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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended January 2, 1999
[ ] 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 (I.R.S. Employer
of incorporation or organization) Identification Number)
1212 TERRA BELLA AVENUE, MOUNTAIN VIEW CA 94043-1824
(Address of principal executive offices)
(Zip Code)
(650) 940-4700
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 22, 1999, was approximately $13,334,160 based on the
closing price reported for such date on the Nasdaq National Market System. For
purposes of this disclosure shares of Common Stock held by each executive
officer and director and by each holder of 5% or more of the outstanding shares
of Common Stock have been excluded from this calculation because such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of March 22, 1999, Registrant had 6,528,096 shares of Common Stock
outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for the Registrant's 1999 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference into Part III
of this Annual Report on Form 10-K.
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Table of Contents Page No.
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Part I
Item 1. Business.......................................................................1
Item 2. Properties....................................................................14
Item 3. Legal Proceedings.............................................................15
Item 4. Submission of Matters to a Vote of Security Holders...........................15
Part II
Item 5. Market for Registrants' Common Equity and Related Stockholder Matters.........15
Item 6. Selected Financial Data.......................................................16
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................17
Item 7A. Quantitative and Qualitative Disclosure about Market Risk.....................27
Item 8. Financial Statements and Supplementary Data...................................28
Item 9. Disagreements on Accounting and Financial Disclosure..........................47
Part III
Item 10. Directors and Executive Officers of the Registrant............................49
Item 11. Executive Compensation........................................................49
Item 12. Security Ownership of Certain Beneficial Owners and Management................49
Item 13. Certain Relationships and Related Transactions................................49
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...............50
Signatures......................................................................................52
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PART I
This Annual Report on Form 10-K (The "Annual Report") contains certain
forward-looking statements within the meaning of section 21E of the Securities
Exchange Act of 1934, as amended, (The "Exchange Act"), including statements
that indicate what the Company "believes," "expects" and "anticipates" or
similar expressions. These statements involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements of the Company to differ materially from those expressed or implied
by such forward-looking statements. Such factors include, among others, the
information contained under the captions "Part I, Item 1, Business," and Part
II, Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this Annual Report. This 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 Annual Report. The Company
undertakes no obligation to publicly release the results of any revision of
these forward-looking statements. The reader is strongly urged to read the
information set forth under the captions Part I, Item 1, "Business," and Part
II, Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a more detailed description of these significant
risks and uncertainties.
ITEM 1. BUSINESS
GENERAL
IRIDEX Corporation ("IRIDEX") is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. Our products are sold in the United States
predominantly through a direct sales force and internationally through 65
independent distributors into 74 countries. We market our products using three
brand names: IRIS Medical to the ophthalmology market, IRIDERM to the
dermatology market, and Light Solutions to the research market.
Our ophthalmology products treat eye diseases, including the three
leading causes of irreversible blindness. The current family of ophthalmology
laser systems includes the IRIS Medical OcuLight SL, OcuLight SLx, OcuLight GL
and OcuLight GLx Laser Photocoagulation systems (each an "OcuLight System"). Our
dermatology products treat skin diseases, primarily vascular and pigmented
lesions. In June 1997, we launched the IRIDERM DioLite 532 Laser System to
address the dermatology market. The DioLite 532 Laser System is sold primarily
for office-based use by dermatologists. Each ophthalmic and dermatology system
consists of a small, portable laser console and interchangeable delivery
devices. We believe that our semiconductor-based systems are more portable,
economical, reliable and flexible than competing systems which use traditional
vacuum tube-based technology. Since our first shipment in 1990, more than 2,500
IRIDEX medical laser systems have been sold worldwide, primarily for hospital
and office-based use by ophthalmologists and dermatologists.
IRIDEX Corporation was incorporated in California in February 1989 as
IRIS Medical Instruments, Inc. In 1996, we changed our name to IRIDEX
Corporation and reincorporated in Delaware. We conduct most of our business
through our wholly-owned operating subsidiary, IRIS Medical Instruments, Inc.
Our executive offices are located at 1212 Terra Bella Avenue, Mountain View,
California 94043-1824, and our telephone number is (650) 940-4700. As used in
this Form 10-K, the terms "Company," "IRIDEX," "we," "us" and "our" refer to
IRIDEX Corporation, a Delaware corporation, and, when the context so requires,
our wholly owned subsidiaries, IRIS Medical Instruments, Inc. and Light
Solutions Corporation, both California corporations and IRIDEX Foreign Sales
Corporation, a Barbados corporation, and our dermatology division IRIDERM.
THE IRIDEX STRATEGY
We are one of the worldwide leaders in developing, manufacturing,
marketing and selling innovative and cost-effective medical laser systems. The
key elements of our strategy are:
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Broaden Product Lines by Leveraging Existing Technology. In 1996, we
introduced a new visible laser system, the OcuLight GL, for ophthalmology. In
1997, we introduced the DioLite 532, based on the same visible light technology
as the OcuLight GL, for the dermatology market. In 1998, we introduced the
OcuLight GLx, a new version of the OcuLight GL, with increased power and
delivery device capability. The characteristics of these new products are
similar to those which have made our previous products successful, such as low
cost ownership, reliability and portability.
Develop and Validate New Applications. We seek to develop and validate
treatments that are less costly, reduce complications and achieve better
clinical results than existing treatments. Our products are currently being used
in multiple studies in the United States and internationally to demonstrate the
clinical benefits of its technology in treatment. Examples of these studies
include several studies to treat different stages of age-related macular
degeneration and international studies which are evaluating the use of our G-
Probe as a primary treatment for glaucoma. We announced in March 1999 that a
pilot study on age-related macular degeneration (AMD) produced results
demonstrating that lipid deposits, drusen, associated with dry AMD were
eliminated or reduced significantly and visual acuity were significantly
improved by using our OcuLight infrared laser photocoagulators.
Continue to Enhance Products. One of our core strengths has been our
regular introduction of new delivery devices and product upgrades to enhance the
benefits of our laser systems. In September 1998, we introduced our next
generation of portable Slit Lamp Adaptors, which offer superior viewing ability
with new UltraView optics combined with precision laser beam steering using a
new self-centering micromanipulator. We intend to continue our investment in
research and development to improve the performance of our systems. We also
intend to develop additional technologies which can more cost effectively
address the needs of the ophthalmic and dermatology markets. To enhance our
research and development efforts, we collaborate with an extensive network of
academic leaders who provide input and advice, as well as assist in validating
the efficacy of new products and applications.
Expand Medical Practice Versatility. We provide products that allow
ophthalmologists to expand their practice by increasing the offering of delivery
services available to physicians and adding to the clinical procedures that can
be performed in the ophthalmologist's office. In September 1998, we obtained
clearance from the FDA for a Dermatology Kit which allows our OcuLight GL laser
photocoagulator, which is currently used by ophthalmologists to treat a variety
of eye diseases, to also treat vascular and pigmented skin lesions.
Provide Total Disease Management. We intend to pursue both therapeutic
and adjunctive diagnostic systems. An adjunctive diagnostic system is used
either to screen and identify more patients who require therapy or objectively
assess the adequacy of therapy. We believe that a significant opportunity exists
to provide diagnostic equipment to the ophthalmic and optometric communities. We
intend to pursue our entrance into this diagnostic market through both internal
development and selected acquisitions. By pursuing therapeutic and diagnostic
systems, we intend to provide total disease management.
Develop New Markets through Strategic Alliances. We intend to establish
strategic alliances in order to expedite and lower the cost of developing and
bringing to market new products, both to the ophthalmology and dermatology
markets and to markets not currently addressed by our products. Through these
alliances, we will seek access to technologies that we do not currently possess.
In May 1996, we signed a Development and Distribution Agreement with Miravant
Medical Technologies, formerly known as PDT, Inc. ("Miravant"), a company
engaged in the development of photodynamic drugs and applications, to provide
lasers to activate certain photodynamic drugs developed by Miravant.
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PRODUCTS
We utilize a systems approach to product design. Each system includes a
console, which generates the laser energy, and a number of interchangeable
peripheral delivery devices, including disposable delivery devices, for use in
specific clinical applications. This approach allows our customers to purchase a
basic system and add additional delivery devices as their needs expand or as we
develop new applications. This systems approach also brings economies-of-scale
to our product development and manufacturing efforts since each application does
not require the design and manufacture of complete stand-alone products. Our
primary non-disposable products range in price from $2,500 to $50,000.
Consoles. Our laser consoles incorporate the economic and technical
benefits of semiconductor laser technology, which is the basis of our
semiconductor-based laser systems.
Infrared Photocoagulator Consoles. These OcuLight photocoagulator
consoles are available in two infrared output power ranges: the OcuLight
SL at 2 Watts and the OcuLight SLx at 3 Watts. Each console weighs 14
pounds, has dimensions of 4"H x 12"W x 12"D, draws a maximum of 60 Watts
of wall power, and requires no external air or water cooling.
Veterinary Infrared Console. Introduced in 1994, the DioVet laser system
is used by veterinary ophthalmologists worldwide to treat glaucoma,
retinal disorders, and tumors in dogs, cats, horses and other animals.
The laser's 810 nm wavelength enables transscleral glaucoma and retinal
procedures that are less traumatic and painful that cryotherapy while
providing greater accuracy to the treatment area. The small size of the
DioVet allows easy transport to multiple clinics or remote locations.
Visible Photocoagulator Consoles. In September 1996, we introduced a new
semiconductor-based photocoagulator, the OcuLight GL, which delivers
visible laser light. In June 1997, we launched a dermatology product,
the DioLite 532, also based on visible semiconductor-based technology.
In January 1999 we shipped a new version on the OcuLight GL, the
OcuLight GLx, with increased power and delivery device capability. These
consoles weigh 15 pounds, have dimensions of 6"H x 12"W x 12"D, draw a
maximum of 300 Watts of wall power and require no external air or water
cooling.
Peripheral Delivery Devices. Our versatile family of consoles and
delivery devices has been designed to allow the addition of new capabilities
with a minimal incremental investment. A user adds capabilities by simply
purchasing a new interchangeable delivery device. We have developed both
disposable and nondisposable delivery devices and expect to continue to develop
additional devices.
Ophthalmic Delivery Devices:
TruFocus Laser Indirect Ophthalmoscope. The indirect ophthalmoscope is
worn on the physician's head and is used to treat peripheral retinal
disorders, particularly in infants or adults requiring treatment in the
supine position. This product can be used both for diagnosis and
treatment at the point-of-care.
Slit Lamp Adapter. These adapters allow the physician to utilize a
standard slit lamp for both diagnosis and treatment. A slit lamp adapter
can be installed by the doctor in several minutes converting over 50
variations of a standard diagnostic slit lamp into a therapeutic
photocoagulator delivery system. Slit lamp adapters are used for
treatment of both retinal and glaucomal diseases.
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Operating Microscope Adapter. These adapters allow the physician to
utilize a standard operating microscope for both diagnosis and laser
treatment. These devices are similar to slit lamp adapters except they
are oriented horizontally and therefore can be used to deliver retinal
photocoagulation to a supine patient.
EndoProbe. The EndoProbe is used for endophotocoagulation, a retinal
treatment performed in the hospital operating room or surgery center.
These sterile disposable probes are available in tapered, angled,
fluted, active aspiration and illuminating styles.
G-Probe. The G-Probe is used to treat medically and surgically
uncontrolled glaucoma, in many instances replacing cyclocryotherapy, or
freezing of the eye. The G-Probe's non-invasive procedure takes about
ten minutes, is done to an anesthetized eye in the doctor's office and
results in less pain and fewer adverse side effects than
cyclocryotherapy. The G-Probe is a sterile disposable product.
DioPexy Probe. The DioPexy Probe is a hand-held instrument which is used
to treat retinal tears and breaks transsclerally, noninvasively through
the sclera as an alternative method of attaching the retina. Advantages
include increased precision, less pain and less inflammation than
traditional cryotherapy.
Dermatology Delivery Devices:
DioLite Handpiece. The DioLite Handpiece is a hand held instrument that
is used to treat vascular and pigmented lesions. These devices are
available in 200, 500, 700, 1000 and 1400 micron sizes.
ScanLite Scanner. The ScanLite is a computer pattern generator with
integrated controls designed to enhance the capabilities of the DioLite
532 laser system. It allows rapid and uniform treatment of large-area
vascular and pigmented lesions including port wine stains, matted
telangiectasia, and cafe au lait stains.
We have also developed a new Laser system with Miravant. This system
emits a laser beam to activate a photodynamic drug being developed by Miravant
in order to achieve a therapeutic result in the treatment of age-related macular
degeneration. Clinical studies are currently underway to test the efficacy of
this procedure. Miravant has entered into a co-development agreement with
Pharmacia & Upjohn to more rapidly develop the photodynamic drug and validate
its use in clinical studies. We expect that, if successful, the development of
this product and the receipt of the appropriate regulatory approval thereof will
take about 2 years. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors That May Affect Our Future
Results--We Depend on Development of New Products and New Applications" and
"--We Depend on Collaborative Relationships."
In March 1999, we announced a new laser system, the IRIDERM 810 for hair
removal. The new laser system is currently being promoted for export only and we
expect units to be available for shipment during the fourth quarter of 1999.
The following chart lists the eye diseases that can be treated using our
photocoagulator systems, including the preferred delivery devices. The selection
of delivery device is often determined by the severity and location of the
disease. The chart also lists the skin diseases or conditions that can be
treated with the DioLite 532.
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CONDITION PROCEDURE CONSOLE DELIVERY DEVICES
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Ophthalmology Treatments:
Age-related Macular
Degeneration Retinal Photocoagulation Infrared & Visible Slit Lamp Adapter
Diabetic Retinopathy
Macular Edema Grid Retinal
Photocoagulation Infrared & Visible Slit Lamp Adapter & Operating
Microscope Adapter
Focal Retinal
Photocoagulation Visible Slit Lamp Adapter
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CONDITION PROCEDURE CONSOLE DELIVERY DEVICES
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Proliferative Pan-Retinal
Photocoagulation Infrared & Visible Slit Lamp Adapter, Operating
Microscope Adapter, Laser
Indirect Ophthalmoscope,
EndoProbe
Glaucoma
Primary Open-Angle Trabeculoplasty Infrared & Visible Slit Lamp Adapter
Angle-closure Iridotomy(1) Infrared & Visible Slit Lamp Adapter
Uncontrolled Transscleral Infrared G-Probe
Cyclophotocoagulation
Retinal Detachment Retinopexy Retinal Infrared & Visible Slit Lamp Adapter, Laser Indirect
Photocoagulation Ophthalmoscope, Operating
Microscope Adapter, EndoProbe
Transscleral Retinal Infrared DioPexy Probe
Photocoagulation
Retinopathy of Prematurity Retinal Photocoagulation Infrared Laser Indirect Ophthalmoscope
Ocular Tumors Retinal Photocoagulation Infrared Slit Lamp Adapter, Operating
Microscope Adapter, Laser
Indirect Ophthalmoscope
Dermatology Treatments:
Vascular Lesions Selective Photothermolysis Visible DioLite Handpiece
Pigmented Lesions Selective Photothermolysis Visible DioLite Handpiece
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(1) This indication is currently not cleared by the U.S. FDA.
