit. . . . . . . . . . . . . . . . . . . . . . 3,238 3,085
----------- -----------
Operating expenses:
Research and development . . . . . . . . . . . . . . . . . . 950 1,145
Sales, general and administrative. . . . . . . . . . . . . . 2,464 2,287
----------- -----------
Total operating expenses. . . . . . . . . . . . . . . . . . . 3,414 3,432
----------- -----------
Loss from operations. . . . . . . . . . . . . . . . . . . . . (176) (347)
Interest and other income, net. . . . . . . . . . . . . . 54 43
----------- -----------
Loss before benefit from income taxes . . . . . . . . . . . . (122) (304)
Benefit from income taxes . . . . . . . . . . . . . . . 40 97
----------- -----------
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . $ (82) $ (207)
=========== ===========
Basic and diluted net loss per share. . . . . . . . . . . . . $ ( 0.01) $ ( 0.03)
=========== ===========
Shares used in computing basic and diluted net loss per share 6,913 6,838
=========== ===========
<FN>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 29, MARCH 30,
2003 2002
----------- -----------
Cash flows from operating activities:
Net loss $ (82) $ (207)
Adjustments to reconcile net income loss to net cash
provided by (used in) operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . 202 226
Provision for inventories. . . . . . . . . . . . . . . . . . . . . . . . . (2) 10
Provision for doubtful accounts. . . . . . . . . . . . . . . . . . . . . . (1) (4)
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . - (8)
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . 1,652 131
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 191
Prepaids and other current assets . . . . . . . . . . . . . . . . . . . (379) (99)
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 339 (578)
Accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . (16) (477)
----------- -----------
Net cash provided by (used in) operating activities . . . . . . . . . . . 1,824 (815)
----------- -----------
Cash flows from investing activities:
Proceeds from maturity of available-for-sale securities . . . . . . . . . . 937 2,059
Acquisition of property and equipment . . . . . . . . . . . . . . . . . . . (80) (109)
----------- -----------
Net cash provided by investing activities . . . . . . . . . . . . . . . . 857 1,950
----------- -----------
Cash flows from financing activities:
Issuance of common stock. . . . . . . . . . . . . . . . . . . . . . . . . . 21 108
----------- -----------
Net cash provided by financing activities . . . . . . . . . . . . . . . . 21 108
----------- -----------
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . 2,702 1,243
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . 9,186 4,613
----------- -----------
Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . $ 11,888 $ 5,856
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Change in unrealized losses on available-for-sale securities . . . . $ (1) $ (2)
<FN>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
IRIDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 29, MARCH 30,
2003 2002
----------- -----------
Net loss $ (82) $ (207)
Other comprehensive loss:
Change in unrealized loss on
available-for-sale securities (1) (2)
----------- -----------
Comprehensive loss $ (83) $ (209)
=========== ===========
<FN>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
IRIDEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
IRIDEX Corporation 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 presentation have been included.
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 our Annual Report on Form 10-K, which was filed with
the Securities and Exchange Commission on March 28, 2003. The results of
operations for the three month period ended March 29, 2003 is not necessarily
indicative of the results for the year ending January 3, 2004 or any future
interim period.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's significant accounting policies are disclosed in our Annual
Report on Form 10-K for the year ended December 28, 2002 which was filed with
the Securities and Exchange Commission on March 28, 2003. The Company's
significant accounting policies have not materially changed as of March 29,
2003.
3. WARRANTY
The Company accrues for an estimated warranty cost upon shipment of
products in accordance with SFAS No. 5, "Accounting for Contingencies." Actual
warranty costs incurred have not materially differed from those accrued. The
Company's warranty policy is effective for shipped products which are considered
defective or fail to meet the product specifications. Warranty costs are
reflected in the income statement as a cost of sales. A reconciliation of the
changes in the Company's warranty liability for the three months ending March
29, 2003 follows (in thousands):
Balance at the beginning of the quarter $ 796
Accruals for warranties issued during the quarter 440
Settlements made in kind during the quarter (555)
------
Balance at the end of the quarter $ 681
======
7
4. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees"("APB 25") and complies with the
disclosure provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by SFAS No.
