IRIDEX Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter ended June 30, 2018 (13 weeks); comparisons are with the quarter ended July 1, 2017. Six-month results are compared with the six months ended July 1, 2017. Financial figures below are in U.S. dollars; “$m” means millions.
Business context
IRIDEX develops, manufactures and sells ophthalmic laser systems, delivery devices and consumables for glaucoma and retinal conditions, plus service and support. It operates as one ophthalmology segment. U.S. sales are primarily direct; international sales are primarily through distributors, with direct sales capabilities in Germany.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $10.304m | $10.002m | $19.813m | $20.485m |
| Gross profit | $4.268m | $4.495m | $8.190m | $8.960m |
| Gross margin | 41.4% | 44.9% | 41.3% | 43.7% |
| Operating expenses | $7.550m | $7.236m | $15.089m | $13.559m |
| Operating loss | $(3.282)m | $(2.741)m | $(6.899)m | $(4.599)m |
| Net loss | $(3.280)m | $(2.750)m | $(6.883)m | $(4.616)m |
| Basic and diluted loss per share | $(0.28) | $(0.24) | $(0.59) | $(0.40) |
Cash flow and liquidity: For the six months, operating cash use was $5.053m, investing cash use was $0.560m, and financing cash use was $0.090m. Cash fell by $5.662m to $16.045m from $21.707m at year-end 2017. Working capital was $22.9m, down from $29.1m. The company reported no fixed- or variable-rate debt outstanding. Management said existing cash and cash equivalents should meet anticipated cash needs for the next 12 months.
Balance-sheet highlights: Total assets were $35.143m and total liabilities were $10.710m at June 30, 2018. The company had $9.093m of inventory and $2.316m of deferred revenue. Contractual obligations totaled $19.623m, including $5.127m of operating lease payments and $14.496m of purchase commitments. No material off-balance-sheet arrangements were reported.
Material changes versus prior periods
- Q2 revenue rose 3.0%; six-month revenue fell 3.3%. Q2 international system sales increased $0.793m while domestic system sales decreased $0.528m. For the six months, domestic system sales declined $1.408m, partly offset by $0.444m growth in international system sales.
- Recurring revenue was nearly flat in Q2 (+0.6%) and increased 2.6% for the six months, reflecting higher G6 probe sales partly offset by lower legacy probe sales.
- Gross margin fell 3.5 percentage points in Q2 and 2.4 points for the six months. Management cited unfavorable geographic mix, partly offset by higher-margin G6 revenue and lower manufacturing overhead or variances.
- Six-month sales and marketing expense increased 25.0% and general and administrative expense increased 13.9%, including higher personnel costs, commissions, legal expense and costs related to German operations. R&D expense declined 26.0%, primarily due to lower headcount-related costs.
- Management attributed weaker domestic system sales in part to the voluntary recall of the TruFocus LIO Premiere accessory initiated in the prior quarter.
Outlook, commentary and risks
- No specific revenue, earnings or margin guidance was provided. Management expects gross margins to fluctuate with geographic and product mix, new products, manufacturing variances and production volumes.
- The February 2018 voluntary LIO recall covered 104 units at customer sites worldwide; the company reported three adverse events during procedures in which the accessory was used. Recall costs, customer response and any further regulatory developments may affect results.
- In January 2018, IRIDEX sued Quantel entities, alleging patent and MicroPulse trademark infringement and breach of agreement. The filing states that an unsuccessful outcome could materially adversely affect the company; litigation costs and diversion of management resources are also risks.
- Warranty liability declined to $0.926m from $1.735m at year-end. The company reversed warranty expense accrued in December 2017 for certain products shipped outside the United States because the reserve was no longer considered necessary; warranty accruals were negative $0.345m in the six-month period.
- Key disclosed risks include continued operating losses and cash usage, product quality and recall exposure, reliance on limited-source suppliers and distributors, competition, regulatory and reimbursement changes, international sales and currency exposure, and potential effects of tariffs. Two vendors accounted for 26% of purchases in the first half.
- The company filed a lawsuit against Quantel, and disclosed no subsequent events requiring financial-statement disclosure. Management concluded disclosure controls were effective as of June 30, 2018.
Important facts for investors to verify
- Whether the LIO recall is resolved, including remediation costs, customer impact and any additional adverse-event or regulatory developments.
- Whether domestic system sales recover and international growth and recurring consumables sales can offset domestic weakness.
- Whether gross margins stabilize and spending growth, particularly in sales and marketing and German operations, produces sufficient revenue gains.
- Cash burn and liquidity against contractual commitments, especially purchase commitments, and the assumptions behind management’s 12-month cash sufficiency assessment.
- Developments and potential financial consequences of the Quantel litigation, as well as supplier concentration and warranty reserve estimates.