RESEARCH AND DEVELOPMENT
Our research and development activities are performed internally by its
research and development staff comprised of 17 individuals and is supplemented
by consultants with specialized expertise. Research and development efforts are
directed toward both development of new products and development of new
applications using existing products. Our expenditures for research and
development totaled approximately $3,099,000, $1,716,000 and $1,286,000 in 1998,
1997 and 1996, respectively. In addition, we receive funds under grant from the
United States government for research. We have close working relationships with
ophthalmic researchers, clinicians and dermatologists around the world who
provide new ideas, test the feasibility of these new ideas, and assist us in
validating new products and new applications before they are introduced.
We are supporting pre-clinical and clinical studies to develop new
photocoagulation treatments and applications. The objectives of developing new
applications are to expand the number of patients who can be treated, to more
effectively treat diseases, to treat patients earlier in the treatment regimen
and to reduce the side-effects of treatment. Examples of such studies include:
Ophthalmic Applications
Age-Related Macular Degeneration. We are supporting a multi-center
clinical trial which is testing a prophylactic treatment of age-related
macular degeneration (PTAMD trial). This trial treats patients with dry
AMD using our OcuLight infrared laser systems with the objective of
reducing the rate of progression of the disease from the dry form of AMD
to the wet form of AMD. We are also evaluating whether patient vision
improves as a result of this application.
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Glaucoma. Preliminary studies are underway to evaluate the use of the
G-Probe as a first-line treatment modality for various glaucomas.
Diabetic Retinopathy. Studies are underway to investigate the treatment
of diabetic retinopathy using minimal impact infrared photocoagulation
with the objective of causing regression of the disease with less loss
of vision than conventional therapy.
Ocular Tumors. Clinical studies have reported successful treatment of
ocular tumors using OcuLight infrared lasers.
CUSTOMERS AND CUSTOMER SUPPORT
Our products are currently sold to ophthalmologists, including glaucoma
specialists, retinal specialists, pediatric ophthalmologists, and to
dermatologists. Other customers include research and teaching hospitals,
government installations, surgi-centers and hospitals. No customer or
distributor accounted for 10% or more of total sales in 1998, 1997 or 1996. See
"Managements' Discussion and Analysis of Financial Condition and Results of
Operations."
We are continuing our efforts to broaden our customer base through the
development of new products and new applications. We currently estimate that
there are approximately 15,000 ophthalmologists in the United States and 45,000
internationally who are each potential customers. We believe there are
approximately 10,000 dermatologists in the U.S. Additionally, we estimate that
there are approximately 4,800 and 18,000 hospitals in the United States and
internationally, respectively, as well as approximately 2,200 ambulatory
surgical centers in the United States which potentially represent multiple unit
sales. Because independent ophthalmologists and dermatologists frequently
practice at their own offices as well as through affiliation with hospitals or
other medical centers, each independent ophthalmologist, dermatologist, hospital
and medical center is a potential customer for our products. We are seeking to
broaden our customer base by developing new diagnostic products directed at
addressing the needs of optometrists and dermatologists.
We seek to provide superior customer support and service. An
"around-the-clock" telephone service line is maintained to service customers. If
a problem with a product cannot be diagnosed and resolved by telephone, a
replacement unit is shipped overnight to any domestic customer, and the problem
unit is returned to us. The small size and rugged design of our products allows
for economical shipment and quick response to customers almost anywhere in the
world.
SALES AND MARKETING
To support our sales process, we conduct marketing programs which
include direct mail, trade shows, public relations, advertising in trade and
academic journals and newsletters. We annually participate in approximately 87
trade shows or meetings in the United States and 65 trade shows or meetings
internationally. These meetings allow us to present our products to existing and
prospective buyers. While the sales cycle varies from customer to customer, it
averages 12 months and typically ranges from two to 24 months. Our sales and
marketing organization is based at our corporate headquarters in Mountain View,
with area sales managers located in California, Florida, Georgia, Illinois,
Kentucky, Maryland, Massachusetts, New Jersey, Ohio, Texas, and Virginia.
International product sales represented 36.6%, 51.8% and 49.6% of our
sales in 1998, 1997 and 1996, respectively. Our products are sold
internationally through our 65 independent distributors into 74 countries and in
the United States predominantly through our direct sales force. International
sales are administered
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through our corporate headquarters in Mountain View, California, along with
three area sales managers. Our distribution agreements with our international
distributors are generally exclusive and typically can be terminated by either
party without cause on 90 days notice. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Factors That May Affect Future
Results --We Depend on International Sales."
We believe that educating patients and physicians about the long-term
health benefits and cost-effectiveness of diagnosis and treatment of diseases
that cause blindness at an early stage is critical to market acceptance of our
ophthalmic products. We believe that the trend toward management of health care
costs in the United States will lead to increased awareness of and emphasis on
disease prevention, and cost-effective treatments and, as a result, will
increase demand for our ophthalmic laser products as well as our prospective
diagnostic products.
We work with our customers to enhance our ability to identify new
applications for our products, validate new procedures using our products,
respond more effectively to new procedures and expedite regulatory approvals of
new products and applications. Customers include key opinion leaders who are
often the heads of the departments or professors at universities. These
luminaries in the field of ophthalmology and dermatology are key to the
successful introduction of new technologies and their subsequent acceptance by
the general market. Acceptance of our products by these early adopters is key to
our strategy in the validation of our technology. In addition, we believe that
widespread adoption of our laser platforms will require education about our
products as compared to competing systems.
OPERATIONS
The manufacture of ophthalmic and dermatology laser systems is a complex
process involving precision components, intricate procedures, and environmental
controls. Completed systems must pass quality control and reliability tests
before shipment. We purchase substantially all of our components that are either
standard or built to proprietary specifications and subassemblies from various
independent suppliers and sub-contractors. We assemble critical subassemblies
and the final product at our Mountain View, California facility. Most of the
subcontractors are located within 10 miles of our Mountain View, California
facility. There are risks associated with the use of independent suppliers and
sub-contractors, including unavailability of or delays in obtaining adequate
supplies of components and potentially reduced control of quality, production
costs and the timing of delivery. Any failures by such third parties to
adequately perform may delay the submission of products for regulatory approval,
impair our ability to deliver products on a timely basis, or otherwise impair
our competitive position. Establishing our own capabilities to manufacture these
components would require significant scale-up expenses and additions to
facilities and personnel and could adversely affect our earnings.
We have qualified two or more sources for most of the components used in
our products. In the past, we have experienced delays in manufacturing due to
the inability of a supplier to deliver certain diode components in volume and on
a timely basis. We continue to work with our suppliers to ensure that such
difficulties do not reoccur. Additionally, we qualified a second source for this
diode. The process of qualifying suppliers is ongoing and may be lengthy,
particularly as new products are introduced. We do not have long-term or volume
purchase agreements with any of our suppliers and currently purchase components
on a purchase order basis. Our business, financial condition and results of
operations would be adversely affected if we are unable to obtain components in
the quantities required at a reasonable cost and on a timely basis or if we
could not expand manufacturing capacity to meet demand or if operations at our
single facility were disrupted. See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors That May
Affect Future Results--We Face Risks of Manufacturing."
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As of April 1998 we received certification for ISO 9001/EN 46001. ISO
9001/EN 46001 is a documented international quality system demonstrating
compliance to the European Medical Device Directive.
International regulatory bodies often establish 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 to the European Medical Device Directive and
all applicable standards. In July 1998 we received CE registration under Annex
II guidelines, the most stringent path to CE registration. With Annex II CE
registration, IRIDEX Corporation has demonstrated its ability to both understand
and comply with all applicable European standards. This allows us to register
any product upon our internal verification of compliance to all applicable
European Standards. Currently all 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.
COMPETITION
Competition in the market for devices used for ophthalmic and
dermatological treatments is intense and is expected to increase. This market is
also characterized by rapid technological innovation and change and our products
could be obsoleted 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. In addition to
other companies that manufacture photocoagulators, we compete with
pharmaceuticals, other technologies and other surgical techniques. Our principal
competitors in ophthalmology are Coherent, Inc., Nidek, Inc. ("Nidek"), Carl
Zeiss, Inc. ("Zeiss"), Alcon International, Keeler Instruments, Inc. ("Keeler")
and HGM Medical Laser Systems, Inc. ("HGM"). Of these companies, Nidek, Zeiss,
Alcon International and Keeler currently offer a competitive,
semiconductor-based laser system in ophthalmology and other competitors may
introduce semiconductor-based laser systems. Our principal competitors in
dermatology are Laserscope and HGM. Some competitors have substantially greater
financial, engineering, product development, manufacturing, marketing and
technical resources than we do. Such companies also have greater name
recognition than us and long-standing customer relationships. In addition, other
medical companies, academic and research institutions or others may develop new
technologies or therapies, including medical devices, surgical procedures or
pharmacological treatments and obtain regulatory approval for products utilizing
such techniques that are more effective in treating the conditions targeted by
us or are less expensive than our current or future products. Our technologies
and products could be rendered obsolete by such developments. Any such
developments could have a material adverse effect on our business, financial
condition and results of operations. See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors That May
Affect Future Results--Our Market is Competitive."
PATENTS AND PROPRIETARY RIGHTS
Patents and Proprietary Rights. 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 six United States patents on the technologies related to our
products and processes. The Company has applied for two additional patents
related to our solid state laser products. There can be no assurance that any of
our patent applications will issue as patents, that any patents now or hereafter
held by us will offer any degree of protection or that our patents or patent
applications will not be challenged, invalidated or circumvented in the future.
Moreover, our competitors, many of which have substantial resources and have
made substantial investments in competing technologies, may seek to apply for
and obtain
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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. 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 competitors of ours. Because patent applications are
maintained in secrecy in the United States until patents are issued and are
maintained in secrecy for a period of time outside the United States, we have
not conducted any searches to determine whether our technology infringes any
patents or patent applications. 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. This may adversely impact
the Company's operating results.
Any claims, with or without merit, could be time-consuming, result in
costly litigation and diversion of technical and management personnel, cause
shipment delays, require us to develop noninfringing technology or require us to
enter into royalty or licensing agreements. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. An adverse determination in
a judicial or administrative proceeding or failure to obtain necessary licenses
could prevent us from manufacturing and selling our products, which would have a
material adverse effect on our business, results of operations and financial
condition. Conversely, litigation may be necessary to enforce patents issued to
us, to protect trade secrets or know-how owned by us or to determine the
enforceability, scope and validity of the proprietary rights of others. Both the
defense and prosecution of intellectual property suits or interference
proceedings are costly and time consuming.
GOVERNMENT REGULATION
The medical devices to be marketed and manufactured by us are subject to
extensive regulation by numerous governmental authorities, including federal,
state, and foreign governmental agencies. Pursuant to the Federal Food, Drug,
and Cosmetic Act, as amended, and the regulations promulgated thereunder (the
"FDA Act"), the Food and Drug Administration (the "FDA") serves as the principal
federal agency with authority over medical devices and regulates the research,
clinical testing, manufacture, labeling, distribution, sale, marketing and
promotion of such devices. Noncompliance with applicable requirements can result
in, among other things, fines, injunctions, civil penalties, recall or seizures
of products, total or partial suspension of production, failure of the
government to grant premarket clearance or approval for devices, withdrawal of
marketing approvals, and criminal prosecution. The FDA also has the authority to
request repair, replacement or refund of the cost of any device manufactured or
distributed by us.
In the United States, medical devices are classified into one of three
classes (Class I, II or III), on the basis of the controls deemed necessary by
the FDA to reasonably assure their safety and effectiveness. Under FDA
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<PAGE> 12
regulations, Class I devices are subject to general controls (for example,
labeling, premarket notification and adherence to Quality System Regulations
("QSRs") requirements). Class II devices are subject to general and special
controls (for example, performance standards, postmarket surveillance, patient
registries, and FDA guidelines). Generally, Class III devices are those which
must receive premarket approval (or "PMA") by the FDA to ensure their safety and
effectiveness.
Before a new device can be introduced into the market, the manufacturer
must generally obtain marketing clearance through either a 510(k) premarket
notification or a PMA. A 510(k) clearance will be granted if the submitted
information establishes that the proposed device is "substantially equivalent"
to a legally marketed Class I or II medical device, or to a Class III medical
device for which the FDA has not called for a PMA. The FDA may determine that a
proposed device is not substantially equivalent to a legally marketed device, or
that additional information or data are needed before a substantial equivalence
determination can be made. A request for additional data may require that
clinical studies of the device's safety and efficacy be performed.
Commercial distribution of a device for which a 510(k) notification is
required can begin only after the FDA issues an order finding the device to be
"substantially equivalent" to a predicate device. The FDA has recently been
requiring a more rigorous demonstration of substantial equivalence than in the
past. Even in cases where the FDA grants a 510(k) clearance, it can take the FDA
from four to twelve months from the date of submission to grant a 510(k)
clearance, but it may take longer.
A "not substantially equivalent" determination, or a request for
additional information, could delay the market introduction of new products that
fall into this category and could have a materially adverse effect on our
business, financial condition and results of operations. For any of our products
that are cleared through the 510(k) process, modifications or enhancements that
could significantly affect the safety or efficacy of the device or that
constitute a major change to the intended use of the device will require new
510(k) submissions.
A PMA application must be filed if a proposed device is not
substantially equivalent to a legally marketed Class I or Class II device, or if
it is a Class III device for which the FDA has called for PMAs. A PMA
application must be supported by valid scientific evidence which typically
includes extensive data, including human clinical trial data to demonstrate the
safety and effectiveness of the device. The PMA application must also contain
the results of all relevant bench test, laboratory and animal studies, a
complete description of the device and its components, and a detailed
description of the methods, facilities and controls used to manufacture the
device. In addition, the submission may require the applicant to detail the
proposed labeling, advertising literature and training methods.