148 "Accounting for Stock - Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123."
Under APB 25, compensation expense for grants to employees is based on the
difference, if any, on the date of the grant, between the fair value of the
Company's stock and the option's exercise price. SFAS 123 defines a "fair value"
based method of accounting for an employee stock option or similar equity
investment. The pro forma disclosure of the difference between compensation
expense included in net loss and the related cost measured by the fair value
method is presented in the table at the end of this note. The Company accounts
for equity instruments issued to non-employees in accordance with the provisions
of SFAS 123 and Emerging Issues Task Force Issue No. 96-18, "Accounting for
Equity Instruments that are Issued to Other Than Employees, or in Conjunction
with Selling Goods and Services." Stock-based compensation expense related to
stock options granted to non-employees is recognized on a straight line basis as
the stock options are earned. The stock-based compensation expense will
fluctuate as the deemed fair market value of the common stock fluctuates. There
were no equity instruments issued to non-employees during the three months ended
March 29, 2003. To comply with the pro forma reporting requirements of SFAS 123,
compensation cost is also estimated for the fair value of Employee Stock
Purchase Plan ("ESPP") issuances, which are included in the pro forma totals
below.
The following table provides a reconciliation of net loss to pro forma net
loss as if the fair value method, pursuant to SFAS 123, had been applied to all
employee awards (in thousands, except per share data):
Three Months Ended Three Months Ended
March 29, 2003 March 30, 2002
Net loss, as reported $ (82) $ (207)
Less: Total stock based compensation expense (114) (176)
-------------------- --------------------
determined under fair value based method for all
awards to employees
Pro forma net loss $ (196) $ (383)
==================== ====================
Basic net loss per share:
As reported $ (0.01) $ (0.03)
==================== ====================
Pro forma $ (0.03) $ (0.06)
==================== ====================
Diluted net loss per share:
As reported $ (0.01) $ (0.03)
==================== ====================
Pro forma $ (0.03) $ (0.06)
==================== ====================
8
The determination of fair value of all options granted by the Company
includes assumptions on expected volatility, risk free interest rate, expected
term and expected dividends.
4. INVENTORIES:
Inventories are stated at the lower of cost or market. Cost is based on
actual sales computed on a first in, first out basis. The components of
inventories consist of the following (in thousands):
MARCH 29, DECEMBER 28,
2003 2002
------------ -------------
(unaudited)
Raw materials and work in progress $ 6,214 $ 6,511
Finished goods . . . . . . . . . . 4,402 4,214
------------ -------------
Total inventories. . . . . . . . . $ 10,616 $ 10,725
============ =============
5. COMPUTATIONS OF NET LOSS PER COMMON SHARE
Basic and diluted net loss per share are computed by dividing net loss for
the period by the weighted average number of shares of common stock outstanding
during the period. The calculation of diluted net loss per share excludes
potential common stock if their effect is anti-dilutive. Potential common stock
consists of incremental common shares issuable upon the exercise of stock
options. Basic and diluted net loss per share are equivalent for all periods
presented due to the Company's net loss position.
During the three months ended March 29, 2003 and March 30, 2002, options
to purchase 1,713,563 and 654,678 shares of common stock at weighted average
exercise prices of $5.26 and $7.98 per share were outstanding, but were not
included in the computations of diluted net loss per common share because it
would have an antidilutive effect. These options could dilute earnings per share
in future periods.
6. BUSINESS SEGMENTS
We operate in two reportable segments: the ophthalmology medical device
segment and the aesthetics 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.
