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IRIX > SEC Filings for IRIX > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for IRIDEX CORP

Form 10-Q for IRIDEX CORP


5-Nov-2012

Quarterly Report


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, long term growth, market acceptance and adoption of our products and operating results; license revenue; gross margins; expenses; managing cash flows; general economic conditions and levels of international sales; tax and corporate strategy; effects of seasonality; FDA inspections; our current and future liquidity and capital requirements; and levels of future investment in research and development efforts. 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 30, 2012 and detailed from time to time in our reports filed with the Securities and Exchange Commission. The reader is cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this quarterly report on Form 10-Q. We undertake no obligation to update such forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview

IRIDEX Corporation is a leading worldwide provider of therapeutic based laser systems, delivery devices and consumable instrumentation used to treat sight-threatening eye diseases in ophthalmology. In February 2012, we completed the sale of our aesthetics business to Cutera, Inc. We view this as a significant step forward in executing our long term strategy because it allows us to focus solely on our ophthalmology business which is our core strength, and affords us with the best opportunity for long term profitable growth. In accordance with US GAAP, we have disclosed the financial results from our aesthetics business as discontinued operations. This discussion and analysis will focus on our ophthalmology business because it constitutes our continuing business and therefore provides more relevant information to the reader of our financial statements both on a retrospective and prospective basis.

We manage and evaluate our business in one segment - ophthalmology. We break down this segment by geography - Domestic (U.S.) and International (the rest of the world). In addition, we review trends by laser system sales (consoles and durable delivery devices) and recurring sales (single use disposable laser probes and other associated instrumentation (consumables), service and support).

Our ophthalmology revenues arise from the sale of our IQ and OcuLight laser systems, consumables and service and support activities. Our current family of IQ products includes IQ 532, IQ 577 and IQ 810 laser photocoagulation systems and our OcuLight products include OcuLight TX, OcuLight Symphony (Laser Delivery System), OcuLight SL, OcuLight SLx, OcuLight GL and OcuLight GLx laser photocoagulation systems.

Our ophthalmology products are sold in the United States predominantly through a direct sales force and internationally through approximately 70 independent distributors into over 100 countries. Sales to international distributors are made on open credit terms or letters of credit and are currently denominated in U.S. dollars and accordingly are not subject to risks associated with currency fluctuations.

Cost of revenues consists primarily of the cost of purchasing components and sub-systems; assembling, packaging, shipping and testing components at our facility; direct labor and associated overhead; warranty, royalty and amortization of intangible assets; and depot service costs.

Research and development expenses consist primarily of personnel costs, materials to support new product development and research support provided to clinicians at medical institutions developing new applications which utilize our products, and regulatory expenses. Research and development costs have been expensed as incurred.

Sales and marketing expenses consist primarily of costs of personnel, sales commissions, travel expenses, advertising and promotional expenses.

General and administrative expenses consist primarily of costs of personnel, legal, accounting and other public company costs, insurance and other expenses not allocated to other departments.

Results of Operations

The following table sets forth certain operating data as a percentage of
revenues:



                                                      Three Months Ended                                           Nine Months Ended
                                        September 29, 2012              October 1, 2011              September 29, 2012              October 1, 2011
Revenues                                               100.0 %                     100.0 %                          100.0 %                     100.0 %
Cost of revenues                                        50.4 %                      51.7 %                           51.2 %                      51.0 %

Gross margin                                            49.6 %                      48.3 %                           48.8 %                      49.0 %

Operating expenses:
Research and development                                12.8 %                      10.8 %                           13.4 %                      11.2 %
Sales and marketing                                     23.8 %                      21.2 %                           23.8 %                      21.7 %
General and administrative                              20.4 %                      13.2 %                           16.3 %                      13.0 %

Total operating expenses                                57.0 %                      45.2 %                           53.5 %                      45.9 %

(Loss) income from continuing
operations                                              (7.4 )%                      3.1 %                           (4.7 )%                      3.1 %
Legal settlement                                         0.0 %                       0.0 %                            3.2 %                       3.2 %
Interest and other expense, net                         (1.5 )%                     (0.6 )%                          (0.8 )%                     (0.2 )%

(Loss) income from continuing
operations before income taxes                          (8.9 )%                      2.5 %                           (2.3 )%                      6.1 %
(Benefit from) provision for
income taxes                                            (1.8 )%                     (0.6 )%                          (0.6 )%                      0.7 %

(Loss) income from continuing
operations, net of tax                                  (7.1 )%                      3.1 %                           (1.7 )%                      5.4 %
(Loss) income from discontinued
operations, net of tax                                  (2.4 )%                      1.1 %                            6.6 %                       2.0 %

Net (loss) income                                       (9.5 )%                      4.2 %                            4.9 %                       7.4 %


Table of Contents

The following comparisons are between the three month periods ended September 29, 2012 and October 1, 2011:

Revenues.