Upon receipt of a PMA application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit a
substantive review. If the FDA determines that the PMA application is
sufficiently complete to permit a substantive review, the FDA will accept the
application for filing. Once the submission is accepted for filing, the FDA
begins an in-depth review of the PMA. An FDA review of a PMA application
generally takes one to two years from the date the PMA application is accepted
for filing, but may take significantly longer. The review time is often
significantly extended by the FDA asking for more information or clarification
of information already provided in the submission. During the review period, an
advisory committee, typically a panel of clinicians, will likely be convened to
review and evaluate the application and provide recommendations to the FDA as to
whether the device should be approved. The FDA is not bound by the
recommendations of the advisory panel. Toward the end of the PMA review process,
the FDA generally will conduct an inspection of the manufacturer's facilities to
ensure that the facilities are in compliance with applicable QSR requirements,
which includes good manufacturing practices.
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<PAGE> 13
If the FDA's evaluations of both the PMA application and the
manufacturing facilities are favorable, the FDA will either issue an approval
letter or an approvable letter, which may contain a number of conditions which
must be met in order to secure final approval of the PMA. When and if those
conditions have been fulfilled to the satisfaction of the FDA, the agency will
issue a PMA approval letter, authorizing commercial marketing of the device for
certain indications. The FDA may also determine that additional clinical trials
are necessary or other deficiencies exist in the PMA, in which case PMA approval
may be delayed. The PMA process can be expensive, uncertain and lengthy and a
number of devices for which the FDA approval has been sought by other companies
have never been approved for marketing.
If human clinical trials of a device are required in connection with
either a 510(k) notification or a PMA, and the device presents a "significant
risk," the sponsor of the trial (usually the manufacturer or the distributor of
the device) is required to file an investigational device exemption ("IDE")
application prior to commencing human clinical trials. The IDE application must
be supported by data, typically including the results of animal and laboratory
testing. If the IDE application is reviewed and approved by the FDA and one or
more appropriate institutional review boards ("IRBs"), human clinical trials may
begin at a specific number of investigational sites with a specific number of
patients, as approved by the FDA. If the device presents a "nonsignificant risk"
to the patient, a sponsor may begin the clinical trial after obtaining approval
for the study by one or more appropriate IRBs.
All of our products have obtained either an independent 510(k) clearance
or are modifications of previously cleared 510(k) devices, which do not require
the submission of a new 510(k) notification. However, the FDA may not agree with
our determination that a 510(k) notification is not required for the modified
devices and require us to submit a new 510(k) notification for the modification.
If the FDA requires us to submit a new 510(k) notification for the modified
devices, we may be prohibited from marketing the modified device until the
510(k) notification is cleared by the FDA.
We have also established a strategic alliance with Miravant to
manufacture a device designed to photoactivate an ophthalmic drug currently
under development by Miravant. Miravant is responsible for obtaining the
required regulatory approvals. Under the FDA's combination products policy, the
ophthalmic drug and photoactivating device may be considered a drug-device
combination product and, therefore, be required to undergo the new drug approval
process. The steps required before a new drug can be commercially distributed in
the United States include (1) conducting appropriate pre-clinical laboratory and
animal tests, (2) submitting to the FDA an application for an investigational
new drug ("IND"), which must become effective before clinical trials may
commence, (3) conducting well-controlled human clinical trials that establish
the safety and effectiveness of the drug, (4) filing a new drug application
("NDA") with the FDA, and (5) obtaining FDA approval of the NDA prior to any
commercial distribution of the drug. The new drug approval process is expensive,
lengthy and uncertain, and many new drug products have never been approved for
marketing. An approved NDA may be required for the ophthalmic drug and
photoactivating device as a combination product. If required, the approval may
not be obtained. In addition, the FDA may require separate premarket clearance
for the photoactivating device through either a 510(k) notification or a PMA. If
required, premarket clearance or approval may not be obtained.
Any products manufactured or distributed by us pursuant to FDA
clearances or approvals are subject to pervasive and continuing regulation by
the FDA, including recordkeeping requirements and reporting of adverse
experiences with the use of the device. Device manufacturers are required to
register their establishments and list their devices with the FDA and certain
state agencies, and are subject to periodic inspections by the FDA and certain
state agencies. The FDA Act requires devices to be manufactured to comply with
applicable QSR
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<PAGE> 14
regulations which impose certain procedural and documentation requirements upon
us with respect to manufacturing, design, development and quality assurance
activities.
Labeling and promotion activities are subject to scrutiny by the FDA and
in certain instances, by the Federal Trade Commission. The FDA actively enforces
regulations prohibiting marketing of products for unapproved uses. We and our
products are also subject to a variety of state laws and regulations in those
states or localities where our products are or will be marketed. Any applicable
state or local regulations may hinder our ability to market our products in
those states or localities. Manufacturers are also subject to numerous federal,
state and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal of hazardous or potentially hazardous substances. We may be required to
incur significant costs to comply with such laws and regulations now or in the
future. Such laws or regulations may have a material adverse effect upon our
ability to do business.
Exports of our products are regulated by the FDA and are covered by the
Export Amendment of 1996, which greatly expanded the export of approved and
unapproved United States medical devices. However, some foreign countries
require manufacturers to provide an FDA certificate for products for export
("CPE") which requires the device manufacturer to certify to the FDA that the
product has been granted premarket clearance in the United States and that the
manufacturing facilities appeared to be in compliance with QSR at the time of
the last QSR inspection. The FDA will refuse to issue a CPE if significant
outstanding QSR violations exist.
The introduction of our products in foreign markets will also subject us
to foreign regulatory clearances which may impose additional substantial costs
and burdens. International sales of medical devices are subject to the
regulatory requirements of each country. The regulatory review process varies
from country to country. Many countries also impose product standards,
packaging, requirements, labeling requirements and import restrictions on
devices. In addition, each country has its own tariff regulations, duties and
tax requirements. The approval by the FDA and foreign government authorities is
unpredictable and uncertain. The necessary approvals or clearances may not be
granted on a timely basis, if at all. Delays in receipt of, or a failure to
receive, such approvals or clearances, or the loss of any previously received
approvals or clearances, could have a material adverse effect on our business,
financial condition and results of operations.
Changes in existing requirements or adoption of new requirements or
policies by the FDA or other foreign and domestic regulatory authorities could
adversely affect our ability to comply with regulatory requirements. Failure to
comply with regulatory requirements could have a material adverse effect on the
Company's business, financial condition and results of operations. We may be
required to incur significant costs to comply with laws and regulations in the
future. These laws or regulations may have a material adverse effect upon our
business, financial condition or results of operations.
REIMBURSEMENT
Our 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 carefully review and are increasingly
challenging the prices charged for medical products and services. Reimbursement
rates from private companies vary depending on the procedure performed, the
third-party payor, the insurance plan and other factors. Medicare reimburses
hospitals on a prospectively-determined fixed amount for the costs associated
with an in-patient hospitalization based on the patient's discharge diagnosis.
Medicare reimburses physicians a prospectively-determined fixed amount based on
the procedure performed, regardless of the actual costs incurred by the hospital
or physician in furnishing the care and unrelated to the specific devices used
in that procedure. Third-party payers are increasingly scrutinizing whether to
cover new products and the level of reimbursement for covered products.
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<PAGE> 15
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. Additionally,
Miravant may not be able to obtain coverage for its use of drugs with our
OcuLight Systems, or the reimbursement may not be adequate to cover the
treatment procedure. Doctors, clinics, hospitals and other users of our products
may not obtain adequate reimbursement for use of our products from third-party
payers. Changes in government legislation or regulation or in private
third-party payers' policies toward reimbursement for procedures employing our
products may prohibit adequate reimbursement. These could have a material
adverse effect on our business, results of operations and financial condition.
Moreover, 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. Most of the treatment procedures for our DioLite 532 dermatology
systems are billed to private-pay customers.
PRODUCT LIABILITY AND INSURANCE
We may be subject to product liability claims in the future. Our
products are highly complex and are used to treat extremely delicate eye tissue
and skin conditions on and near a patient's face. Our products are often used in
situations where there is a high risk of serious injury or adverse side effects.
In addition, although we recommend that our disposable products only be used
once and so prominently label these disposables, we believe that certain
customers may nevertheless reuse these disposable products. Were such a
disposable product not adequately sterilized by the customer between such uses,
a patient could suffer serious consequences, possibly resulting in a suit
against the Company for damages. Accordingly, the manufacture and sale of
medical products entails significant risk of product liability claims. Although
we maintain product liability insurance with coverage limits of $6.0 million per
occurrence and an annual aggregate maximum of $7.0 million, the coverage of our
insurance policies may not be adequate. Such insurance is expensive and in the
future may not be available on acceptable terms, if at all. A successful claim
brought against us in excess of our insurance coverage could have a material
adverse effect on our business, results of operations and financial condition.
To date, we have not experienced any product liability claims.
BACKLOG
We generally ship our products within a few days after acceptance of a
customer's purchase order. Accordingly, we do not believe that our backlog at
any particular time is indicative of future sales levels.
EMPLOYEES
At January 2, 1999, we had a total of 91 full-time employees, including
37 in operations, 27 in sales and marketing, 17 in research and development and
10 in finance and administration. We also employ, from time to time, a number of
temporary and part-time employees as well as consultants on a contract basis. At
January 2, 1999, we employed 8 such persons. We intend to hire additional
personnel during the next twelve months in each of these areas. Our future
success will depend in part on its ability to attract, train, retain and
motivate highly qualified employees, who are in great demand. We may not be
successful in attracting and retaining such personnel. Our employees are not
represented by a collective bargaining organization, and we have never
experienced a work stoppage or strike. We consider our employee relations to be
good.
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<PAGE> 16
EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers and their ages as of January 2, 1999 were as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Theodore A. Boutacoff........ 51 President, Chief Executive Officer and Director
Robert Kamenski.............. 44 Chief Financial Officer and Vice President,
Administration
Eduardo Arias................ 54 Senior Vice President, Worldwide Sales
Timothy Powers............... 37 Vice President, Operations
James L. Donovan............. 61 Vice President, Corporate Business Development and
Director
</TABLE>
Mr. Boutacoff co-founded IRIDEX and since February 1989 has served as
its President, Chief Executive Officer and a member of its Board of Directors.
Prior to co-founding the Company, Mr. Boutacoff held various positions,
including Director of New Business and Clinical Development, Director of
Marketing and Director of Regulatory Affairs, with the Medical Division of
Coherent, Inc., a manufacturer of laser systems for science, medicine and
industry. Mr. Boutacoff holds a B.S. degree in civil engineering from Stanford
University.
Mr. Kamenski joined IRIDEX in March 1997 as Vice President, Finance and
Administration and was appointed Chief Financial Officer in October 1997. Prior
to joining us from July 1992 to March 1997, Mr. Kamenski held various positions,
including Chief Financial Officer and Vice President of Finance and
Administration, with TeleSensory Corporation. Mr. Kamenski holds a B.B.A. degree
in accounting from the University of Wisconsin-Milwaukee and is a member of the
American Institute of CPAs.
Mr. Arias co-founded IRIDEX and served as Vice President, Sales &
Marketing from April 1989 until September 1991 when he was promoted to the
position of Senior Vice President, Worldwide Sales. Prior to co-founding the
Company, Mr. Arias held various positions, including Director of Marketing and
Sales, Medical Group and Director of International Operations, at Coherent, Inc.
Mr. Powers joined IRIDEX in July 1997 as Vice President, Operations.
Prior to joining us, from November 1988 to July 1997, Mr. Powers held various
positions, including Vice President of Operations, at Strato/Infusaid, Inc., a
Pfizer subsidiary. Mr. Powers holds a Masters of Management Science degree in
manufacturing engineering and a Bachelors of Science degree in industrial
technology, both from the University of Lowell in Massachusetts.
Mr. Donovan co-founded IRIDEX and, since February 1989, has served as a
member of our Board of Directors. From February 1989 to October 1997 Mr. Donovan
served as our Chief Financial Officer, except in the period June to November
1996, and is currently serving as our Vice President, Corporate Business
Development. Prior to co-founding the Company, Mr. Donovan served as General
Manager of the Medical Division and Chief Financial Officer of Coherent, Inc.
Mr. Donovan holds a B.S. degree in business administration from Southern Oregon
State College.
ITEM 2. PROPERTIES
We relocated our operating facilities in September 1997 to 37,000 square
feet of space in Mountain View, California. The new building houses
manufacturing, research and development and serves as our headquarter offices.
The lease term expires in 2002 and contains a renewal option.
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<PAGE> 17
Management believes that our new facility will be adequate for our
current needs and that suitable additional space or alternative space will be
available as needed in the future on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION FOR COMMON EQUITY
Our Common Stock has been traded on the Nasdaq National Market System
under the symbol "IRIX" since our initial public offering on February 15, 1996.
The following table sets forth for the periods indicated the high and low
closing prices for our Common Stock.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
FISCAL 1999
First Quarter (through March 22, 1999)......................... $5.750 $3.000
FISCAL 1998
First Quarter.................................................. $9.125 $6.500
Second Quarter................................................. 11.375 7.625
Third Quarter.................................................. 8.250 3.625
Fourth Quarter................................................. 4.625 1.938
FISCAL 1997
First Quarter.................................................. $8.750 $4.750
Second Quarter................................................. 9.625 5.375
Third Quarter.................................................. 12.625 8.250
Fourth Quarter................................................. 12.375 7.500
</TABLE>
FISCAL 1998
On March 22, 1999, the closing price on the Nasdaq National Market for
our Common Stock was $5.063 per share. As of January 2, 1999, there were
approximately 70 holders of record of our Common Stock.
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<PAGE> 18
DIVIDEND POLICY
We have never paid cash dividends on our Common Stock. We currently
intend to retain any earnings for use in our business and do not anticipate
paying cash dividends in the foreseeable future. In addition, the payment of
cash dividends to our stockholders is currently prohibited by our bank line of
credit. See Note 4 of Notes to Consolidated Financial Statements.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data as of and for the
years ended January 2, 1999, December 31, 1997, 1996, 1995, 1994 and have been
derived from and are qualified by reference to, our consolidated financial
statements audited by PricewaterhouseCoopers LLP, independent accountants. The
selected consolidated statement of income data as of December 31, 1995 and 1994
and the consolidated balance sheet data as of December 31, 1996, 1995 and 1994
have been derived from our audited financial statements not included herein.
These historical results are not necessarily indicative of the results of
operations to be expected for any future period.
The data set forth below (in thousands, except per share data) are
qualified by reference to, and should be read in conjunction with Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the consolidated financial statements included in Item 8.
"Financial Statements and Supplementary Data."