9
Information on reportable segments for the three months ended March 29,
2003 and March 30, 2002 is as follows (in thousands):
Three Months Ended March 29, 2003 Three Months Ended March 30, 2002
(unaudited) (unaudited)
Ophthalmology Aesthetics Total Ophthalmology Aesthetics Total
Medical Medical Medical Medical
Devices Devices Devices Devices
Sales $ 5,724 $ 1,502 $ 7,226 $ 5,078 $ 1,885 $ 6,963
Direct Cost 1,966 706 2,672 1,672 874 2,546
of Goods
Sold
Direct Gross 3,758 796 4,554 3,406 1,011 4,417
Margin
Total
Unallocated
Costs (4,676) (4,721)
-------- --------
Pre-tax loss (122) (304)
======== ========
Indirect costs of manufacturing, research and development, and selling,
general and administrative costs are not allocated to the segments.
The Company's assets and liabilities are not evaluated on a segment basis.
Accordingly, no disclosure on segment assets and liabilities is provided.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. We do
not expect the adoption of this standard to have a material impact on our
financial position or on our results of operations.
10
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, and Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do no
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or quarterly period beginning after June 15, 2003. We do not expect the
adoption of this standard to have a material impact on our financial position or
on our results of operations.
11
ITEM 2.
MANAGEMENT'S 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 and shipment rate of our products, including the actual
timing of shipments of our Millennium Endolase module to Bausch & Lomb;
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; expected reductions of employee-related costs
as a result of our reduction in force in the second quarter of 2002; 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 March 28, 2003 and detailed from time to time in the 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 management's
analysis only as of the date of this 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.
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
sales for the periods indicated.
THREE MONTHS ENDED
MARCH 29, MARCH 30,
2003 2002
---------- ----------
Sales . . . . . . . . . . . . . . . . 100.0% 100.0%
Cost of sales . . . . . . . . . . . . 55.2 55.7
---------- ----------
Gross profit . . . . . . . . . . . . 44.8 44.3
---------- ----------
Operating expenses:
Research and development . . . . . . 13.1 16.4
Sales, general and administrative. . 34.1 32.9
---------- ----------
Total operating expenses . . . . . 47.2 49.3
---------- ----------
Loss from operations. . . . . . . . . (2.4) (5.0)
Interest and other income, net. . . . 0.7 0.6
---------- ----------
Loss before benefit from income taxes (1.7) (4.4)
Benefit from income taxes . . . . . . 0.6 1.4
---------- ----------
Net loss (1.1)% (3.0)%
========== ==========
12
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
March 29, 2003 March 30, 2002
Amount Percentage Amount Percentage
of total sales of total sales
Domestic $ 4,541 62.8% $ 3,998 57.4%
International 2,685 37.2% 2,965 42.6%
------- --------------- ------- ---------------
Total $ 7,226 100.0% $ 6,963 100.0%
------- --------------- ------- ---------------
Ophthalmology:
Domestic $ 3,423 47.4% $ 2,817 40.4%
International 2,301 31.8% 2,261 32.5%
------- --------------- ------- ---------------
Total $ 5,724 79.2% $ 5,078 72.9%
------- --------------- ------- ---------------
Aesthetics:
Domestic $ 1,118 15.5% $ 1,181 17.0%
International 384 5.3% 704 10.1%
------- --------------- ------- ---------------
Total $ 1,502 20.8% $ 1,885 27.1%
------- --------------- ------- ---------------
Combined Ophthalmology and Aesthetics Sales
Sales for the three months ended March 29, 2003 increased 3.8% to $7.2 million
from $7.0 million for the three months ended March 30, 2002. On a segment
basis, the $0.6 million increase in sales of our ophthalmology products was
offset by a $0.4 million decrease in sales of aesthetics products.
Ophthalmology Sales
Ophthalmology sales increased 12.7% to $5.7 million for the three months
ended March 29, 2003 from $5.1 million for the three months ended March 30,
2002. For the three month period ended March 29, 2003 domestic ophthalmology
sales increased 21.5% to $3.4 million from $2.8 million for the comparable prior
three month period. Domestic ophthalmology sales increased during this period
mainly as a result of a $0.6 million increase in unit sales of visible laser
consoles, including the Millennium Endolase module, which is incorporated as a
component of Bausch & Lomb's Millennium Microsurgical System, and because of an
increase in unit sales of disposable delivery devices, including the BriteLight
Illuminating EndoProbe. International ophthalmology sales remained flat at
approximately $2.3 million for each of the three month periods ending March 29,
2003 and March 30, 2002.
