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IRIX > SEC Filings for IRIX > Form 10-K on 27-Mar-2014All Recent SEC Filings

Show all filings for IRIDEX CORP

Form 10-K for IRIDEX CORP


Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations


IRIDEX Corporation is a leading worldwide provider of therapeutic based laser consoles, delivery devices and consumable instrumentation used to treat sight-threatening eye diseases in ophthalmology. In February 2012, we sold our aesthetics business to Cutera, Inc. We view this as a significant step forward in our strategy because it allows us to focus solely on our ophthalmology business which is our core strength. Management believes that this path affords the Company 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 primarily on our ophthalmology business because this is our continuing business and therefore provides more relevant and comparable information to the reader of our financial statements both on a retrospective and prospective basis. 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.

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 consumable laser probes and other associated instrumentation ("consumables"), service and support).

Our ophthalmology revenues arise primarily from the sale of our IQ and OcuLight laser systems, consumables, 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. Certain of our laser systems are capable of performing traditional continuous wavelength photocoagulation and our patented Fovea-Friendly MicroPulse laser photocoagulation. Towards the end of 2012, we introduced the TxCell Scanning Laser Delivery System which saves significant time in a variety of laser photocoagulation procedures in allowing physicians to deliver the laser in a multi-spot scanning mode, a more efficient method for these procedures than the traditional single spot mode. Our current family of laser probes includes a wide variety of products in 20, 23 and 25 gauge for vitreoretinal surgery and glaucoma surgery.

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 - 2013, 2012 and 2011

Our fiscal year ends on the Saturday closest to December 31. Fiscal 2013 ended on December 28, 2013, fiscal 2012 ended on December 29, 2012, and fiscal 2011 ended on December 31, 2011. Fiscal years 2013, 2012 and 2011 each included 52 weeks of operations.

The following table sets forth certain data from continuing operations as a percentage of revenue from continuing operations for the periods indicated.

                                                                 Percentage of Revenue
                                                                      Years Ended
                                                      FY 2013           FY 2012           FY 2011
                                                   Dec 28, 2013      Dec 29, 2012      Dec 31, 2011
Total revenues                                             100.0 %           100.0 %           100.0 %
Cost of revenues                                            51.4              51.7              50.9
Gross margin                                                48.6              48.3              49.1
Operating expenses:
Research and development                                     9.6              13.0              11.8
Sales and marketing                                         20.2              23.3              22.4
General and administrative                                  13.1              14.5              12.8
Proceeds from demutualization of insurance                                       -                 -
carrier                                                     (1.2 )
Legal settlement, net of expenses                              -                 -              (3.8 )
Total operating expense                                     41.7              50.8              43.2
Income (loss) from continuing operations                     6.9              (2.5 )             5.9
Legal settlement                                               -               2.3               2.4
Interest and other expense, net                             (1.0 )            (0.6 )            (0.9 )
Income (loss) from continuing operations before                               (0.8               7.4
income taxes                                                 5.9                   )
Provision for (benefit from) income taxes                    0.1              (0.3 )             0.9
Income (loss) from continuing operations, net of                              (0.5               6.5
tax                                                          5.8                   )
Income (loss) from discontinued operations, net                               (0.8               1.4
of tax                                                         -                   )
Gain on sale of discontinued operations, net of                                5.5                 -
tax                                                            -
Income from discontinued operations, net of tax                -               4.7               1.4
Net income                                                   5.8 %             4.2 %             7.9 %

Comparison of 2013 and 2012


Our total revenues increased $4.4 million or 13.0% from $33.9 million in 2012 to $38.3 million in 2013, as a result of increases in both system sales and in our recurring revenues. The increase in system sales was due to an increase in sales of our IQ lasers that features MicroPulse, both domestic and international. The increase in recurring revenues was attributable to the inclusion of sales generated by the independent sales force resulting from the Peregrine distribution and supply agreement, as well as an increase in sales of our licensed GreenTip product by our distribution partner, Alcon, Inc. ("Alcon"). OEM sales are expected to cease shortly as our OEM partner, Bausch & Lomb, Incorporated ("B&L"), has discontinued selling this product.