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Sales .......................................... $ 23,585 $ 18,073 $ 12,364 $ 8,801 $ 7,182
Cost of sales .................................. 10,308 7,612 4,899 2,798 2,423
-------- -------- -------- ------- -------
Gross profit ........................... 13,277 10,461 7,465 6,003 4,759
-------- -------- -------- ------- -------
Operating expenses:
Research and development ................... 3,099 1,716 1,286 742 629
Selling, general and administrative ........ 8,358 6,074 5,197 3,787 3,383
Nonrecurring charge for acquisition
of technology ............................ -- -- -- 80 --
-------- -------- -------- ------- -------
Total operating expenses ................ 11,457 7,790 6,483 4,609 4,012
-------- -------- -------- ------- -------
Income from operations ......................... 1,820 2,671 982 1,394 747
Other income (expense), net .................... 511 607 699 58 (1)
-------- -------- -------- ------- -------
Income before Benefit (provision) for
income taxes .............................. 2,331 3,278 1,681 1,452 746
Benefit (provision) for income taxes ........... (583) (1,180) (676) (452) 1,039
-------- -------- -------- ------- -------
Net income ..................................... $ 1,748 $ 2,098 $ 1,005 $ 1,000 $ 1,785
======== ======== ======== ======= =======
Net income per common share(1) ................. $ 0.27 $ 0.33 $ 0.18 $ 0.78 $ 1.60
======== ======== ======== ======= =======
Shares used in per common share
calculation(1) ............................ 6,480 6,406 5,725 1,276 1,118
======== ======== ======== ======= =======
Diluted net income per common share(1) ......... $ 0.26 $ 0.31 $ 0.16 $ 0.23 $ 0.42
======== ======== ======== ======= =======
Shares used in diluted income per common share
calculation(1) ............................ 6,765 6,755 6,410 4,354 4,242
======== ======== ======== ======= =======
</TABLE>
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<PAGE> 19
<TABLE>
<CAPTION>
JANUARY 2, DECEMBER 31,
------- -----------------------------------
1999 1997 1996 1995 1994
------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and
available-for-sale securities $10,876 $13,488 $15,114 $1,227 $ 684
Working capital ................. $23,450 $21,716 $20,777 $4,339 $2,973
Total assets .................... $28,377 $26,686 $23,707 $6,395 $4,436
Total stockholders' equity ...... $25,885 $23,880 $21,478 $4,685 $3,436
</TABLE>
- ----------
(1) See Note 10 of Notes to Consolidated Financial Statements for an
explanation of shares used in per share calculations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those set forth in such
forward looking statements as a result of the factors set forth under "Factors
That May Affect Future Results" and other risks detailed from time to time in
the Company's reports filed with the Securities and Exchange Commission.
OVERVIEW
IRIDEX Corporation is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. Our products are sold in the United States
predominantly through a direct sales force and internationally through 65
independent distributors into 74 countries. We market our products using three
brand names: IRIS Medical to the ophthalmology market, IRIDERM to the
dermatology market and Light Solutions to the research market.
Our ophthalmology products treat eye diseases, including the three
leading causes of irreversible blindness. The current family of ophthalmology
laser systems includes the IRIS Medical OcuLight SL, OcuLight SLx, OcuLight GL
and OcuLight GLx Laser Photocoagulation systems (each an "OcuLight System"). Our
dermatology products treat skin diseases, primarily vascular and pigmented
lesions. In June 1997, we launched the IRIDERM DioLite 532 Laser System to
address the dermatology market. The DioLite 532 Laser System is sold primarily
for office-based use by dermatologists. Each ophthalmic and dermatology system
consists of a small, portable laser console and interchangeable delivery
devices. We believe that our semiconductor-based systems are more portable and
economical and have a greater degree of reliability and flexibility than
competing systems which use traditional vacuum tube-based technology. Since our
first shipment in 1990, more than 2,500 IRIDEX medical laser systems have been
sold worldwide, primarily for hospital and office-based use by ophthalmologists
and dermatologists.
Our revenues arise primarily from the sale of our IRIS Medical OcuLight
Systems, IRIDERM DioLite 532 consoles, delivery devices, disposables and, to a
lesser extent, revenues from service and support activities, and the sale of
Light Solutions products and research grants. Revenue from product sales is
generally recognized at the time of shipment (net of allowances or discounts),
while revenue from services is recognized upon performance of the applicable
services. Our sales have increased primarily due to growth in unit sales
(including additional unit sales resulting from the introduction of the OcuLight
GL during the second half of 1996, the DioLite 532 in June 1997 and OcuLight GLx
in January 1999), greater market penetration and an expanded product offering.
We believe that future growth in unit sales will be derived both from a growth
in the market for photocoagulator products and from the replacement of installed
photocoagulators which use vacuum tube- based technology.
Our sales in the United States are derived from direct sales to end
users and internationally are derived from sales to 65 distributors who resell
to hospitals and physicians. Sales to international distributors are made
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<PAGE> 20
on open credit terms or letters of credit and generally are not subject to a
right of return unless we terminate a distributor. Although sales of our
products internationally currently are denominated in United States dollars,
international sales are subject to a variety of risks including fluctuations in
foreign currency exchange rates, shipping delays, generally longer receivable
collection periods, changes in applicable regulatory policies, international
monetary conditions, domestic and foreign tax policies, trade restrictions,
duties and tariffs and economic and political instability. The recent currency
devaluation in many Asian countries has had the effect of significantly
increasing the purchase price of our products to our distributors and customers
in that region. Product sales were lower for the affected Asian region during
1998 as a result. We expect lower sales to the Asian region to continue during
1999. While these currency factors and other factors listed above have been
mitigated by product sales in other regions and in the United States, future
currency fluctuations or other factors discussed above may have a material
adverse effect on our business, financial condition or results of operation. See
"--Factors That May Affect Future Results--We Depend on International Sales."
Cost of sales consists primarily of the cost of purchasing components
and sub-systems, assembling, packaging and testing components at our facility,
and the direct labor and associated overhead. Cost of service and support
consists of expenses related directly to service, support and training
activities. Research and development expenses consist primarily of personnel
costs, materials and research support provided to clinicians at medical
institutions developing new applications which utilize our products. Research
and development costs have been expensed as incurred. Sales, general and
administrative expenses consist primarily of costs of personnel, sales
commissions, travel expenses, advertising and promotional expenses, facilities,
legal and accounting, insurance and other expenses which are not allocated to
other departments.
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
sales for the periods indicated:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Sales ......................................... 100.0% 100.0% 100.0%
Cost of sales ................................. 43.7 42.1 39.6
----- ----- -----
Gross profit ............................. 56.3 57.9 60.4
----- ----- -----
Operating expenses:
Research and development ................. 13.1 9.5 10.4
Sales, general and administrative ........ 35.5 33.6 42.0
----- ----- -----
Total operating expenses ................. 48.6 43.1 52.4
----- ----- -----
Income from operations ........................ 7.7 14.8 8.0
Other income, net ............................. 2.2 3.3 5.6
----- ----- -----
Income before provision for income taxes ...... 9.9 18.1 13.6
Provision for income taxes .................... (2.5) (6.5) (5.5)
----- ----- -----
Net income .................................... 7.4% 11.6% 8.1%
===== ===== =====
</TABLE>
Sales. Sales were $23.6 million in 1998, $18.1 million in 1997 and $12.4
million in 1996. These sales represented increases of 30.5%, from 1997 to 1998
and 46.2% from 1996 to 1997. The increase in our sales in 1998 as compared to
1997 was due to increased unit volumes, primarily as a result of increased sales
of the OcuLight GL and sales of the DioLite, offset in part by decreased average
selling prices, particularly with respect to our more mature products. The
increase in our sales in 1997 as compared to 1996 was primarily attributable to
increased unit volumes and the introduction of the DioLite, offset in part by
decreased average selling prices and reduced ability to ship units due to a
shortage of a certain component. International sales accounted for 36.6% of
total sales in 1998, 51.8% in 1997 and 49.6% in 1996. International sales as a
percentage of revenues decreased in 1998 from 1997 levels. The decrease is
primarily due to continued lower sales from the economically weakened Asian
region. The decrease was partially offset by increased sales into
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<PAGE> 21
European countries. We began to be impacted by lower sales from the Asian region
during the second half of 1997. International sales as a percentage of revenues
increased in 1997 over 1996 primarily due to strong international sales to Asia
and Europe during the first half of the year. We expect international sales as a
percentage of revenues for 1999 to be substantially equivalent to the 1998 rate.
We expect future growth in sales to be primarily derived from sales of the
OcuLight GL, GLx and the DioLite 532.
Gross Profit. Gross profit was $13.3 million in 1998, $10.5 million in
1997 and $7.5 million in 1996. Gross profit represented 56.3% of sales in 1998,
57.9% in 1997 and 60.4% of sales in 1996. Gross profit as a percentage of sales
decreased in 1998 as compared to 1997 due primarily to proportionately higher
overhead production costs resulting from our move to a larger facility in
September 1997, increased unit volume of lower gross margin products and lower
average selling prices. Such gross profit margin decreases were offset in part
by a decrease in international sales which have lower gross profit margins and
an increase in the sales of the DioLite which have higher gross profit margins.
Gross profit as a percentage of sales decreased in 1997 as compared to 1996
primarily due to increased sales of our OcuLight GL and an increase in
international sales which, on average, have lower gross profit margins.
Moreover, increasing competition has continued to result in a downward trend in
average selling prices and has led to lower gross profit margins. We intend to
continue our efforts to reduce the cost of components and thereby mitigate the
impact of price reductions on our gross profit. We believe gross profit in
dollars will increase as volumes increase and unit production costs will
decrease as costs are engineered out of new products. However, gross margins as
a percentage of sales will continue to fluctuate due to changes in the relative
proportions of domestic and international sales, the mix of product sales, costs
associated with future product introductions and a variety of other factors.
Research and Development. Research and development expenses increased by
80.6% in 1998 to $3.1 million and by 33.4% in 1997 to $1.7 million. These
expenses were 13.1% of sales in 1998, 9.5% of sales in 1997 and 10.4% of sales
in 1996. The increase in 1998 was primarily due to increased personnel and
prototype expenses related to the newly released products, the OcuLight GLx and
Slit Lamp Adapters with UltraView optics and unreleased products and a decrease
in the volume of research work conducted under grants from the U.S. Federal
Government as described below. In addition, a portion of the increase was
attributable to development expenses for the IRIDERM 810, which we recently
announced. The increase in research and development expenses during 1997 was
primarily attributable to an increase in personnel as we strengthened our
product development efforts, particularly those directed at the introduction of
the DioLite 532. We expect these expenses for research and development to
continue to increase in absolute dollars during 1999 in connection with new
product development activities. We also conduct research and development
pursuant to grants from the U.S. Federal Government. Under the terms of these
grants, we typically retain the right to commercially market the technology
developed by us. The amounts we receive for these research and development
efforts are recognized as sales, and the related labor and material costs are
charged to cost of sales. As a result, our reported research and development
expense does not entirely reflect our research and development efforts.
Sales, General and Administrative. Sales, general and administrative
expenses grew by 37.6% in 1998 to $8.4 million and by 16.9% in 1997 to $6.1
million. These expenses were 35.5% of sales in 1998, 33.6% of sales in 1997 and
42.0% of sales in 1996. The increases in sales, general and administrative
expenses in these periods were primarily due to the hiring of additional sales
and marketing employees to address new sales opportunities and to support
expanding unit volumes, higher sales commissions and the growth in the
infrastructure of our
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<PAGE> 22
finance and administrative group which were necessary to support our expanded
operations. Costs associated with the launch of the OcuLight GLx during 1998 and
the sales of the DioLite 532 and the OcuLight GL during 1997 also increased
sales and marketing expenses during these periods. In addition, sales, general
and administrative expenses increased due to our move to a new facility in 1997.
The increases in sales, general and administrative expenses for 1997 were
partially offset the decreases in sales expenses associated with increasing
international sales to independent, non-employee, non-commissioned distributors.
Other income, net. Other income, net consists primarily of interest
income. Interest income was $483,000, $623,000 and $691,000 in 1998, 1997 and
1996, respectively. This income was primarily from interest earned on
available-for-sale securities. Interest income decreased in 1998 and 1997
compared to 1996 because of increased investments in lower yield, tax preferred
securities and overall lower cash balances in connection with internal
investments in the enterprise resource planning ("ERP") system and in leasehold
improvements associated with our new facility.
Income Taxes. We had an effective tax rate of 25%, 36% and 40% in 1998,
1997 and 1996, respectively. The tax rate for 1998 and 1997 was lower than the
statutory rate of 40% because of certain tax benefits associated with tax exempt
interest on tax preferred securities and with tax credits for research and
experimental activities. In 1998, the statutory rate was reduced by tax exempt
interest of 5%, research and experimental credits of 5% and other items of 2%.
In 1997, the statutory rate was reduced by tax exempt interest of 2% and
research and experimental credit of 2%.
LIQUIDITY AND CAPITAL RESOURCES
In February 1996, we sold 1,982,500 shares of our Common Stock in
connection with our initial public offering ("IPO"). The net proceeds of this
offering were approximately $15.7 million after deducting underwriting discounts
and commissions and expenses of the offering. We have used a portion of the net
proceeds from the IPO for purchases of inventory, the "ERP" system, leasehold
improvements and payment of certain accrued liabilities.
At January 2, 1999, our primary sources of liquidity included cash, cash
equivalents and available-for-sale securities of $10.9 million. In addition, we
have available $1,000,000 under our unsecured line of credit which bears
interest at the bank's prime rate and expires in September 1999. As of January
2, 1999, no borrowings were outstanding under this credit facility. We believe
that, based on current estimates, our current cash, available-for-sale
securities and the credit facility will be sufficient to meet our working
capital and capital expenditure requirements at least through the next twelve
months. However, we believe that the level of financial resources is a
significant competitive factor in our industry, and accordingly we may choose to
raise additional capital through debt or equity financing prior to the end of
1999.
Net cash used in operations totaled $1,976,000, $88,000 and $1,256,000
in 1998, 1997 and 1996, respectively. In 1998, sources of cash included net
income of $1.7 million and increases in accounts payable of $127,000, offset by
uses of cash with increases in inventories of $2.5 million, increases in
accounts receivable of $1.6 million and decreases of accrued expenses of
$438,000. In 1997, sources of cash included net income of $2.1 million and
increases in accounts payable and accrued liabilities of $584,000, offset
by uses of cash with increases in inventories of $2.1 million and increases in
accounts receivable of $732,000. The increase in inventories is primarily due to
an increase in supplies of key components and dual sourcing. During 1996, while
we waited for FDA approval of the OcuLight GL, we built up our inventory of the
OcuLight GL in order to be able to allocate substantial manufacturing resources
to producing the OcuLight GL. When the introduction of the OcuLight GL was
delayed due to delays in FDA approval and the inability to obtain certain
components, we experienced increases in inventory levels and manufacturing labor
inefficiencies. To improve manufacturing efficiency in 1997, we engineered dual
sources for key components of the OcuLight GL and initiated a purchasing program
to increase the amount of safety stock of key components. These measures
resulted in increased levels of materials inventory which we reduced in part in
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<PAGE> 23
1997 as we reduced the inventory level of the OcuLight SL. We intend to continue
to maintain an increased level of inventory of certain key components.