13
Aesthetics Sales
Aesthetics sales decreased 20.3% to $1.5 million for the three months ended
March 29, 2003 from $1.9 million for the three months ended March 30, 2002. For
the three month period ended March 29, 2003 domestic aesthetic sales decreased
5.3% to $1.1 million from $1.2 million for the comparable prior year three month
period. Domestic aesthetics sales decreased during this period due to a $0.1
million decrease in domestic average selling prices. International aesthetic
sales decreased $0.3 million or 45.5% to $0.4 million for the three months ended
March 29, 2003 from $0.7 million for the comparable prior year three-month
period. The decrease in international sales for this period was due primarily
to decreased unit sales of aesthetics laser consoles resulting from the
continuing worldwide economic uncertainty, the conflict in Iraq and the outbreak
of SARS in Asia during the first quarter. In addition, our aesthetics product
sales, both domestically and internationally, continue to be affected by the
current weak economic conditions and because aesthetic procedures are typically
elective procedures that are deferred by patients in difficult economic times.
See "-Factors that May Affect Future Results - Our Business Has Been Adversely
Impacted by the Current Worldwide Economic Slowdown and Related Uncertainties."
Gross Profit. Our gross profit increased 5.0% to $3.2 million for the three
months ended March 29, 2003 compared to $3.1 million for the three months ended
March 30, 2002. Gross profit as a percentage of sales for the three months ended
March 29, 2003 increased to 44.8% from 44.3% for the comparable prior year three
month period. The total 0.5% increase in gross profit as a percentage of sales
during this period included a 1.5% beneficial impact from less manufacturing
overhead costs combined with higher sales, a 0.6% beneficial impact from
increased sales of products with higher gross margins, a 0.2% beneficial impact
from decreased direct manufacturing costs, offset in part by a 1.8% unfavorable
impact from lower average selling prices compared to the three months ended
March 30, 2002. 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. 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 Fluctuate from Quarter to Quarter and Year to Year."
Research and Development. Our research and development expenses decreased
by 17.0% to $1.0 million for the three months ended March 29, 2003 from $1.1
million for the three months ended March 30, 2002. Research and development
expenses decreased as a percentage of sales to 13.1% for the three months ended
March 29, 2003 from 16.4% for the comparable prior year three-month period. The
decrease in research and development expense in absolute dollars and as a
percentage of sales for the three month period ended March 29, 2003 was due
primarily to reduced payroll costs of $0.2 million associated with a reduction
in force in June 2002.
Sales, General and Administrative. Our sales, general and administrative
expenses increased by 7.7% to $2.5 million for the three months ended March 29,
2003 from $2.3 million for the three months ended March 30, 2002. As a
percentage of sales, sales, general and administrative expenses increased to
34.1% for the three months ended March 29, 2003 from 32.8% for the comparable
prior year three-month period. The increase in sales, general and
14
administrative expense in absolute dollars and as a percentage of sales for the
three month period ended March 29, 2003 was due primarily to $0.1 million in
increased selling activities by our direct sales force, $0.1 million in
increased spending on marketing programs and $0.1 million in increased spending
on insurance and accounting fees offset, in part, by $0.1 million in reduced
marketing and administrative payroll costs associated with a reduction in force
in June 2002.
Interest and Other Income, net. For the three months ended March 29, 2003
we had net other income of $0.05 million as compared with net other income of
$0.04 million for the three months ended March 30, 2002. The change in net other
income for this period was due primarily to an increase in interest income.