    (in millions)              FY 2013       FY 2012       Change in $       Change in %
    Systems - domestic        $     8.4     $     7.1     $         1.3              18.3 %
    Systems - international        10.9           9.4               1.5              16.0 %
    Recurring revenues             18.7          17.1               1.6               9.4 %
    OEM                             0.3           0.3                 -                 -
    Total revenues            $    38.3     $    33.9     $         4.4              13.0 %

Gross Profit.

Gross profit was $18.6 million in 2013 compared with $16.3 million in 2012, an increase of $2.2 million or 13.7%. The increase in gross profit was primarily due to the increase in revenues. Gross margin as a percent of revenue was 48.6% compared with 48.3%, an increase of 0.3% due to overhead efficiencies and cost reductions, which were partly offset by a change in product mix.

Gross margins as a percentage of revenues are expected to 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 decreased $0.7 million or 16.0% from $4.4 million in 2012 to $3.7 million in 2013. The decrease in spending was primarily attributable to a decrease in headcount and associated costs. Additionally, project development materials decreased as a result of units being released to production. We anticipate an increase in the spending level in R&D in support of new products and certain product cost reduction programs we are initiating going forward.

Sales and Marketing.

Sales and marketing expenses decreased $0.2 million or 2.2%, from $7.9 million in 2012 to $7.7 in 2013. Marketing expenditures decreased $0.6 million due to reduced headcount and program spending as we transitioned from traditional marketing programs to online digital marketing programs, these savings were, partly offset by costs associated with the expansion of our independent sales force resulting from the Peregrine agreement and increased commissions associated with increased revenues.

General and Administrative.

General and administrative expenses increased $0.1 million or 2.0%, from $4.9 million in 2012 to $5.0 million in 2013. The 2012 expenses included $0.7 million in severance and related costs. Excluding these costs, the increase of $0.8 million was primarily attributable to the introduction of the Medical Device Tax introduced in connection with the Patient Protection and Affordable Care Act in 2013, which cost us $0.3 million for the year and an increase in compensation charges of $0.4 million for the year.

Proceeds from Demutualization of Insurance Carrier.

In January 2013, we received $0.5 million as a result of the demutualization of our product and liability insurance carrier.

Other Income (expense).

The legal settlement relates to payments received from Synergetics, Inc. associated with a 2007 settlement of legal claims for patent infringement. The $0.8 million received in 2012 represented the final payment.

Interest and other expense, net consisted primarily of expense recorded for the fair value re-measurement of the contingent earn-out liabilities incurred as a result of the Company's recent acquisitions and was $0.4 million in 2013 and $0.2 million in 2012.

Income Taxes.

We recorded a provision for income taxes of $31 thousand for the year ended December 28, 2013 compared to a benefit for income taxes of $0.1 million for the year ended December 29, 2012. Our effective tax rate on continued operations for the year ended December 28, 2013 was 1.4% compared to an effective tax rate of 37% for the year ended December 29, 2012. Our effective tax rate decreased due mainly to the change from 2012 pretax loss from continuing operations of $0.3 million to 2013 pretax income from continuing operations of $2.3 million. Our tax rate is benefiting from a decrease in the valuation allowance we currently have booked against our deferred tax asset and benefiting from a deduction under
Section 199 of the Internal Revenue Code of 1986, as amended ("IRC"). Ultimately, assuming we remain profitable, the entire valuation allowance will be released and our tax rate will return to more normal levels. At the end of 2013, the valuation allowance totaled $10.0 million.

Comparison of 2012 and 2011


Total revenues from continuing operations in 2012 were $33.9 million compared with $33.2 million in 2011, an increase of $0.7 million or 2.1%. The increase was due primarily to our recurring revenues which improved as a result of the onset of revenues from the licensing and distribution agreement with Alcon. Our ophthalmology system revenues remained consistent period to period. Our OEM revenue continued to decline as anticipated because this revenue is generated from a product that is now in its end of life phase.

    (in millions)              FY 2012       FY 2011       Change in $       Change in %
    Systems - domestic        $     7.1     $     7.2     $        (0.1 )            (1.4 )%
    Systems - international         9.4           9.3               0.1               1.1 %
    Recurring revenues             17.1          16.2               0.9               5.6 %
    OEM                             0.3           0.5              (0.2 )           (40.0 )%
    Total revenues            $    33.9     $    33.2     $         0.7               2.1 %

Gross Profit.