We used approximately $2.4 million, $4.4 million, and $1.6 million for
investing activities in 1998, 1997 and 1996, respectively, primarily for the
purchase of available-for-sale securities and the acquisition of fixed assets.
Net cash provided by financing activities during 1998, 1997 and 1996 was
$245,000, $299,000, and $15,782,000, respectively, which consisted primarily of
issuance of stock, including our 1996 initial public offering.
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. On February 12, 1999, we purchased 25,000 shares of our
Common Stock from the open market.
Year 2000 Disclosure
We use a significant number of information technology ("IT") and non-IT
systems in our internal operations. IT systems include applications for various
financial, business and administrative functions and non-IT systems include
those that have embedded technology in the systems. These systems may contain
source code that is unable to properly interpret calendar years beginning with
the upcoming year 2000. Systems that do not properly recognize such
date-sensitive information may fail or create erroneous results. Also, we may be
exposed to risks from systems of parties with whom we transact material
business. Our products that we sell to our customers, do not contain any
internal embedded calendars in them and therefore we do not anticipate any
problems related to the Year 2000 issue to develop with our products.
We are assessing our Year 2000 risk exposure and plan to implement
remedial and corrective action where necessary. We have reviewed all of our
major internal systems, including financial, business, administrative and
manufacturing systems, to assess Year 2000 readiness and to identify critical
systems that require correction or remediation. Based on the results of this
assessment, we have installed a new ERP system and upgraded our phone system
software to be fully Year 2000 compliant.
Also, we may be exposed to risks from systems of parties with whom we
transact material business. We are working with critical suppliers of products
and services to assess their Year 2000 readiness with respect both to their
operations and the products and services they supply to us. Inquiries have been
made and responses are being monitored, with appropriate follow-up where
required. This analysis will continue into 1999, with corrective action taken
commensurate with the criticality of affected products and services. We depend
significantly on revenue from sales of our products placed from customers from
other countries. We do not know the extent that Year 2000 problems will affect
current and potential customers, whether international or domestic customers. A
disruption in their business may cause a delay in or cancellation of orders that
may adversely affect our business, financial condition or results of operations.
We are in process of developing various contingency plans to address
potential problems with critical internal systems and third party interactions.
Our contingency plans include procedures for dealing with a major disruption of
internal business systems, plans for long term factory shutdown and
identification of alternative vendors of critical materials in the event of Year
2000 related disruption in supply. Contingency planning will continue through
1999.
Our costs to date related to the Year 2000 issue consist of the costs of
a new ERP system and phone system upgrade and the reallocation of internal
resources to evaluate our Year 2000 situation, assess systems and make
contingency plans. We have currently spent approximately $400,000 on capital
expenditures for the cost of software, hardware, external consulting fees and
other related upgrades. We believe the costs of reallocation of
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<PAGE> 24
internal resources to address this issue is immaterial based on the review of
department budgets and staff allocations. We estimate that no more than $50,000,
if that, will be needed to continue to assess, monitor, plan contingencies and
make appropriate remediation, where needed. The estimate is based on our current
assessment of our systems and the responses of our critical third parties.
Based on currently available information, management does not believe
that the Year 2000 issues discussed above related to internal systems or
products sold to customers will have a material adverse impact on our financial
condition or overall trends in results of operations. However, we are exposed to
risks from third parties, both suppliers not delivering parts or services as
expected and customers delaying or not ordering from us and from interruptions
of internal systems. Additionally, we may experience unknown system
interruptions or have unplanned costs to correct unplanned problems. Any of
these risks may result in a situation, which may have a material adverse effect
on our business, financial condition or results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. To date, we have not engaged in derivative and
hedging activities. We will adopt SFAS No. 133 as required for our first
quarterly filing of 2000.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We Rely on Continued Market Acceptance of Our Products. We currently
market visible and infrared light semiconductor-based photocoagulator medical
laser systems to the ophthalmic market. We also market a visible light
semiconductor-based photocoagulator medical laser system to the dermatological
market. We believe that continued and increased sales, if any, of these medical
laser systems is dependent upon the following factors:
o Product performance, procedures and price;
o Opinions of medical advisors and associates;
o Recommendations by ophthalmologists, dermatologists, clinicians,
and their associated opinion leaders;
o Performance of these laser systems and treatments which are a
beneficial alternative to competing technologies and treatments;
o The willingness of opthalmologists and dermotologists to convert
to semiconductor-based or infrared laser systems from visible
argon gas or ion-based laser systems;
o The level of reimbursement for treatments administered with our
products; and
o Our ability to introduce new products into these markets.
Any significant decline in market acceptance of our products would have a
material adverse effect on our business, results of operations and financial
condition.
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<PAGE> 25
Our Market is Competitive. Competition in the market for devices used
for ophthalmic and dermatological 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
Coherent, Inc., Nidek, Inc. ("Nidek"), Carl Zeiss, Inc. ("Zeiss"), Alcon
International, Keeler Instruments, Inc. ("Keeler") and HGM Medical Laser
Systems, Inc. ("HGM") and our principal competitors in dermatology are
Laserscope and HGM. Some competitors have substantially greater financial,
engineering, product development, manufacturing, marketing and technical
resources than we do. In addition to other companies that manufacture
photocoagulators, we compete with pharmaceutical solutions, other technologies
and other surgical techniques. Other 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.
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 . Although our OcuLight Systems and our DioLite 532
been successfully introduced, we continue to face risks associated with
manufacturing these products. Various difficulties may occur despite testing.
Furthermore, we depend on third parties to manufacture substantially all of the
components used in our products and have in the past experienced delays in
manufacturing when a sole source supplier was unable to deliver components in
volume and on a timely basis. Such a problem may reoccur. See "--We Depend on
Key Manufacturers and Suppliers." As a result of these factors, we may not be
able to continue to manufacture our existing products or future products on a
cost-effective and timely basis.
We Depend on Key Manufacturers and Suppliers. We rely on third parties
to manufacture substantially all of the components used in our products,
although we assemble critical subassemblies and the final product at our
facility in Mountain View, California. There are risks associated with the use
of independent manufacturers, including unavailability of or delays in obtaining
adequate supplies of optics and laser diodes. We have qualified two or more
sources for most of the components used in our products. In the past, we
experienced delays in our manufacturing the OcuLight GL due to the inability of
a supplier to deliver components in volume and on a timely basis. We have
qualified a second source for this diode component. The process of qualifying
suppliers is ongoing and may be lengthy, particularly as new products are
introduced. We do not have long-term or volume purchase agreements with any of
our suppliers and currently purchase components on a purchase order basis. These
components may not be available in the quantities required, on reasonable terms,
or at all. Establishing our own capabilities to manufacture these components
would be expensive and could significantly decrease our profit margins. Our
business, results of operations and financial condition would be adversely
affected if we are unable to continue to obtain components as required at a
reasonable cost.
We Depend on International Sales. We derive and expect to continue to
derive, a large portion of our revenue from international sales. In 1998, 1997
and 1996, our international sales were $8.6 million, $9.4 million and $6.1
million, or 36.6%, 51.8%, and 49.6%, respectively, of total sales. Therefore, a
large portion of our revenues will continue to be subject to the risks
associated with international sales. Economic difficulties in Asia and the
devaluation of the currencies of many Asian countries in the past couple of
years has significantly increased the purchase price of our products to our
distributors in that region. Product sales were lower for the affected Asian
region during the fourth quarter of 1997 and 1998 as a result of the economic
downturn and currency problem. We expect lower sales from this Asian region to
continue into 1999. Each of the factors stated above could have a material
adverse effect on our ability to deliver products on a competitive and timely
basis.
Our Operating Results Fluctuate from Quarter to Quarter. Although we
have been profitable on an annual and quarterly basis for the last six years,
our sales and operating results have varied substantially on a quarterly
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<PAGE> 26
basis and may 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:
o The timing of the introduction and market acceptance of new
products, product enhancements and new applications;
o The cost and availability of components and subassemblies;
o Changes in our pricing and our competitors;
o Our long and highly variable sales cycle;
o Changes in customers' or potential customers' budgets; and
o Increased product development costs.
In addition to these factors, our quarterly results have been and are expected
to continue to be affected by seasonal factors.
Our expense levels are based, in part, on expected future sales. If
sales levels in a particular quarter do not meet expectations, we may be unable
to adjust operating expenses quickly enough to compensate for the shortfall of
sales, and our results of operations may be adversely affected. In addition, we
have historically made a significant portion of each 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. As a result of the above factors, sales for any future quarter are
not predictable with any significant degree of accuracy and operating results in
any period should not be considered indicative of the results to be expected for
any future period. There can be no assurance that we will remain profitable in
the future or that operating results will not vary significantly.
We Depend on Development of New Products and New Applications. Our
future success is dependent upon, among other factors, our ability to develop,
obtain regulatory approval, manufacture and market new products. 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 and general economic conditions affecting purchasing
patterns. Any failure in our ability to successfully develop and introduce new
products or enhanced versions of existing products could have a material adverse
effect on our business, operating results and financial condition. We are
seeking to expand the market for our existing and new products by working with
clinicians and third parties to identify new applications and procedures for our
products. Failure to develop and achieve market acceptance of new applications
or new products would have a material adverse effect on our business, results of
operations and financial condition.
We Must Manage Growth. We have experienced, and may continue to
experience growth in production, the number of employees, the scope of our
business, our operating and financial systems and the geographic area of our
operations. This growth has resulted in new and increased responsibilities for
management personnel and our operating, inventory and financial systems. To
effectively manage future growth, if any, we have been required to continue to
implement and improve operational, financial and management information systems,
procedures and controls. We have implemented a new enterprise-wide management
information system. We must also expand, train, motivate and manage our work
force. Our personnel, systems, procedures and controls may not be adequate to
support our existing and future operations. Any failure to implement and improve
our operational, financial and
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<PAGE> 27
management systems or to expand, train, motivate or manage employees could have
a material adverse effect on our business, results of operations and financial
condition.
We Depend on Collaborative Relationships. We have entered into
collaborative relationships with academic medical centers and physicians in
connection with the research and development and clinical testing of our
products. We plan to collaborate with third parties to develop and commercialize
existing and new products. In May 1996, we executed an agreement with Miravant,
formerly known as PDT, Inc., a maker of photodynamic drugs to collaborate on a
device that emits a laser beam to activate a photodynamic drug developed by
Miravant for the treatment of wet AMD. The development of this new photodynamic
system will require approximately two years and significant financial and other
resources. This collaborative development effort may not continue or it may not
result in the successful development and introduction of a photodynamic system
and the amount and timing of resources to be devoted to these activities are not
within our control. 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.
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 Proprietary Rights. 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 six United States patents on the
technologies related to our products and processes. Our patent applications may
not issue as patents, any patents now or in the future may not offer any degree
of protection, or our patents or patent applications may be challenged,
invalidated or circumvented in the future. 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. Because patent applications are
maintained in secrecy in the United States until patents are issued and are
maintained in secrecy for a period of time outside the United States, we have
not conducted any searches to determine whether our technology infringes any
patents or patent applications. 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. This may adversely impact
our operating results.
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Any claims, with or without merit, could be time-consuming, result in
costly litigation and diversion of technical and management personnel, cause
shipment delays or require us to develop noninfringing technology or to enter
into royalty or licensing agreements. Although patent and intellectual property
disputes in the medical device area have often been settled through licensing or
similar arrangements, costs associated with such arrangements may be substantial
and could include ongoing royalties. An adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
us from manufacturing and selling our products, which would have a material
adverse effect on our business, results of operations and financial condition.
Conversely, litigation may be necessary to enforce patents issued to us, to
protect trade secrets or know-how owned by us or to determine the
enforceability, scope and validity of the proprietary rights of others. Both the
defense and prosecution of intellectual property suits or interference
proceedings are costly and time consuming.
We Are Subject To Government Regulation. The medical devices that we
market and manufacture are subject to extensive regulation by the FDA and by
foreign and state governments. Under the FDA 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 manufacturer must obtain market
clearance through either the 510(k) premarket notification process or the
lengthier premarket approval ("PMA") application process. Obtaining these
approvals can take a long time and delay the introduction of a product. For
example, the introduction of the OcuLight GL in the United States was delayed
about three months from our expectations due to the longer than expected time
period required to obtain FDA premarket clearance. Noncompliance with applicable
requirements, including Quality System Regulations ("QSR"), can result in, among
other things, fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, failure of the government
to grant premarket clearance or premarket approval for devices, withdrawal of
marketing approvals, and criminal prosecution. The FDA also has the authority to
request repair, replacement or refund of the cost of any device we manufacture
or distribute. 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.
International regulatory bodies often establish 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 to the European Medical Device Directive and
all applicable standards. In July 1998 we received CE registration under Annex
II guidelines, the most stringent path to CE registration. With Annex II CE
registration, IRIDEX Corporation has demonstrated its ability to both understand
and comply with all applicable European standards. This allows us to register
any product upon our internal verification of compliance to all applicable
European Standards. Currently all 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.
We Face Product Liability Risks. We may be subject to product liability
claims in the future. Our products are highly complex and are used to treat
extremely delicate eye tissue and skin conditions on and near a patient's face.
In addition, although we recommend that our disposable products only be used
once and so prominently labels these disposables, we believe that certain
customers may nevertheless reuse these disposable products. Accordingly, the
manufacture and sale of medical products entails significant risk of product
liability claims. Although we maintain product liability insurance with coverage
limits of $6.0 million per occurrence and an annual aggregate maximum of $7.0
million, our coverage from our insurance policies may not be adequate. Such
insurance is expensive and in the future may not be available on acceptable
terms, if at all. A successful claim brought against us in excess of our
insurance coverage could have a material adverse effect on our business, results
of operations and financial condition. To date, we have not experienced any
product liability claims.
Our Stock Price is Volatile. The trading price of our Common Stock has
been subject to wide fluctuations in response to a variety of factors since our
initial public offering in February 1996. Volatility in price and volume has had
a substantial effect on the market prices of many technology companies for
reasons unrelated or disproportionate to the operating performance of such
companies. These broad market fluctuations could have a significant impact on
the market price of our Common Stock.