Income Taxes. The effective income tax rate for the the three month periods
ending March 29, 2003 and March 30, 2002 was 32%. The tax rate for these periods
was lower than the Federal and State combined statutory rate of 40% because of
certain tax benefits associated with tax credits for research and development
activities.
LIQUIDITY AND CAPITAL RESOURCES
At March 29, 2003, our primary sources of liquidity included cash and cash
equivalents and available-for-sale securities in the aggregate amount of $13.3
million. In addition, we have available $4 million under our unsecured line of
credit which bears interest at the bank's prime rate and expires in October
2003. As of March 29, 2003, no borrowings were outstanding under this credit
facility. We expect to renew the line of credit in October 2003, assuming that
the terms continue to be acceptable.
During the three months ended March 29, 2003, we generated $2.7 million in
cash and cash equivalents. During this period, operating activities provided
$1.8 million of cash. Sources of cash from operating activities included a
decrease in net accounts receivable of $1.7 million, an increase in net accounts
payable and accrued expenses of $0.3 million, depreciation of $0.2 million and,
a decrease in net inventories of $0.1 million offset by uses of cash including a
net loss of $0.1 million and an increase in prepaid expenses of $0.4 million.
The decrease in accounts receivable resulted primarily from increased collection
efforts. The increase in prepaid expenses was due primarily to a prepayment to a
supplier of a product that we distribute. The decrease in inventory was due
mainly to the implementation of an inventory reduction program, whereby
inventory purchases were reduced.
Investing activities provided $0.9 million in cash and cash equivalents
during the three months ended March 29, 2003, primarily due to net proceeds from
maturity of available for sale securities of $0.9 million.
Net cash provided by financing activities during the three months ended
March 29, 2003 was $0.02 million which consisted of the issuance of common stock
under employee option plans and the employee stock purchase plan.
We believe that, based on current estimates, our cash, cash equivalents and
available-for-sale securities together with cash generated from operations and
our credit facility will be sufficient to meet our anticipated cash requirements
for the next 12 months. However, if the current economic downturn remains
protracted, we may need to expend our cash reserves to fund our operations. Our
liquidity could be negatively affected by a continued decline in demand for our
products, the need to invest in new product development or reductions in
spending by our customers as a result of the continuing economic downturn or
other factors. 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."
15
In December 1998, we instituted a stock repurchase program whereby up to
150,000 shares of our common stock may be repurchased in the open market. We
plan to utilize all of the reacquired shares for reissuance in connection with
employee stock programs. No shares were repurchased during the three months
ended March 29, 2003. To date, we have purchased 103,000 shares of our common
stock under this program.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are disclosed in our Annual
Report on Form 10-K for the year ended December 28, 2002 which was filed with
the Securities and Exchange Commission on March 28, 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. We do
not expect the adoption of this standard to have a material impact on our
financial position or on our results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, and Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or quarterly period beginning after June 15, 2003. We do not expect the
adoption of this standard to have a material impact on our financial position or
on our results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
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
semiconductor-based photocoagulator medical laser systems to the ophthalmic
market. We also market a visible and infrared light semiconductor-based
photocoagulator medical laser system to the aesthetics market. We believe that
continued and increased sales, if any, of these medical laser systems is
dependent upon a number of factors including the following:
16
- Product performance, features, ease of use, scalability and
durability;
- Recommendations and opinions by ophthalmologists, dermatologists,
clinicians, plastic surgeons and their associated opinion
leaders;
- Price of our products and prices of competing products and
technologies;
- Availability of competing products, technologies and alternative
treatments;
- Willingness of ophthalmologists and dermatologists to convert to
semiconductor-based or infrared laser systems from alternative
technologies; and
- Level of reimbursement for treatments administered with our
products.
Any significant decline in market acceptance of our products would have a
material adverse effect on our business, results of operations and financial
condition.