Gross profit remained level at $16.3 million in 2012 even though revenues increased as a result of a decrease in gross margin to 48.3% in 2012, from 49.1% in 2011. The reduction in gross margin was primarily attributable to increased manufacturing and service costs.

Research and Development.

Research and development expenses increased $0.5 million or 12.1%, from $3.9 million in 2011 to $4.4 million in 2012. The increase is attributable to increases in headcount and project material costs incurred in engineering development projects, and patent expenses as the Company continued to focus on new product introductions.

Sales and Marketing.

Sales and marketing expenses increased $0.4 million or 5.9%, from $7.5 million in 2011 to $7.9 million in 2012. The increase is primarily attributable to increased personnel costs associated with increased headcount and marketing programs.

General and Administrative.

General and administrative expenses increased $0.7 million or 15.7%, from $4.3 million in 2011 to $4.9 million in 2012. The increase in expenses was primarily attributable to employee severance and related costs taken as part of streamlining the Company's operations in the latter half of the year.

Legal Settlement and Other Expense, Net.

The Company received the final annual installment of $0.8 million from the settlement with Synergetics of legal claims related to patent infringement which was consistent with the amount received in 2011. During 2012, the remeasurement on the fair value of the earn-out liability from prior acquisitions resulted in an expense of $0.2 million.

Income Taxes.

We recorded a benefit for income taxes on continuing operations of $0.1 million and an effective tax rate of 37% for fiscal year 2012 compared to a provision for income taxes of $0.3 million and an effective tax rate of 12% for fiscal year 2011. Our tax rate is benefiting from a reduction in the valuation allowance we currently have booked against our deferred tax asset.

Liquidity and Capital Resources

Comparison of 2013 and 2012

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 December 28, 2013, we had cash and cash equivalents of $13.4 million, no debt and working capital of $24.6 million compared to cash and cash equivalents of $11.9 million, no debt and working capital of $20.7 million as of December 29, 2012.

The increase in cash and cash equivalents for the year ended December 28, 2013 was generated primarily by income from continuing operations of $2.2 million, the add back of non-cash items of $1.6 million, partially offset by changes in working capital by $3.1 million. We used $0.4 million on capital expenditures and $0.4 million on paying the contingent earn-out liability arising from our acquisitions of RetinaLabs and Ocunetics. Exercises of stock options generated $1.5 million and we spent $0.4 million to purchase stock under our stock repurchase program, and we received $0.5 million in cash from the release of funds held in escrow related to our 2012 sale of the aesthetics business. 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.

Comparison of 2012 and 2011

During 2012, net cash used in continuing operating activities was $1.1 million. The use of cash resulted primarily from a net loss from continuing operations of $0.2 million plus changes in working capital consuming an additional $2.0 million partially offset by certain non-cash items of $1.1 million. This compares to net cash provided by continuing operating activities in 2011 of $2.3 million which was generated from net income from continuing operations of $2.1 million the add back of non-cash items of $1.2 million less changes in working capital of $1.0 million.

As of December 29, 2012, we had cash and cash equivalents of $11.9 million, no debt outstanding and working capital of $20.7 million compared to cash and cash equivalents of $10.8 million, no debt and working capital of $20.6 million as of December 31, 2011.

Contractual Payment Obligations

As of December 28, 2013, our contractual payment obligations that were fixed and
determinable to third parties for non-cancelable operating leases, contract
manufacturers and other purchase commitments were as follows (in thousands):

                                                          Payments Due by Period
                                           Total        <1 year       1-3 years       3-5 years
Operating leases payments                 $  1,198     $     866     $       318     $        14
Commitments to contract manufacturers
and suppliers                                3,053         1,178           1,500             375
Total contractual cash obligations        $  4,251     $   2,044     $     1,818     $       389

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, net sales and expenses, and the related disclosures. We base our estimates on historical experience, our knowledge of economic and market factors and various other assumptions we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies are affected by significant estimates, assumptions, and judgments used in the preparation of our consolidated financial statements.

Discontinued Operations.

Discontinued operations are accounted for and presented in accordance with Accounting Standards Codification ("ASC") 360, Impairment or Disposal of Long-Lived Assets ("ASC 360"). When a qualifying component of the Company is disposed of or has been classified as held for sale, the operating results of that component are removed from continuing operations for all periods presented and displayed as discontinued operations if: (a) elimination of the component's operations and cash flows from the Company's ongoing operations has occurred (or will occur) and (b) significant continuing involvement by the Company in the component's operations does not exist after the disposal transaction.