                                Three Months Ended         Three Months Ended
(in thousands)                  September 29, 2012           October 1, 2011           Change in $           Change in %
Systems - domestic              $             1,694        $             1,623        $          71                   4.4 %
Systems - international                       1,959                      2,596                 (637 )               (24.5 )%
Recurring revenues                            4,123                      3,894                  229                   5.9 %
OEM                                             105                        145                  (40 )               (27.6 )%

Total revenues                  $             7,881        $             8,258        $        (377 )                (4.6 )%

Domestic System sales were fairly constant however International System sales were down significantly. We experienced lighter sales in the Middle East and South America due mainly to the unsettled business climates in those areas. Recurring revenues increased primarily by the addition of sales of our licensed GreenTip product by our distribution partner, Alcon, and we anticipate benefiting from these sales for the foreseeable future. OEM sales are expected to cease shortly as our OEM partner, B&L, has discontinued selling this product.

Gross Profit and Gross Margin.

Gross profit was $3.9 million compared with $4.0 million in the prior period, a decrease of $0.1 million, or 2.0%. Despite the reduction in revenues, gross margin improved to 49.6% up from 48.3% . This is the result of lowering our cost structure within operations. Our short term goal for gross margin remains 50%.

Gross margins as a percentage of revenues will continue to fluctuate due to changes in the relative proportions of domestic and international sales, the product mix of sales, manufacturing variances, total unit volume changes that lead to greater or lesser production efficiencies and a variety of other factors. See Item 1A. "Risk Factors - Factors That May Affect Future Results - 'Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year.'"

Research and Development.

Research and development ("R&D") expenses increased $0.1 million or 12.5% from $0.9 million to $1.0 million, as a result of increasing headcount and spending on materials and outside services in support of an increased rate of new product introductions. We anticipate expenses will moderate going forward.

Sales and Marketing.

Sales and marketing expenses increased $0.2 million or 7.3% from $1.7 million to $1.9 million. The increases were attributable to an increase in headcount and related cost and to an increase in associated selling and marketing expenses due to and in support of sales. We anticipate our sales and marketing expenses to moderate going forward.

General and Administrative.

General and administrative expenses increased by $0.5 million or 47.9%, from $1.1 million to $1.6 million. We incurred $0.7 million in severance costs as a result of terminating certain employees.

Interest and Other Income (Expense), Net.

Interest and other income (expense), net consisted primarily of additional expense recorded for the fair value remeasurement of the contingent earn-out liabilities incurred as a result of the Company's recent acquisitions.

Income Taxes.

The Company recorded an income tax benefit of $141 thousand and $48 thousand,
respectively, for continuing operations.

The following comparisons are between the nine months ended September 29, 2012
and October 1, 2011:



                                  Nine Months Ended           Nine Months Ended
(in thousands)                    September 29, 2012           October 1, 2011           Change in $           Change in %
Systems - domestic               $              4,485        $             4,884        $        (399 )                (8.2 )%
Systems - international                         7,008                      7,179                 (171 )                (2.4 )%
Recurring revenues                             12,893                     12,090                  803                   6.6 %
OEM                                               245                        386                 (141 )               (36.5 )%

Total revenues                   $             24,631        $            24,539        $          92                   0.4 %

Fluctuations in systems sales were driven primarily by local economic conditions. Recurring revenues increased primarily as a result of the addition of sales of our licensed GreenTip product by our distribution partner, Alcon, and we anticipate benefiting from these sales for the foreseeable future. OEM sales are expected to cease shortly as our OEM partner, B&L, has discontinued selling this product.

Gross Profit and Gross Margin.

Gross profit remained constant at $12.0 million. Gross margin remained fairly constant at 48.8% compared to 49.0%. Our short term goal for gross margin remains 50%.

Gross margins as a percentage of revenues will continue to fluctuate due to changes in the relative proportions of domestic and international sales, the product mix of sales, manufacturing variances, total unit volume changes that lead to greater or lesser production efficiencies and a variety of other factors. See Item 1A. "Risk Factors - Factors That May Affect Future Results - "Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year."

Research and Development.

R&D expenses increased $0.5 million or 19.9% from $2.7 million to $3.3 million, as a result of increasing headcount and spending on materials and outside services in support of an increased rate of new product introductions. We anticipate expenses to moderate going forward.


Table of Contents

Sales and Marketing.

Sales and marketing expenses increased by $0.6 million or 10.3% from $5.3 million to $5.9 million. The increases were attributable to an increase in headcount and related cost and to an increase in associated selling and marketing expenses due to and in support of sales. We anticipate our sales and marketing spending to moderate going forward.