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 aesthetic treatments is intense and is expected
to increase. This market is also characterized by rapid technological
innovation and change and our products could be rendered obsolete as a result of
future innovations. 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, Inc., Carl Zeiss, Inc., Alcon Inc. and Quantel. All of
these companies currently offer a competitive semiconductor-based laser system
in ophthalmology. Our principal competitors in aesthetics are Lumenis Ltd.,
Laserscope, Candela Corporation, Altus Medical Inc and Palomar Medical
Technologies, Inc. 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.
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
of, manufacture and market new products. In October 2002, we announced the
introduction of a number of new products, specifically the OcuLight Symphony
multi-wavelength laser delivery system, an expanded EndoProbe product line and a
5 mm Large Spot Slit Lamp Adapter. We also announced the Millennium Endolase
module, which we manufacture to be included in Bausch & Lomb's Millennium
Microsurgical System. Successful commercialization of these 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. These
variables include 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,
17
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 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.
Our Business Has Been Adversely Impacted By the Worldwide Economic Slowdown
and Related Uncertainties. Weaker economic conditions worldwide have contributed
to the continued slowdown in our business in general. This has resulted in
reduced demand for some of our products, excess manufacturing capacity under
current market conditions and higher overhead costs, as a percentage of revenue.
In particular, demand for our aesthetic products, such as the Apex 800, has been
impacted. Recent political and social turmoil in many parts of the world may
continue to adversely impact global economic conditions. These political, social
and economic conditions and related economic uncertainties make it difficult for
us, our customers and our distributors to forecast orders and sales of our
products and, accordingly, plan future business activities. This level of
uncertainty strongly challenges our ability to operate profitably or grow our
business. If the economic or market conditions continue to further deteriorate,
this may have a material adverse impact on our financial position, results of
operation and cash flows.
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
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 us or our competitors or other
factors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volumes, our net revenues will decline.
In addition, to maintain our gross margins, we must continue to reduce the
manufacturing cost of our products. Further, should average unit prices of our
current products decline, we must develop and introduce new products and product
enhancements with higher margins. 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 Face Risks of Manufacturing. 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. We do not currently intend
to utilize any external 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 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 source. 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:
18
- 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;
- failure of suppliers to manufacture components to our specifications,
and potentially reduced quality; and
- 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, requiring extensive testing and
interoperability 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 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. We do not currently intend to manufacture any of these
components. 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 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 March 29, 2003,
our international sales were $2.7 million or 37.2% of total sales. We
anticipate that international sales will continue to account for a significant
portion of our revenues in the foreseeable future. None of our international
revenues or 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 risks including:
- longer accounts receivable collection periods;
- impact of recessions in economies outside of the United States;
- foreign certification requirements, including continued ability
to use the "CE" mark in Europe;
- reduced or limited protections of intellectual property rights in
jurisdictions outside the United States;
- potentially adverse tax consequences; and
19
- 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. For
additional discussion about our foreign currency risks, see Item 3,
"Quantitative and Qualitative Disclosures About Market Risk."
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. For example, in
September 2000, the Center for Medicare and Medicaid Services, or CMS, advised
that claims for reimbursement for certain age related macular degeneration (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, only three carriers-- Noridian Mutual
Insurance, which is the CMS Part B Carrier for Alaska, Arizona, Colorado,
Hawaii, Iowa, Nevada, North Dakota, Oregon, South Dakota, Washington and
Wyoming; Cigna, which is the carrier for North Carolina, Tennessee and Idaho;
and National Heritage Insurance, which is the carrier for California-- have made
coverage decisions approving the use of the Transpupillary Thermotherapy, or TTT
protocol for the treatment of wet AMD. No other carriers have approved
reimbursement of such AMD procedures using the OcuLight SLx and domestic sales
of the OcuLight SLx laser system 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.
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.