We Face Risks of the Year 2000 Issue. We are assessing our Year 2000
risk exposure and plan to implement remedial and corrective action where
necessary. We have reviewed all of our major internal systems, including
financial, business, administrative and manufacturing systems, to assess Year
2000 readiness and to identify critical systems that require correction or
remediation. Based on the results of this assessment, we have installed a new
ERP system and upgraded our phone system software to be fully Year 2000
compliant. Our
-26-
<PAGE> 29
products that we sell to our customers, do not contain any internal embedded
calendars in them and therefore we do not anticipate any problems related to the
Year 2000 issue to develop with our products.
Also, we may be exposed to risks from systems of parties with whom we
transact material business. We are working with critical suppliers of products
and services to assess their Year 2000 readiness with respect both to their
operations and the products and services they supply to us. We depend
significantly on revenue from sales of our products placed from customers from
other countries. We do not know the extent that Year 2000 problems will affect
current and potential customers, whether international or domestic customers. A
disruption in their business may cause a delay in or cancellation of orders that
may adversely affect our business, financial condition or results of operations.
Based on currently available information, management does not believe
that the Year 2000 issues discussed above related to internal systems or
products sold to customers will have a material adverse impact on our financial
condition or overall trends in results of operations. However, we are exposed to
risks from third parties, both suppliers not delivering parts or services as
expected and customers delaying or not ordering from us and from interruptions
of internal systems. Additionally, we may experience unknown system
interruptions or have unplanned costs to correct unplanned problems. Any of
these risks may result in a situation, which may have a material adverse effect
on our business, financial condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio and generally conduct all transactions
in U.S. dollars. Our investment portfolio only includes highly liquid
instruments with an original maturity of less than one year. We have no
long-term debt obligations at January 2, 1999.
We are subject to fluctuating interest rates that may impact, adversely
or otherwise, our results of operations or cash flows for our available-for-sale
securities and cash and cash equivalents.
The table below presents principal amounts and related weighted average
interest rates as of January 2, 1999 (in thousands) for our investment portfolio
and cash and cash equivalents. All amounts mature in fiscal year 1999.
<TABLE>
<CAPTION>
<S> <C>
Assets
Cash and cash equivalents.................... $5,791
Average interest rate........................ 4.05%
Available-for-sale securities................ $5,085
Average interest rate........................ 4.89%
</TABLE>
The estimated fair value of our cash and cash equivalents approximates
the principal amounts reflected above based on the short maturities of these
financial instruments.
Although payments under the operating lease for our facility are tied to
market indices, we are not exposed to material interest rate risk associated
with the operating lease.
-27-
<PAGE> 30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated balance sheets as of January 2, 1999 and December 31,
1997 and the consolidated statements of income, comprehensive income,
stockholders' equity and cash flows for each of the three years in the period
ended January 2, 1999, together with the related notes and the report of
PricewaterhouseCoopers LLP, independent accountants, are on the following pages.
Additional required financial information is described in Item 14.
-28-
<PAGE> 31
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of IRIDEX Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, comprehensive income,
stockholders' equity, and of cash flows present fairly, in all material
respects, the financial position of IRIDEX Corporation and subsidiaries at
January 2, 1999 and December 31, 1997 and the results of their operations and
their cash flows for each of the three years in the period ended January 2,
1999, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
San Jose, California
January 22, 1999
-29-
<PAGE> 32
IRIDEX CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JANUARY 2, DECEMBER 31,
ASSETS 1999 1997
------ ------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................ $ 5,791 $ 9,900
Available-for-sale securities ........................ 5,085 3,588
Accounts receivable, net of allowance for doubtful
accounts of $327 in 1998 and $305 in 1997 .......... 7,608 6,057
Inventories .......................................... 6,504 3,976
Prepaids and other current assets .................... 347 451
Deferred income taxes ................................ 607 550
------- --------
Total current assets ............................ 25,942 24,522
Property and equipment, net ............................. 2,274 2,133
Intangible assets ....................................... 96 --
Deferred income taxes ................................... 65 31
------- --------
Total assets .................................... $28,377 $ 26,686
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................... $ 879 $ 752
Accrued expenses ..................................... 1,613 2,051
Capital lease obligations ............................ -- 3
------- --------
Total liabilities ............................... 2,492 2,806
------- --------
Commitments (Note 5)
Stockholders' Equity:
Convertible Preferred Stock, $.01 par value:
Authorized: 2,000,000 shares;
Issued and outstanding: none ................... -- --
Common Stock, $.01 par value:
Authorized: 30,000,000 shares;
Issued and outstanding: 6,506,010 shares in
1998 and 6,455,483 shares in 1997 ............. 65 65
Additional paid-in capital ........................... 21,800 21,552
Accumulated other comprehensive income (loss) ........ 7 (2)
Retained earnings .................................... 4,013 2,265
------- --------
Total stockholders' equity ...................... 25,885 23,880
------- --------
Total liabilities and stockholders' equity $28,377 $ 26,686
======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-30-
<PAGE> 33
IRIDEX CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY, 2, YEAR ENDED DECEMBER 31,
1999 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Sales ................................................. $ 23,585 $ 18,073 $ 12,364
Cost of sales ......................................... 10,308 7,612 4,899
-------- -------- --------
Gross profit ........................... 13,277 10,461 7,465
-------- -------- --------
Operating expenses:
Research and development ........................... 3,099 1,716 1,286
Sales, general and administrative .................. 8,358 6,074 5,197
-------- -------- --------
Total operating expenses ............... 11,457 7,790 6,483
-------- -------- --------
Income from operations ................. 1,820 2,671 982
Interest income ....................................... 483 623 691
Other income (expense), net ........................... 28 (16) 8
-------- -------- --------
Income before provision for income taxes 2,331 3,278 1,681
Provision for income taxes ............................ (583) (1,180) (676)
-------- -------- --------
Net income ............................................ $ 1,748 $ 2,098 $ 1,005
======== ======== ========
Net income per common share ........................... $ 0.27 $ 0.33 $ 0.18
======== ======== ========
Shares used in income per common share calculation .... 6,480 6,406 5,725
======== ======== ========
Diluted net income per common share ................... $ 0.26 $ 0.31 $ 0.16
======== ======== ========
Shares used in diluted income per common share
calculation ...................................... 6,765 6,755 6,410
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-31-
<PAGE> 34
IRIDEX CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
-------------------- -------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- ------ --------- ------- --------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995 ......... 1,891,663 $ 19 1,505,424 $15 $ 5,489
Issuance of Common Stock,
net of issuance costs ....... 1,982,500 20 15,639
Issuance of Common Stock
under Stock Option Plan ..... 9,096 9
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 15,665 120
Conversion of Preferred
Stock ....................... (1,891,663) (19) 2,837,495 28 (9)
Net Income .......................
--------- ------ --------- ------- --------
Balances, December 31, 1996 ......... -- -- 6,350,180 63 21,248
Issuance of Common Stock
under Stock Option Plan ..... 65,896 1 59
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 39,407 1 245
Unrealized losses on available-
for-sale securities .........
Net income .......................
--------- ------ --------- ------- --------
Balances, December 31, 1997 ......... 6,455,483 65 21,552
Issuance of Common Stock
under Stock Option Plan ..... 9,086 38
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 41,441 204
Tax benefit of employee stock
transactions ................ 6
Change in unrealized gains on
available-for-sale securities
Net income .......................
--------- ------ --------- ------- --------
Balances, January 2, 1999 ........... -- $-- 6,506,010 $ 65 $ 21,800
========= ====== ========= ======= ========
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER RETAINED
COMPREHENSIVE EARNINGS
INCOME (LOSS) (DEFICIT) TOTAL
------------- -------- --------
<S> <C> <C>
Balances, December 31, 1995 ......... -- $ (838) $ 4,685
Issuance of Common Stock,
net of issuance costs ....... -- -- 15,659
Issuance of Common Stock
under Stock Option Plan ..... 9
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 120
Conversion of Preferred
Stock ....................... --
Net Income ....................... 1,005 1,005
------------- -------- --------
Balances, December 31, 1996 ......... -- 167 21,478
Issuance of Common Stock
under Stock Option Plan ..... 60
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 246
Unrealized losses on available-
for-sale securities ......... $ (2) (2)
Net income ....................... 2,098 2,098
------------- -------- --------
Balances, December 31, 1997 ......... (2) 2,265 23,880
Issuance of Common Stock
under Stock Option Plan ..... 38
Issuance of Common Stock
under Employee Stock
Purchase Plan ............... 204
Tax benefit of employee stock
transactions ................ 6
Change in unrealized gains on
available-for-sale securities 9 -- 9
Net income ....................... 1,748 1,748
------------- -------- --------
Balances, January 2, 1999 ........... $ 7 $ 4,013 $ 25,885
============= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-32-
<PAGE> 35
IRIDEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 2, YEAR ENDED DECEMBER 31,
1999 1997 1996
------- ------ ------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income.................................................. $1,748 $2,098 $1,005
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization.......................... 653 357 238
Provision for doubtful accounts........................ 22 65 (118)
Changes in operating assets and liabilities:
Accounts receivable............................. (1,573) (732) (2,794)
Inventories..................................... (2,528) (2,117) (603)
Prepaids and other current assets............... 104 (329) 163
Deferred income taxes........................... (91) (14) 328
Accounts payable................................ 127 217 242
Accrued expenses................................ (438) 367 283
------ ------ ------
Net cash used in operating activities........... (1,976) (88) (1,256)
------ ------ ------
Cash flows from investing activities:
Purchases of available-for-sale securities.................. (7,675) (6,364) (61,305)
Proceeds from sale and maturity of available-for-sale
securities ............................................... 6,187 3,783 60,298
Acquisition of property and equipment....................... (794) (1,837) (639)
Acquisition of intangible assets............................ (96) -- --
------ ------ ------
Net cash used in investing activities........... (2,378) (4,418) (1,646)
------ ------ ------
Cash flows from financing activities:
Payments of capital lease obligations....................... (3) (7) (6)
Issuance of Common Stock, net............................... 248 306 15,788
------ ------ ------
Net cash provided by financing activities....... 245 299 15,782
------ ------ ------
Net (decrease) increase in cash and
cash equivalents ..................... (4,109) (4,207) 12,880
Cash and cash equivalents, beginning of year................... 9,900 14,107 1,227
------ ------ ------
Cash and cash equivalents, end of year......................... $5,791 $9,900 $14,107
====== ====== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Income taxes........................................... $575 $671 $24
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Change in unrealized gains (losses) on
available-for-sale securities ....................... $9 $(2) $--
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-33-
<PAGE> 36
IRIDEX CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY, 2, YEAR ENDED DECEMBER 31,
1999 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net income ............................................ $ 1,748 $ 2,098 $ 1,005
Other comprehensive income:
Changes in unrealized gain (loss) on
available-for-sale securities .................... 9 (2) --
-------- -------- --------
Comprehensive income .................................. $ 1,757 $ 2,096 $ 1,005
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-34-
<PAGE> 37
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS OF THE COMPANY
Description of Business
IRIDEX Corporation is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. We market our products using three brand names:
IRIS Medical to the ophthalmology market, IRIDERM to the dermatology market, and
Light Solutions to the research market. The terms "Company," "IRIDEX," "we,"
"us" and "our" refer to IRIDEX Corporation, a Delaware corporation, and, when
the context so requires, our wholly-owned subsidiaries, IRIS Medical
Instruments, Inc. and Light Solutions Corporation, both California corporations
and IRIDEX Foreign Sales Corporation, a Barbados corporation, and our
dermatology division IRIDERM.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation
The consolidated financial statements include our accounts and our
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Cash and Cash Equivalents
We consider all highly liquid investments with original maturities of 90
days or less at the time of purchase to be cash equivalents.
Available-for-Sale Securities
All marketable securities as of January 2, 1999 are considered to be
available-for-sale and therefore are carried at fair value. Available-for-sale
securities are classified as current assets when they have scheduled maturities
of less than one year. Available-for-sale securities are classified as non
current assets when they have scheduled maturities of more than one year.
Unrealized holding gains and losses on such securities are reported net of
related taxes as a separate component of stockholders' equity until realized.
Realized gains and losses on sales of all such securities are reported in
interest and other income and are computed using the specific identification
cost method.
Intangible Assets
Intangible assets include patents that are being amortized on a
straight-line basis over seven years. We periodically assess the recoverability
of intangible assets by determining whether amortization of the asset balance
over the remaining life can be recovered through undiscounted future operating
cash flows of the acquired operation. The amount of impairment, if any, is
measured based on projected discounted future operating cash flows and is
recognized as a write down of the asset to net realizable value.
Inventories
Inventories are stated at the lower of cost or market. 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.
-35-
<PAGE> 38
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally three years.
Amortization of leasehold improvements and property and equipment acquired under
capital lease obligations is computed using the straight-line method over the
shorter of the remaining lease term or the estimated useful life of the related
assets, typically three years.
Revenue Recognition
We recognize product sales when product is shipped to the customer, when
acceptance terms, if any, are fulfilled and when contractual obligations are
completed. We accrue for warranty costs and sales returns at the time of
shipment based on our experience.
Research and Development
Research and development expenditures are charged to operations as
incurred.
Advertising
We expense advertising costs as they are incurred. Advertising expenses
for 1998, 1997 and 1996 were $317,000, $170,000 and $175,000, respectively.
Fair Value of Financial Instruments
Carrying amounts of our financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities
approximate fair values due to their short maturities. Estimated fair values for
available-for-sale securities, which are separately disclosed elsewhere, are
based on quoted market prices for the same or similar instruments.
Income Taxes
Income taxes are accounted for under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under SFAS No. 109,
deferred assets and liabilities are recognized for the future consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Valuation allowances are established when necessary to
reduce deferred tax assets to the amounts expected to be realized.
Concentration of Credit Risk and Other Risks and Uncertainties
Our cash and cash equivalents are deposited in demand and money market
accounts of three financial institutions. Deposits held with banks may exceed
the amount of insurance provided on such deposits. Generally these deposits may
be redeemed upon demand and therefore, bear minimal risk.
-36-
<PAGE> 39
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We market our products to distributors and end-users throughout the
world. Sales to international distributors are generally made on open credit
terms and letter of credit. We also offer extended payment terms on selected
sales transactions. Management performs ongoing credit evaluations of our
customers and maintains an allowance for potential credit losses. Historically
we have not experienced any significant losses related to individual customers
or group of customers in any particular geographic area. As of January 2, 1999,
no customers accounted for greater than 10% of accounts receivable.