General and Administrative.

General and administrative expenses increased by $0.8 million or 25.8%, from $3.2 million to $4.0 million. We incurred $0.7 million in severance costs as a result of terminating certain employees

Legal Settlement and Interest and Other Income (Expense), Net.

Legal settlement income amounted to $0.8 million for the nine months ended September 29, 2012 and October 1, 2011, and related to a settlement with Synergetics for legal claims related to patent infringement. The payment received during the nine months ended September 29, 2012 represented the final payment. Interest and other income (expense), net consisted primarily of additional expense recorded for the fair value remeasurement of the contingent earn-out liabilities incurred as a result of the Company's recent acquisitions.

Income from Continuing Operations.

We are moderating our investment in people and programs to promote sales growth while balancing our investments with our revenue growth to return to profitability.

Income Taxes.

For the nine months ended September 29, 2012 and October 1, 2011, the Company recorded an income tax benefit of $134 thousand and a tax provision of $175 thousand, respectively, for continuing operations. The tax benefit is recognized mainly for the anticipated tax refund from carrying back to 2010 the current year's net operating loss from continuing operations.

As a result of the sale of the aesthetics business the Company generated an $18.6 million tax loss from discontinued operations. This loss was created primarily as a result of writing off goodwill and intangibles related to the aesthetics business for tax purposes that had previously been writing off for financial statement purposes in prior accounting periods. The Company intends to carry the tax loss generated back to profits made in 2010 and 2011 and obtain a tax refund of approximately $0.6 million. Resulting from the tax loss carryback, the Company also recognizes a tax benefit from a reduction and reclassification in uncertain tax liabilities of $0.3 million. The remainder of the tax loss (approximately $14.3 million) will be carried forward to offset current and future tax profits. Because of the uncertainty of future taxable profits the Company maintains a full valuation allowance against its deferred tax assets.

Discontinued Operations.

In February 2012, we sold our aesthetics business to Cutera, Inc. The operating results and the associated assets and liabilities of our aesthetics business have been classified as discontinued operations for all periods presented. The Company received $5.1 million in net cash and recorded a pre-tax net gain on the sale of $1.1 million. In addition, as a result of the sale, we were able to record a tax benefit in the amount of $0.9 million, thus the total gain recorded on the sale of the aesthetics business was $2.0 million.

For the quarter ended September 29, 2012, a loss of $190 thousand, net of tax, was incurred, compared with income of $93 thousand, net of tax, generated for the comparable quarter in 2011. For the nine month period ended September 29, 2012, income of $1.6 million, net of tax, generated, compared with income of $0.5 million, net of tax, generated for the comparable nine month period in 2011.

As a result of the sale of the aesthetics business the Company generated an $18.6 million tax loss. This loss was created primarily as a result of writing off goodwill and intangibles related to the aesthetics business for tax purposes that had previously been written off for financial statement purposes in prior accounting periods. The Company intends to carry the tax loss generated back to offset profits made in 2010 and 2011 and obtain a tax refund of approximately $0.6 million. The potential net operating loss carry back also results in a reduction in uncertain tax liabilities of $0.3 million. The remainder of the tax loss (approximately $14.3 million) will be carried forward to be used to offset current year and future tax profits. Because of the uncertainty of future taxable profits the Company maintains a valuation reserve allowance against its deferred tax assets.

Liquidity and Capital Resources.

Liquidity is our ability to generate sufficient cash flows from operating activities to meet our obligations and commitments. In addition, liquidity includes the ability to obtain appropriate financing or to raise capital.

As of September 29, 2012, we had cash and cash equivalents of $13.7 million, working capital of $22.6 million and $0.5 million of cash held in escrow compared to cash and cash equivalents of $10.8 million and working capital of $20.6 million as of December 31, 2011. The $2.9 million increase in cash and cash equivalents and the $0.5 million of cash held in escrow for the nine months ended September 29, 2012 was generated primarily by the sale of the aesthetics business for $5.1 million. For the nine months ended September 29, 2012, net cash used in operating activities amounted to $1.5 million as a result of a $0.4 million net loss from continuing operations, change in operating assets of $2.1 million, offset by non-cash add back items of $1.0 million. We used $0.3 million on capital expenditures and used $0.2 million to pay on the earn-out liability to RetinaLabs. Exercises of stock options generated $0.4 million and we spent $0.6 million to purchase stock under our stock repurchase program. See Item 2, Unregistered Sales of Equity Securities and Use of Proceeds in Part II, Other Information, for additional information.

Management is of the opinion that the Company's current cash and cash equivalents together with our ability to generate cash flows from operations provide sufficient liquidity to operate for the next 12 months.

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