We are Dependent on the Successful Outcome of Clinical Trials of Our
Products and New Applications using our Products. Our success will depend in
part on the successful outcome of clinical trials of our products and new
applications using our products. Clinical trials are long, expensive and
uncertain processes. We are currently supporting several ongoing clinical
trials, including, for example, the TTT4CNV clinical trial. The TTT4CNV clinical
trial is a multi-center, prospective, placebo-controlled, randomized trial
20
conducted at 22 centers in the United States. This clinical trial is a post
marketing study performed within the FDA cleared indications of the OcuLight SLx
and is being conducted to determine whether TTT laser treatment using our
OcuLight SLx infrared laser system and Large Spot Slit Lamp Adapter can reduce
the risk of vision loss for patients with wet AMD. In order to successfully
commercialize the use of our OcuLight SLx for TTT procedures, we must be able
to, among other things, demonstrate with substantial evidence from
well-controlled clinical trials where TTT procedures using the OcuLight SLx
product is both safe and effective. This process may take a number of years. In
March 2003, we announced that the Executive Committee for the TTT4CNV clinical
trial accepted the recommendations of the independent Data and Safety Monitoring
Committee that an adequate number of patients were enrolled to detect a
clinically relevant difference between outcomes in TTT-treated eyes and patients
not being treated. We cannot assure you that results from the TTT4CNV clinical
trial will prove to be successful. If the future results of the TTT4CNV clinical
trial or any other clinical trial regarding our products fails to validate the
safety and effectiveness of treatments using our products, our ability to
generate revenues from new products or new applications using our products would
be adversely affected and our business would be harmed.
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:
- General economic uncertainties and political concerns;
- The timing of the introduction and market acceptance of new products,
product enhancements and new applications;
- Changes in demand for our existing line of aesthetic and ophthalmic
products;
- 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;
- Fluctuations in our product mix between aesthetic and ophthalmic
products and foreign and domestic sales;
- The effect of regulatory approvals and changes in domestic and foreign
regulatory requirements;
- 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;
- Our long and highly variable sales cycle;
- Decreases in the prices at which we can sell our products;
- 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
- Increased product development costs.
21
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 quarter's 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 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. As of March 29, 2003 our direct sales force consisted of 15 employees
and we maintained relationships with 66 independent distributors internationally
selling our products into 107 countries. 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 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
distributorship 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.
We Depend on Collaborative Relationships to Develop, Introduce and Market
New Products, Product Enhancements and New Applications. We have entered into
collaborative relationships with academic medical centers and physicians in
connection with the research and development and clinical testing of our new
products. We plan to collaborate with third parties to develop and commercialize
existing and new products. In October 2002, we announced our collaboration with
Bausch & Lomb to design and manufacture a solid-state green wavelength (532 nm)
laser photocoagulator module, called the Millennium Endolase module. The
Millennium Endolase module is designed to be a component of Bausch & Lomb's
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. 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.
22
Additionally, 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 the
product resulting from the collaboration altogether. 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 Rely on Patents and Other 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
thirteen United States patents and one foreign patent on the technologies
related to our products and processes. We have approximately eleven 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.
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.
23
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.
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 foreign 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
approval process implemented by the FDA under federal law. A device
manufacturer must obtain market clearance through either the 510(k) premarket
notification process or the lengthier premarket approval application process.
Depending upon the type, complexity and novelty of the device and the nature of
the disease or disorder to be treated, the FDA approval 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 FDA good manufacturing
practice regulations, which include quality control and quality assurance
requirements, as well as maintenance of records and documentation. 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" registered, 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 IRIS Medical and
IRIDERM products are CE registered, continued registration is based on
successful review of the process by our European Registrar during their annual
audit. Any loss of registration would 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 in the future. Our
24
products are highly complex and some are used to treat extremely delicate eye
tissue and skin conditions on and near a patient's face. Although we maintain
product liability insurance with coverage limits of $11.0 million per occurrence
and an annual aggregate maximum of $12.0 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.
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 quarterly 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. 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.
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, although we are currently
in a global economic downturn, expect to continue to make significant
investments to enable our future growth through, among other things, new product
development 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 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 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 development
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.
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, credit facilities 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
25
opportunities or respond to competitive pressures or unanticipated requirements.