Our products require approvals from the Food and Drug Administration and
international regulatory agencies prior to commercialized sales. Our future
products may not receive required approvals. If we were denied such approvals of
such approvals were delayed, it would have a materially adverse impact on our
business, results of operations and financial condition.
Use of Estimates
Management makes estimates and assumptions to prepare the financial
statements in conformity with generally accepted accounting principles. These
estimates and assumptions affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fiscal Year
On June 8, 1998, the Board of Directors approved a resolution to adjust
our fiscal year end from December 31 to the 52 or 53-week period that ends the
Saturday nearest December 31, effective for fiscal year 1998. Fiscal year 1998
was a 52-week year.
Computation of Net Income Per Common Share and Per Diluted Common Share
Effective December 31, 1997, we adopted SFAS No. 128 "Earnings Per
Share" and the provisions of the Securities and Exchange Commission Staff
Accounting Bulletin No. 98, and accordingly all prior periods have been
restated. Net income per common share is computed using the weighted average
number of shares of common stock outstanding. Diluted net income per common
share is computed using the weighted average number of dilutive shares of common
stock and common equivalent shares from stock options and preferred stock
outstanding. We have determined that no incremental shares should be included in
the computation of earnings per share and in accordance with Staff Accounting
Bulletin No. 98.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. To date, we have not engaged in derivative and
hedging activities. We will adopt SFAS No. 133 as required for our first
quarterly filing of 2000.
-37-
<PAGE> 40
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications
Certain amounts in the financial statements have been reclassified to
conform with the current year's presentation. The reclassification had no impact
on previously reported income from operations or net income.
3. BALANCE SHEET DETAIL
Available-for-sale securities (in thousands):
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED ESTIMATED MATURITY
COST GAINS (LOSSES) FAIR VALUE DATES
--------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
As of January 2, 1999, available-for-sale securities consisted of the following:
Obligations of state and local
government agencies............. 5,078 7 5,085 2/99 - 6/99
As of December 31, 1997, available-for-sale securities consisted of the following:
Obligations of state and local
government agencies............. 3,590 (2) 3,588 1/98 - 6/98
</TABLE>
There were no realized capital gains or losses recognized in 1998, 1997 and
1996.
-38-
<PAGE> 41
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
JANUARY 2, DECEMBER 31,
--------- ------------
1999 1997
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Raw materials and work in process................................ $3,877 $2,580
Finished goods................................................... 2,627 1,396
------ ------
Total inventories......................................... $6,504 $3,976
====== ======
</TABLE>
<TABLE>
<CAPTION>
1999 1997
------- -----
(IN THOUSANDS)
<S> <C> <C>
Property and Equipment:
Equipment........................................................ $2,157 $1,466
Leasehold improvements........................................... 1,700 1,597
Less accumulated depreciation and amortization................... (1,583) (930)
------ ------
Property and equipment, net............................... $2,274 $2,133
====== ======
</TABLE>
<TABLE>
<CAPTION>
1999 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Accrued Expenses:
Accrued payroll, vacation and related expenses................... $655 $787
Distributor commissions.......................................... 37 141
Accrued warranty................................................. 200 114
Income taxes payable............................................. 14 567
Other accrued expenses........................................... 707 442
------ ------
Total accrued expenses.................................... $1,613 $2,051
====== ======
</TABLE>
4. BANK BORROWINGS
We have a revolving line of credit agreement with a bank expiring on
September 30, 1999, which provides for borrowings of up to $1,000,000 at the
bank's prime rate (7.75% at January 2, 1999). The agreement contains restrictive
covenants including prohibiting payment of dividends without the bank's prior
consent. There were no borrowings against the credit line at January 2, 1999.
5. COMMITMENTS
Lease Agreements
We lease our operating facilities under a noncancelable operating lease.
The lease expires in 2002 and contains a renewal option. Rent expense, net of
sublease income, totaled $331,000, $224,000 and $108,000 for the years ended
January 2, 1999, December 31, 1997 and 1996, respectively. Rental income related
to a facility sublease was $182,000, $48,000 and $7,000 for the years ended
January 2, 1999, December 31, 1997 and 1996, respectively.
-39-
<PAGE> 42
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum lease payments under current operating leases at January
2, 1999 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- ------
<S> <C>
1999 509
2000 531
2001 554
2002 93
------
$1,687
======
</TABLE>
License Agreements
The Company is obligated to pay royalties equivalent to 4% and 5% of
sales on certain products under certain license agreements. Royalty expense was
$125,000, $58,900 and $37,000 for the years ended January 2, 1999, December 31,
1997 and 1996, respectively.
6. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
During 1996, we amended our Articles of Incorporation to authorize
2,000,000 shares of undesignated preferred stock. Preferred Stock may be issued
from time to time in one or more series. As of January 2, 1999, we had no
preferred stock issued and outstanding.
TREASURY STOCK
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. We have not repurchased any Common Stock as of January
2, 1999.
STOCK OPTION PLANS
Amended and Restated 1989 Incentive Stock Plan
The Amended and Restated 1989 Plan (the "1989 Plan") provides for the
granting to employees (including officers and employee directors) of incentive
stock options and for the granting to employees (including officers and employee
directors) and consultants of nonstatutory stock options and stock purchase
rights ("SPRs"). The exercise price of incentive stock options and SPRs granted
under the 1989 Plan must be at least equal to the fair market value of the
shares at the time of grant. With respect to any recipient who owns stock
possessing more than 10% of the voting power of our outstanding capital stock,
the exercise price of any option or SPR granted must be at least equal to 110%
of the fair market value at the time of grant. Options granted under the 1989
Plan are exercisable at such times and under such conditions as determined by
the Administrator; generally over a four year period. The maximum term of
incentive stock options granted to any recipient must not exceed ten years;
provided, however, that the maximum term of an incentive stock option granted to
any recipient possessing more than 10% of the voting power of our outstanding
capital stock must not exceed five years. In the case of SPRs, unless the
Administrator determines otherwise, we have
-40-
<PAGE> 43
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
a repurchase option exercisable upon the voluntary or involuntary termination of
the purchaser's employment with us for any reason (including death or
disability). Such repurchase option lapses at a rate determined by the
Administrator. The purchase price for shares repurchased by us is the original
price paid by the purchaser and may be paid by cancellation of any indebtedness
of the purchaser to us. The 1989 Plan expires in August 1999.
1998 Stock Plan
The 1998 Stock Plan (the "1998 Plan") provides for the grant of options
and stock purchase rights to purchase shares of our Common Stock to employees
and consultants. A total of 250,000 shares of Common Stock are reserved for
issuance under the 1998 Plan. The stockholders approved the 1998 Plan in June
1998. The terms of the 1998 Plan are substantially the same as the 1989 Plan.
The 1998 Plan expires in June 2008.
1995 Director Option Plan
In October 1995, we adopted the 1995 Director Option Plan (the "Director
Plan"), under which members of the Board of Directors are granted options to
purchase 11,250 shares upon the first to occur of their appointment or the
adoption of the Director Plan ("First Option") and an option to purchase 3,750
shares ("Subsequent Option") on July 1 of each year thereafter provided that he
or she has served on the Board for at least the preceding six months. The
options granted are at fair market value on the date of grant. The First Option
becomes exercisable as to one-twelfth (1/12) of the shares subject to the First
Option for each quarter over a three-year period. Each Subsequent Option becomes
exercisable as to one-fourth (1/4) of the shares subject to the Subsequent
Option for each quarter, commencing one quarter after the First Option and any
previously granted Subsequent Options have become fully exercisable. Options
granted under the Director Plan have a term of 10 years.
In the event of our merger with or into another corporation, resulting
in a change of control, or the sale of substantially all of our assets, each
Director Plan option becomes exercisable in full and shall be exercisable for 30
days after written notice to the holder of the event causing the change in
control.
Unless terminated sooner, the Director Plan will terminate in 2005. The
Board has authority to amend or terminate the Director Plan, provided no such
amendment may impair the rights of any optionee without the optionee's consent.
Information with respect to activity under these option plans are set
forth below (in thousands except share and per share data):
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
SHARES -----------------------------------------------
AVAILABLE NUMBER AGGREGATE WEIGHTED AVG
FOR GRANT OF SHARES PRICE EXERCISE PRICE
--------- --------- --------- --------------
<S> <C> <C> <C> <C>
Balances, January 1, 1996............ 313,340 466,998 $509 $1.09
Options granted.............. (275,850) 275,850 2,127 $7.71
Options exercised............ (9,096) (9) $99
Options terminated........... 100,508 (100,508) (421) $4.19
------- --------- -----
Balances, December 31, 1996.......... 137,998 633,244 $2,206 $3.48
Additional shares reserved... 500,000 -- -- --
Options granted.............. (437,775) 437,775 2,922 $6.68
Options exercised............ (65,896) (60) $.91
</TABLE>
-41-
<PAGE> 44
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
SHARES ---------------------------------------------------
AVAILABLE NUMBER AGGREGATE WEIGHTED AVG
FOR GRANT OF SHARES PRICE EXERCISE PRICE
--------- --------- --------- --------------
<S> <C> <C> <C> <C>
Options terminated 43,336 (43,336) (208) $ 4.80
-------- --------- -------
Balances, December 31, 1997 243,559 961,787 $ 4,860 $ 5.05
Additional shares reserved 310,000 -- -- --
Options granted (936,889) 936,889 4,628 $ 4.94
Options exercised (9,101) (38) $ 4.18
Options terminated 572,074 (572,074) (4,031) $ 7.05
-------- ---------- -------
Balances, January 2, 1999 188,744 1,317,501 $ 5,419 $ 4.11
======== ========== =======
</TABLE>
In December 1998, we offered non-executive officer employees the right
to cancel certain outstanding Stock Options and receive new options with an
exercise price of $4.00 per share, the closing price of the common stock on the
date individual employees agreed to cancel their original outstanding stock
options. Options to purchase a total of 548,000 shares at original exercise
prices ranging from $5.00 to $14.75 per share were canceled and new options were
issued in December 1998. Under the terms of this offer new options are subject
to new vesting terms from the date of issuance.
The following table summarizes information with respect to stock options
outstanding at January 2, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE
CONTRACTUAL LIFE
RANGE OF EXERCISE PRICES AT 1/2/99 (YEARS) PRICE AT 1/2/99 PRICE
------------------------ ----------- ------------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$0.16 - $ 0.16 50,797 1.89 $0.16 50,797 $0.16
$1.00 - $ 1.00 179,654 5.68 $1.00 170,501 $1.00
$2.00 - $ 2.00 98,750 6.79 $2.00 79,668 $2.00
$3.93 - $ 7.62 857,300 8.67 $4.45 70,474 $6.06
$8.00 - $14.88 131,000 7.77 $9.49 21,606 $8.92
--------- -------
$0.16 - $14.88 1,317,501 7.77 $4.13 393,046 $2.43
========= =======
</TABLE>
At December 31, 1997 and 1996, options to purchase 961,787 and 245,284
shares of Common Stock were exercisable at weighted average exercise prices of
$2.49 and $0.86, respectively.
The following information concerning our stock option and employee stock
purchase plans is provided in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation." We account for such plans in accordance with
Accounting Principles Board No. 25 and related Interpretations.
-42-
<PAGE> 45
The fair value of each option grant has been estimated on the date of
grant using the Black-Scholes multiple option pricing model with the following
weighted average assumptions used grants in 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- --------------------------- ---------------------------
GROUP A GROUP B GROUP A GROUP B GROUP A GROUP B
------- ------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Risk-free Interest
Rates 4.82% 4.79% 5.84%-6.72% 5.69%-6.72% 5.76%-6.70% 5.06%-6.64%
Expected Life from
Date of Vesting 3 yrs. 2 yrs. 3 yrs. 2 yrs. 3 yrs. 2 yrs.
Volatility 0.78 0.78 0.62 0.62 0.00-0.62 0.00-0.62
Dividend Yield -- -- -- -- -- --
</TABLE>
The weighted average expected life was calculated based on the exercise
behavior of each group. Group A represents officers and directors who are a
smaller group holding a greater average number of options than other option
holders and who tend to exercise later in the vesting period. Group B are all
other option holders, virtually all of whom are employees. This group tends to
exercise earlier in the vesting period.
The weighted average fair value per share of those options granted in
1998, 1997 and 1996 was $3.12, $3.85 and $4.42, respectively.
We have also estimated the fair value for the purchase rights issued
under our 1995 Employee Stock Purchase Plan, under the Black-Scholes valuation
model using the following assumptions for 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk-free Interest Rates 5.61% 5.09% 5.37%
Expected Life 0.5 year 0.5 year 0.5 year
Volatility 0.78 0.62 0.62
Dividend Yield -- -- --
</TABLE>
The weighted average fair value per share of those purchase rights
granted in 1998, 1997 and 1996 was $3.33, $2.27 and $3.08, respectively.
The following proforma income information has been prepared following
the provisions of SFAS No. 123:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
(amounts in thousands except per share data)
1998 1997 1996
------ --------- ------
<S> <C> <C> <C>
Net income-- as reported $1,748 $ 2,098 $1,005
Net income-- proforma $ 815 $ 1,564 $ 886
Net income per common share-- as
reported $ 0.27 $ 0.33 $ 0.18
Net income per common share--
proforma $ 0.13 $ 0.24 $ 0.17
Net income per common share--
assuming dilution-as reported $ 0.26 $ 0.31 $ 0.16
Net income per common share--
assuming dilution-proforma $ 0.12 $ 0.23 $ 0.14
</TABLE>
The above proforma effects on income may not be representative of the
effects on net income for future years as option grants typically vest over
several years and additional options are generally granted each year.
-43-
<PAGE> 46
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1995 Employee Stock Purchase Plan
Our 1995 Employee Stock Purchase Plan (the "Purchase Plan") was adopted
by the Board of Directors in October 1995. On April 28, 1997, the shareholders
approved an amendment to increase the total number of shares of common stock for
issuance under the Purchase Plan from 50,000 to 100,000. The Purchase Plan
permits eligible employees (including officers and employee directors) to
purchase Common Stock through payroll deductions, which may not exceed 10% of an
employee's compensation. No employee may purchase more than $25,000 worth of
stock in any calendar year or more than 1,000 shares of Common Stock in any
twelve-month period. The price of shares purchased under the Purchase Plan is
85% of the lower of the fair market value of the Common Stock at the beginning
of the offering period or the end of the offering period. The Purchase Plan will
terminate in 2005, unless terminated sooner by the Board of Directors.
7. EMPLOYEE BENEFIT PLAN
We have a plan known as the IRIS Medical Instruments 401(k) trust to
provide retirement benefits through the deferred salary deductions for
substantially all employees. Employees may contribute up to 15% of their annual
compensation to the plan, limited to a maximum amount set by the Internal
Revenue Service. The plan also provides for Company contributions at the
discretion of the Board of Directors. No Company contributions have been made to
the plan since inception.