On December 30, 2011, we entered into an agreement to sell our aesthetics business to Cutera, Inc. The sale of the aesthetics business was completed on February 2, 2012. The operating results of our aesthetics business were therefore classified as discontinued operations, and the associated assets and liabilities were classified as discontinued for all periods presented under the requirements of ASC 360.

Revenue Recognition.

Our revenues arise from the sale of laser consoles, delivery devices, consumables and service and support activities. Revenue from product sales is recognized upon receipt of a purchase order and product shipment provided that no significant obligations remain and collection of the receivables is reasonably assured. Shipments are generally made with Free-On-Board ("FOB") shipping point terms, whereby title passes upon shipment from our dock. Any shipments with FOB receiving point terms are recorded as revenue when the shipment arrives at the receiving point. Cost is recognized as product sales revenue is recognized. The Company's sales may include post-sales obligations for training or other deliverables. For revenue arrangements such as these, we recognize revenue in accordance with ASC 605, Revenue Recognition, Multiple-Element Arrangements. The Company allocates revenue among deliverables in multiple-element arrangements using the relative selling price method. Revenue allocated to each element is recognized when the basic revenue recognition criteria is met for each element. The Company is required to apply a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of selling price ("VSOE"),
(ii) third-party evidence of selling price ("TPE") and (iii) best estimate of the selling price ("ESP"). In general, the Company is unable to establish VSOE or TPE for all of the elements in the arrangement; therefore, revenue is allocated to these elements based on the Company's ESP, which the Company determines after considering multiple factors such as management approved pricing guidelines, geographic differences, market conditions, competitor pricing strategies, internal costs and gross margin objectives. These factors may vary over time depending upon the unique facts and circumstances related to each deliverable. As a result, the Company's ESP for products and services could change. Revenues for post-sales obligations are recognized as the obligations are fulfilled.

In international regions, we utilize distributors to market and sell our products. We recognize revenue upon shipment for sales to these independent, third-party distributors as we have no continuing obligations subsequent to shipment. Generally our distributors are responsible for all marketing, sales, installation, training and warranty labor coverage for our products. Our standard terms and conditions do not provide price protection or stock returns rights to any of our distributors.

Royalty revenues are typically based on licensees' net sales of products that utilize our technology and are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured, such as upon the earlier of the receipt of a royalty statement from the licensee or upon payment by the licensee.


Inventories are stated at the lower of cost or market and include on-hand inventory physically held at the Company's facility, sales demo inventory and service loaner inventory. Cost is determined on a standard cost basis which approximates actual cost on a first-in, first-out ("FIFO") method. Lower of cost or market is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolete or impaired inventory and are charged to cost of revenues. Once the cost of the inventory is reduced, a new lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Factors influencing these adjustments include changes in demand, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates.

Sales Returns Allowance and Allowance for Doubtful Accounts.

The Company estimates future product returns related to current period product revenue. We analyze historical returns, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowance. Significant management judgment and estimates must be made and used in connection with establishing the sales returns allowance in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. Our provision for sales returns is recorded net of the associated costs. The balance for the provision of sales returns have not historically been material.

Similarly management must make estimates regarding the uncollectibility of accounts receivable. We are exposed to credit risk in the event of non-payment by customers to the extent of amounts recorded on the consolidated balance sheets. As sales levels increase the level of accounts receivable would likely also increase. In addition, in the event that customers were to delay their payments to us, the levels of accounts receivable would likely also increase. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on past payment history with the customer, analysis of the customer's current financial condition, the aging of the accounts receivable balance, customer concentration and other known factors.


We provide reserves for the estimated cost of product warranties at the time revenue is recognized based on historical experience of known product failure rates and expected material and labor costs to provide warranty services. We generally provide a two-year warranty on our products. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Alternatively, if estimates are determined to be greater than the actual amounts necessary, we may reverse a portion of such provisions in future periods. Actual warranty costs incurred have not materially differed from those accrued. Our warranty policy is applicable to products which are considered defective in their performance or fail to meet the product specifications. Warranty costs are reflected in the consolidated statements of operations as cost of revenues.

Income Taxes.

. . .

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