Any inability to raise additional capital when we require it would seriously
harm our business.
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. We receive only
limited attention by securities analysts and may experience an imbalance between
supply and demand for our common stock resulting from low trading volumes. In
addition, the stock market has experienced extreme volatility in the last few
years that has often been unrelated to the performance of particular companies.
These broad market fluctuations could have a significant impact on the market
price of our common stock regardless of our performance.
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 March 29, 2003.
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 fiscal year 2002 and the interest rates are
primarily fixed.
QUALITATIVE DISCLOSURES
Interest Rate Risk. Our primary interest rate risk exposures relate to:
- The available-for-sale securities will fall in value if market
interest rates increase.
- The impact of interest rate movements on our ability to obtain
adequate financing to fund future operations.
We have the ability to hold at least a portion of the fixed income
investments until maturity and therefore would not expect the operating results
or cash flows to be affected to any significant degree by a sudden change in
market interest rates on its short- and long-term marketable securities
portfolio.
Management evaluates our financial position on an ongoing basis.
26
Currency Rate Risk.
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
Within 90 days prior to the filing date of this quarterly report (the
"Evaluation Date"), our President and Chief Executive Officer, who is our
principal executive officer, and our Chief Financial Officer and Vice President,
Administration, who is our principal financial officer, performed an evaluation
of the effectiveness of our "disclosure controls and procedures" (as defined in
Rules 13a-14(c) and 15(d) - 14(c) of the Securities and Exchange Act of 1934, as
amended). Based on that evaluation, our President and Chief Executive Officer
and our Chief Financial Officer and Vice President Administration concluded
that, as of the Evaluation Date, our disclosure controls and procedures were
effective to ensure that material information about IRIDEX Corporation and our
consolidated subsidiaries is made known to us by others within those entities,
particularly during the period in which this quarterly report was being
prepared.
CHANGES IN INTERNAL CONTROLS
There have been no significant changes in our internal controls or in other
factors that could significantly affect our disclosure controls and procedures
subsequent to the Evaluation Date.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as
added by Section 202 of the Sarbanes-Oxley Act of 2002, the Registrant is
responsible for disclosing the non-audit services approved by the Company's
Audit Committee to be performed by PricewaterhouseCoopers LLP, the Company's
independent auditor. Non-audit services are defined in the law as services
other than those provided in connection with an audit or a review of the
financial statements of the Company. The additional engagements of
PricewaterhouseCoopers LLP for the matters listed below are each considered by
the Company to be audit-related services that are closely related to the
financial audit process. During the quarterly period covered by this filing,
the Audit Committee approved the additional engagements of
PricewaterhouseCoopers LLP for certain tax matter consultations and for the
review of the Company's filings under the Securities Act of 1933, as amended.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None.
TRADEMARK ACKNOLWEDGEMENTS
IRIDEX, the IRIDEX logo, IRIS Medical, Oculight, EndoProbe and Apex are our
registered trademarks. IRIDERM and Britelight product names are our trademarks.
All other trademarks or trade names appearing in the Form 10-Q are the property
of their respective owners.
28
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: May 13, 2003 By: /s/ Robert Kamenski
-----------------------
Robert Kamenski
Chief Financial Officer and Vice President,
Administration
(Principal Financial and
Principal Accounting Officer)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND 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, Theodore A. Boutacoff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of IRIDEX
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures 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
quarterly report is being prepared;
29
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 13, 2003
By: /s/ THEODORE A. BOUTACOFF
----------------------------------
Name: Theodore A. Boutacoff
Title: President and Chief Executive Officer
(Principal Executive Officer)
30
I, Robert Kamenski, certify that:
1. I have reviewed this quarterly report on Form 10-Q of IRIDEX
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures 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
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
31
Date: May 13, 2003
By: /s/ ROBERT KAMENSKI
---------------------------------
Name: Robert Kamenski
Title: Chief Financial Officer and Vice President,
Administration
(Principal Financial and Accounting Officer)
32