IRIDEX Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; comparable periods ended July 2, 2011. Unaudited interim results. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
IRIDEX develops and sells ophthalmic laser systems, delivery devices, consumables, and service. In February 2012, it sold its aesthetics business to Cutera and reports that business as discontinued operations. Management says the sale enables the company to focus on ophthalmology, its continuing business.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $8.445m | $8.085m | $16.750m | $16.281m |
| Gross profit / margin | $4.111m / 48.7% | $3.938m / 48.7% | $8.097m / 48.3% | $8.022m / 49.3% |
| Operating expenses | $4.461m | $3.698m | $8.683m | $7.522m |
| Income (loss) from continuing operations, before legal settlement and tax | $(0.350)m | $0.240m | $(0.586)m | $0.500m |
| Income from continuing operations, net of tax | $0.397m | $0.899m | $0.132m | $1.084m |
| Net income | $0.336m | $0.909m | $1.941m | $1.475m |
| Diluted EPS | $0.03 | $0.09 | $0.19 | $0.14 |
Q2 revenue increased 4.5%; six-month revenue increased 2.9%. Q2 recurring revenue rose 9.6% to $4.395m, while domestic system sales declined 4.2% and international system sales increased 2.9%. For the first half, recurring revenue grew 7.0%; domestic system sales fell 14.4%, partly offset by 10.2% growth in international system sales. Management attributed recurring-revenue growth primarily to GreenTip product sales through Alcon. OEM revenue declined, and management expected it to cease shortly after Bausch & Lomb discontinued the related product.
Operating expenses rose in both comparison periods, led by higher R&D, sales and marketing, and general and administrative costs. Management attributed the increases to headcount and product-development and sales investment. The $0.8m Synergetics legal-settlement receipt was the final payment under a 2007 patent settlement and materially supported reported continuing-operations income. Without separating that item, continuing operations reported a Q2 loss before the settlement and tax of $0.350m and a first-half loss of $0.586m.
First-half net income included $1.809m of income from discontinued operations, including a $2.032m after-tax gain on the aesthetics sale. The continuing aesthetics business recorded a $0.061m Q2 loss and a $0.223m first-half loss, net of tax.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $13.785m at June 30, 2012, compared with $10.789m at December 31, 2011. A further $0.510m of restricted cash related to discontinued operations was reported.
- Working capital was approximately $23.2m. Total assets were $31.292m; total liabilities were $6.525m. The balance sheet reports no bank borrowings; the Silicon Valley Bank loan agreement expired in June 2012.
- For the six months, continuing-operations operating cash flow was a use of $1.970m, investing cash use was $0.174m, and financing cash provided was $0.068m. Discontinued operations provided $5.072m of net cash, including $4.632m from investing activities. Overall cash increased $2.996m.
- Management said cash and expected operating cash generation would provide sufficient liquidity for the next 12 months. It attributed the cash increase primarily to the $5.1m net cash proceeds from the aesthetics sale. The company repurchased $0.296m of shares and received $0.364m from option exercises during the first half.
- Current liabilities included a $0.800m deferred-revenue balance. The earn-out liability was $0.681m, measured using Level 3 inputs; its valuation depends on uncertain assumptions.
Outlook, risks and unusual items
- Management’s short-term gross-margin goal is 50%; reported Q2 margin was 48.7% and first-half margin was 48.3%. It expected R&D spending to rise to support new products and sales and marketing spending to increase to drive sales. Management said it intended to balance higher investment with revenue growth to maintain profitability for the year; no specific revenue or earnings guidance was provided.
- The aesthetics sale reduces the business to ophthalmology. The filing warns the sale may adversely affect near-term results because the former business covered its direct costs; IRIDEX may need to adjust costs or grow ophthalmology revenue. The company also provided customary transaction indemnities.
- First-half sale accounting included $5.1m net cash proceeds, a $1.149m pre-tax gain, and a $0.883m tax benefit reported in discontinued operations. The company cited an approximately $18.5m tax loss from the disposal, expected a roughly $0.6m refund from carryback, and said approximately $15m would be carried forward. Deferred tax assets remained subject to a valuation allowance.
- Key risks include quarter-to-quarter sales volatility and seasonality; competition, pricing and reimbursement pressures; reliance on distributors and the Alcon collaboration; discontinued B&L-related OEM sales; product-development, regulatory and clinical-trial execution; sole- or limited-source suppliers; and product quality, warranty, and liability exposure. International sales represented 47.4% of Q2 sales. The company said it did not hedge currency exposure.
- Management reported effective disclosure controls as of June 30, 2012 and no material changes to internal control over financial reporting. It said no pending litigation was believed likely to have a material adverse effect.
Important facts for investors to verify
- Whether ophthalmology revenue growth can offset the loss of the aesthetics business and declining domestic system and OEM sales.
- Whether higher operating investment translates into growth while the company achieves its stated full-year profitability objective and approaches its 50% gross-margin goal.
- The sustainability of recurring GreenTip revenue and the extent of dependence on Alcon and international distributors.
- Cash generation excluding the one-time aesthetics-sale proceeds and legal-settlement payment; confirm liquidity as the bank facility has expired.
- The assumptions and potential cash impact of earn-out liabilities, transaction indemnities, tax-loss carrybacks and carryforwards, and the valuation allowance.