8. INCOME TAXES
The provision for income taxes includes:
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 2, YEAR ENDED DECEMBER 31,
---------- -----------------------
1999 1997 1996
---- ------ ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal............................................... $425 $1,010 $247
State................................................. 67 234 101
Deferred:
Federal............................................... 105 (95) 258
State................................................. (14) 31 70
---- ------ ----
Income tax provision.............................. $583 $1,180 $676
==== ====== ====
</TABLE>
The Company's effective tax rate differs from the statutory federal
income tax rate as shown in the following schedule:
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 2, DECEMBER 31,
---------- --------------------
1999 1997 1996
---- ---- ----
<S> <C> <C> <C>
Income tax provision at statutory rate..................... 34% 34% 34%
State income taxes, net of federal benefit................. 3% 6% 6%
Tax Exempt Interest........................................ (5%) (2%) --
Research and Experimental Credits.......................... (5%) (2%) --
</TABLE>
-44-
<PAGE> 47
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 2, DECEMBER 31,
---------- --------------------
1999 1997 1996
---- ---- ----
<S> <C> <C> <C>
Other...................................................... (2%) -- --
---- ---- ----
Effective tax rate......................................... 25% 36% 40%
==== ==== ====
</TABLE>
The tax effect of temporary differences and carry-forwards that give
rise to significant portions of the deferred tax assets are presented below (in
thousands):
<TABLE>
<CAPTION>
JANUARY 2, DECEMBER 31,
---------- ------------
1999 1997
---- ----
<S> <C> <C>
Depreciation ....................................... $ 67 $ 7
Accrued liabilities ................................ 255 131
Allowance for excess and obsolete inventories ...... 70 164
State tax .......................................... 12 68
Allowance for Doubtful Accounts .................... 115 121
Other .............................................. 153 90
---- ----
Net deferred tax asset ............................. $672 $581
==== ====
</TABLE>
9. MAJOR CUSTOMERS AND BUSINESS SEGMENTS
In 1998, we adopted SFAS No. 131, "Disclosures abut Segments of an
Enterprise and Related Information." We concluded that we operate in two
reportable segments: the laser medical device segment and the laser research
segment. In the laser medical device segment, we develop, manufacture and market
medical devices for the ophthalmology and dermatology markets. Our revenues
arise from the sale of consoles, delivery devices, disposables and service and
support activities. In the research segment we conduct research and development
under research grants from the U.S. Federal Government and others. Under the
terms of these grants we typically retain the right to commercially market the
technology developed. The laser research segment did not meet the quantitative
requirements for a reportable segment as defined in SFAS No. 131 and has been
aggregated accordingly.
In the years ended January 2, 1999, December 31, 1997 and 1996, no
customer individually accounted for more than 10% of our revenue.
Revenue information shown in thousands by geographic region is as
follows:
<TABLE>
<CAPTION>
JANUARY 2, YEAR ENDED DECEMBER 31,
---------- -----------------------
1999 1997 1996
------- ------- -------
<S> <C> <C> <C>
United States ..................... $14,958 $ 8,709 $ 6,236
Europe ............................ 4,503 3,690 3,073
Rest of Americas .................. 1,552 1,706 812
Asia/Pacific Rim .................. 2,572 3,968 2,243
------- ------- -------
$23,585 $18,073 $12,364
======= ======= =======
Revenues are attributable to countries based on location of customers.
</TABLE>
-45-
<PAGE> 48
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the years ended January 2, 1999, December 31, 1997 and 1996, no
country individually accounted for more than 10% of our sales, except for the
United States, which accounted for 64.5% of sales in 1998, 49.1% in 1997 and
51.4% in 1996.
10. COMPUTATION OF NET INCOME PER COMMON SHARE AND PER DILUTED COMMON SHARE
A reconciliation of the numerator and denominator of net income per
common share and diluted net income per common share is provided as follows
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 2, YEAR ENDED DECEMBER 31,
---------- -----------------------
1999 1997 1996
------ ------ ------
<S> <C> <C> <C>
Numerator -- Net income per common share and per diluted
common share
Net income ................................................... $1,748 $2,098 $1,005
====== ====== ======
Denominator -- Net income per common share
Weighted average common stock outstanding ............... 6,480 6,406 5,725
====== ====== ======
Net income per common share .................................. $ 0.27 $ 0.33 $ 0.18
====== ====== ======
Denominator -- Diluted net income per common share
Weighted average common stock outstanding ............... 6,480 6,406 5,725
Effect of dilutive securities
Weighted average common stock options ................... 285 349 331
Weighted average convertible preferred stock ............ -- -- 354
------ ------ ------
Total weighted average stock and options outstanding ......... 6,765 6,755 6,410
====== ====== ======
Diluted net income per common share........................... $ 0.26 $ 0.31 $ 0.16
====== ====== ======
</TABLE>
- ----------
During 1998, 1997 and 1996, there were 300,500, 64,037, and 10,178 outstanding
options to purchase shares, respectively, at a weighted average exercise price
of $7.69, $9.49, and $9.83 per share, respectively. These shares were not
included in the computations of diluted net income per common share because the
exercise price of the common shares exceeded, the market price of the related
options.
11. SELECTED QUARTERLY FINANCIAL DATA, (UNAUDITED)
<TABLE>
<CAPTION>
INTERIM FINANCIAL INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER
-----------------------------------------
FIRST SECOND THIRD FOURTH
----- ----- ----- -----
<S> <C> <C> <C> <C>
Year Ended January 2, 1999
Sales .......................................... $5,872 $6,002 $5,200 $6,511
Gross Profit ................................... 3,382 3,515 2,550 3,830
Net Income ..................................... 655 525 43 525
Net income per common share .................... 0.10 0.08 0.01 0.08
Diluted net income per common share ............ 0.10 0.08 0.01 0.08
Year Ended December 31, 1997
Sales .......................................... 3,320 4,356 4,641 5,756
Gross profit ................................... 1,883 2,513 2,654 3,411
Net income ..................................... 185 514 596 803
</TABLE>
-46-
<PAGE> 49
IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
INTERIM FINANCIAL INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER
-----------------------------------------
FIRST SECOND THIRD FOURTH
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net income per common share .................... 0.03 0.08 0.09 0.12
Diluted net income per common share............. 0.03 0.08 0.09 0.12
</TABLE>
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
-47-
<PAGE> 50
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Stockholders and Board of Directors
IRIDEX Corporation
Our audits of the consolidated financial statements referred to in our
report dated January 22, 1999 appearing on page 29 of this Form 10-K also
included an audit of the financial statement schedule listed in Item 14(a)(2) of
this Form 10-K. In our opinion, this financial statement schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
San Jose, CA
January 22, 1999
-48-
<PAGE> 51
PART III
Certain information required by Part III has been omitted from this Form
10-K. This information is instead incorporated by reference to our definitive
proxy statement (the "Proxy Statement"), which we will file within 120 days
after the end of our fiscal year pursuant to Regulation 14A in time for our
Annual Meeting of Stockholders to be held June 2, 1999.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding our directors is incorporated by reference to
"ELECTION OF DIRECTORS -- Nominees" in our Proxy Statement for the Company's
1999 Annual Meeting of Stockholders. The information concerning our current
executive officers is found under the caption "Executive Officers of the
Registrant" in Part I hereof is also incorporated by reference into this Item
10.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
"EXECUTIVE COMPENSATION" in our Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in our Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
-49-
<PAGE> 52
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE IN
FORM 10-K
REPORT
---------
<S> <C>
(a) The following documents are filed in Part II of this Annual Report on Form 10-K:
1. FINANCIAL STATEMENTS
Report of Independent Accountants ......................................... 29
Consolidated Balance Sheets as of January 2, 1999 and December 31, 1997.... 30
Consolidated Statements of Income for the years ended
January 2, 1999, December 31, 1997 and 1996................................ 31
Consolidated Statements of Stockholders' Equity for the years ended
January 2, 1999, December 31, 1997 and 1996................................ 32
Consolidated Statements of Cash Flows for the years ended January 2,
1999, December 31, 1997 and 1996........................................... 33
Consolidated Statements of Comprehensive Income for the years
ended January 2, 1999, December 31, 1997 and 1996.......................... 34
Notes to Consolidated Financial Statements................................. 35
2. FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule is included in Item 14(d):
Schedule II - Valuation and Qualifying Accounts............................ 53
</TABLE>
Other schedules have been omitted because they are either not required,
applicable, or the required information is included in the consolidated
financial statements or notes thereto.
3. EXHIBITS
Refer to (c) below
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 1998.
-50-
<PAGE> 53
(C) EXHIBITS
<TABLE>
<CAPTION>
EXHIBITS EXHIBIT TITLE
-------- -------------
<S> <C>
3.1(1) Amended and Restated Certificate of Incorporation of Registrant
3.2(3) Amended and Restated Bylaws of Registrant.
10.1(1) Form of Indemnification Agreement with directors and officers.
10.2(1) Amended and Restated 1989 Incentive Stock Plan and form of agreement thereunder.
10.3(1) 1995 Employee Stock Purchase Plan and form of agreement thereunder.
10.4(1) 1995 Director Option Plan and form of agreement thereunder.
10.5(1) 1995 Profit Sharing Plan
10.6(1) Third Restated Registration Rights Agreement dated as of October 27, 1995 by and among
Registrant and certain individuals and entities named therein.
10.7(1) Lease Agreement dated December 6, 1996 by and between Zappettini Investment Co. and
the Registrant.
10.8(1) Business Loan Agreement dated October 4, 1995 between Mid-Peninsula Bank and the
Registrant.
10.9(4) 1998 Stock Option Plan
10.10(2)* Development and Distribution Agreement dated as of May 28, 1996 between Miravant, Inc.
(formerly PDT, Inc.) and the Company.
22.1(1) Subsidiaries of Registrant.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (See page 52).
27.1 Financial Data Schedule.
</TABLE>
- ----------
* Confidential treatment has been granted with respect to certain portions of
this exhibit.
(1) Incorporated by reference to the like-numbered exhibits filed with the
Registration Statement on Form SB-2 (No. 333-00320-LA) which was declared
effective on February 15, 1996.
(2) Incorporated by reference to the exhibits in Registrant's Report on Form
10-Q for the quarter ended June 30, 1996.
(3) Incorporated by reference to the Exhibits in Registrant's Report on Form
10-Q for the quarter ended October 3, 1998.
(4) Incorporated by reference to the Exhibits in Registrant's Proxy Statement
for the Company's 1998 Annual Meeting of Stockholders which was filed April
30, 1998.
TRADEMARK ACKNOWLEDGMENTS
IRIDEX, the IRIDEX logo, IRIS Medical, OcuLight, SmartKey, and EndoProbe
are our registered trademarks. IRIDERM, G-Probe, DioPexy, DioVet, TruFocus,
TrueCW, UltraView and DioLite 532 product names are our trademarks. All other
trademarks or trade names appearing in the Form 10-K are the property of their
respective owners.
-51-
<PAGE> 54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Mountain
View, State of California, on the 31st day of March, 1999.
IRIDEX CORPORATION
By: /s/ Theodore A. Boutacoff
-------------------------------------
Theodore A. Boutacoff
President, Chief Executive Officer,
and Director
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Theodore A. Boutacoff and Robert
Kamenski, jointly and severally, their attorney-in-fact, each with full power of
substitution, for him in any and all capacities, to sign on behalf of the
undersigned any amendments to this Report on Form 10-K, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, and each of the undersigned does hereby
ratifying and confirming all that each of said attorneys-in-fact, of his
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following persons in the capacities and on the dates
indicated.
<TABLE>
<S> <C> <C>
/s/ Theodore A. Boutacoff President, Chief Executive Officer, and March 31, 1999
- --------------------------------- Director (Principal Executive Officer)
(Theodore A. Boutacoff)
/s/ Robert Kamenski Chief Financial Officer and Vice March 31, 1999
- --------------------------------- President, Administration (Principal
(Robert Kamenski) Financial and Accounting Officer)
/s/ James L. Donovan Vice President, Corporate Business March 31, 1999
- --------------------------------- Development and Director
(James L. Donovan)
/s/ William Boeger, III Director March 31, 1999
- ---------------------------------
(William Boeger, III)
/s/ Milton Chang Director March 31, 1999
- ---------------------------------
(Milton Chang)
/s/ Donald L. Hammond Director March 31, 1999
- ---------------------------------
(Donald L. Hammond)
/s/ Joshua Makower Director March 31, 1999
- ---------------------------------
(Joshua Makower)
/s/ John M. Nehra Chairman of the Board March 31, 1999
- ---------------------------------
(John M. Nehra)
</TABLE>
-52-
<PAGE> 55
SCHEDULE II
IRIDEX CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING OF COSTS AND AT END OF
DESCRIPTION THE PERIOD EXPENSES DEDUCTIONS THE PERIOD
- ------------------------------------ ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance for the year ended
December 31, 1996:
Allowance for doubtful accounts
receivable .................... $383 -- $(118) $265
Balance for the year ended
December 31, 1997:
Allowance for doubtful accounts
receivable .................... $265 $ 55 $ (15) $305
Balance for the year ended
January 2, 1999:
Allowance for doubtful accounts
receivable .................... $305 $113 $ (91) $327
</TABLE>
-53-
<PAGE> 56
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration
Statement of IRIDEX Corporation on Form S-8 (File No. 333-57573) of our reports
dated January 22, 1999 on our audits of the consolidated financial statements
and financial statement schedule of IRIDEX Corporation as of January 2, 1999
and December 31, 1997 and for the three years in the period ended January 2,
1999 which reports are included in this Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March [ ], 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> JAN-02-1999
<CASH> 5,791
<SECURITIES> 5,085
<RECEIVABLES> 7,935
<ALLOWANCES> (327)
<INVENTORY> 6,504
<CURRENT-ASSETS> 25,942
<PP&E> 3,857
<DEPRECIATION> (1,583)
<TOTAL-ASSETS> 28,377
<CURRENT-LIABILITIES> 2,492
<BONDS> 0
0
0
<COMMON> 21,865
<OTHER-SE> 4,020
<TOTAL-LIABILITY-AND-EQUITY> 28,377
<SALES> 23,585
<TOTAL-REVENUES> 23,585
<CGS> 10,308
<TOTAL-COSTS> 10,308
<OTHER-EXPENSES> 11,457
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,331
<INCOME-TAX> (583)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,748
<EPS-PRIMARY> 0.27
<EPS-DILUTED> 0.26
</TABLE>
