IRIDEX Corporation — Q3 2018 Form 10-Q
Business context and reporting period. IRIDEX develops, manufactures and sells ophthalmic laser systems, delivery devices and recurring-use consumables, along with service and support. This unaudited filing covers the 13 weeks and 39 weeks ended September 29, 2018, compared with the periods ended September 30, 2017. Financial statement amounts below are in millions of dollars unless otherwise stated.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $11.32 | $10.87 | $31.13 | $31.35 |
| Gross profit / margin | $4.58 / 40.4% | $4.37 / 40.2% | $12.77 / 41.0% | $13.33 / 42.5% |
| Operating loss | $(3.06) | $(3.07) | $(9.96) | $(7.67) |
| Net loss | $(3.07) | $(3.10) | $(9.96) | $(7.71) |
| Loss per share, basic and diluted | $(0.26) | $(0.27) | $(0.85) | $(0.67) |
Q3 revenue increased 4.2%, primarily from higher international system sales; recurring revenue rose modestly. Nine-month revenue declined 0.7%, as lower domestic system sales more than offset growth in international systems and recurring revenue. Nine-month gross margin fell 1.5 percentage points, with unfavorable geographic mix and higher manufacturing overhead partly offset by lower manufacturing variances. Operating expenses rose 8.2% year over year for the nine-month period, led by a 19.5% increase in sales and marketing; lower R&D expense partly offset the increase.
For the nine months, operating cash flow was $(7.97), compared with $(2.63) in 2017; management attributed the larger use mainly to working-capital changes, including lower cash collections and vendor-payment timing. Investing cash use was $0.69 and financing provided $10.56, including $10.64 net proceeds from a September stock offering. Cash increased to $23.73 at September 29, 2018, from $21.71 at fiscal year-end 2017; working capital was $31.0. The company reported no outstanding debt and said existing cash should cover anticipated needs for the next 12 months.
Current liabilities were $10.39 and total liabilities $10.93 at quarter-end. Contractual obligations totaled $18.22: $4.85 of operating lease payments and $13.37 of purchase commitments, including $9.75 due within one year.
Material changes, outlook and risks
- Q3 U.S. revenue was $6.18, down from $6.29; international revenue was $5.14, up from $4.57. For the nine months, U.S. revenue declined to $16.16 from $17.88, while international revenue rose to $14.98 from $13.47.
- Management linked lower nine-month domestic system sales, particularly retina systems, partly to the voluntary recall of the TruFocus LIO Premiere accessory. The recall began in February 2018 after reports of focal cataracts and iris burns; the company expected completion by year-end and had received FDA clearance for an updated device. It warned that further adverse events or weak acceptance of the updated product could require more resources or another recall.
- The company reversed warranty expense accrued in December 2017 for certain products shipped outside the U.S. because those reserves were no longer considered necessary. Warranty liability was $0.83 at quarter-end, down from $1.74 at year-end.
- In September, IRIDEX sold 1,916,667 shares at $6.00 per share, including the underwriters’ overallotment, for approximately $10.6 million net proceeds. Shares outstanding increased; the offering provided liquidity but diluted existing holders.
- No numeric revenue or earnings guidance was provided. Management expects gross margins to fluctuate with geographic and product mix, new-product introductions, manufacturing variances and production volumes.
- Key risks include product quality and manufacturing constraints, reliance on sole- or limited-source suppliers, international-market and currency exposure, competition, regulatory compliance, reimbursement uncertainty and the company’s continuing operating losses and cash use. Non-cancellable purchase commitments are substantial relative to quarterly revenue.
- IRIDEX’s U.S. litigation against Quantel alleges patent and MicroPulse trademark infringement and breach of agreement. Separately, the EPO Opposition Division issued a written decision on October 1, 2018 moving to revoke a European patent; IRIDEX filed an appeal on October 10. Quantel also sought a French non-infringement ruling. Outcomes and potential financial effects are uncertain.
- The filing reports disclosure controls were effective as of September 29, 2018 and no material change in internal control over financial reporting. The filing does not quantify a potential financial impact from the recall or litigation.
Most important facts for investors to verify
- Whether the updated LIO recall was completed as expected, and whether product safety, customer acceptance or warranty costs changed afterward.
- Whether domestic retina system sales recovered and whether recurring probe revenue continued to grow.
- Cash burn, collections and working-capital trends, along with the timing and fulfillment of $13.37 million in purchase commitments.
- Progress and potential consequences of the Quantel cases and the appeal concerning European Patent EP 1 856 774.
- The effect of the September equity offering and subsequent share-based compensation on fully diluted ownership.