IRIDEX CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview IRIDEX Corporation is an ophthalmic medical technology company focused on the development and commercialization of breakthrough products and procedures used to treat sight-threatening eye conditions, including glaucoma and retinal diseases. Certain of our products are powered by our proprietary MicroPulse technology, which is a method of delivering laser energy using a mode which chops the continuous wave laser beam into short, microsecond-long laser pulses. Our products consist of laser consoles, delivery devices and consumable instrumentation, including laser probes. Our laser consoles consist of the following product lines: • Glaucoma – This product line includes our Cyclo G6 laser system used for the treatment of glaucoma; • Medical Retina – Our medical retina product line includes our IQ 532 and IQ 577 laser photocoagulation systems, which are used for the treatment of diabetic macular edema and other retinal diseases; and • Surgical Retina – Our surgical retina line of products includes our OcuLight TX, OcuLight SL, OcuLight SLx, OcuLight GL and OcuLight GLx laser photocoagulation systems. These systems are often used in vitrectomy procedures, which are used to treat proliferative diabetic retinopathy, macular holes, retinal tears and detachments. Our business generates recurring revenues through sales of consumable products, predominantly single-use laser probe devices and other instrumentation, as well as repair, servicing and extended service contracts for our laser systems. Our laser probes consist of the following product lines: • Glaucoma – Probes used in our glaucoma product line include our patented MicroPulse P3 (“MP3”) probe and G-Probe; and • Surgical Retina – Our surgical retina probes include our EndoProbe family of products used in vitrectomy procedures. Ophthalmologists typically use our laser systems in hospital operating room (“OR”) and ambulatory surgical centers (“ASCs”), as well as their offices and clinics. In the ORs and ASCs, ophthalmologists use our laser systems with either an indirect laser ophthalmoscope or a consumable, single use MP3 probe, G-Probe or EndoProbe. Our products are sold in the United States and Germany predominantly through a direct sales force and internationally (aside from Germany) primarily through independent distributors. Sales to international distributors are made on open credit terms or letters of credit and are currently denominated in U.S. dollars and accordingly, are not subject to risks associated with currency fluctuations. However, increases in the value of the U.S. dollars against any local currencies could cause our products to become relatively more expensive to customers in a particular country or region, leading to reduced revenue or profitability in that country or region. Sales to direct end users transacted through our German office are denominated in Euros and are subject to risks associated with the currency fluctuations. Cost of revenues consists primarily of our direct manufacturing costs which includes the cost of components and sub-systems, assembling, packaging, shipping and testing components at our facility, direct labor and associated overhead, warranty, royalty and amortization of intangible assets and depot service costs. For certain of our products, we are responsible for the cost of the fully assembled product that is manufactured by a third-party. Research and development expenses consist primarily of personnel costs, materials to support new product development and research support provided to clinicians at medical institutions developing new applications which utilize our products and regulatory expenses. Research and development costs have been expensed as incurred. Sales and marketing expenses consist primarily of costs of personnel, sales commissions, travel expenses, advertising and promotional expenses. General and administrative expenses consist primarily of costs of personnel, legal, accounting and other public company costs, insurance and other expenses not allocated to other departments. Impact of COVID-19 to our Business The outbreak of the COVID-19 has been declared a pandemic by the World Health Organization and continues to spread globally. The spread of COVID-19 has caused public health officials to recommend, and governments to enact, precautions to mitigate the spread of the virus, including travel restrictions and bans, extensive social distancing guidelines and issuing a “shelter-in-place” order in many regions of the world. The pandemic and these related responses have caused, and are expected to continue to cause a global slowdown of economic activity (including the decrease in demand for a broad variety of goods and services), disruptions in global supply chains and significant volatility and disruption of financial markets. We have adopted several measures in response to the COVID-19 outbreak including instructing employees to work from home while under shelter-in-place orders, slowing our manufacturing operations, and restricting non-critical business travel by our employees. Furthermore, we cannot be certain that these actions will mitigate some or all of the negative effects of the pandemic on our business. The extent of the negative effects of COVID-19 on our financial condition or results of operations remains uncertain. Any actual effects on our financial condition or results of operations may differ from any estimates reflected in our financial statements, and such effects may not be fully reflected in our financial condition or results of operations until future periods, if at all. 21 The Company has been deemed an essential business and therefore, has continued to operate in a more limited capacity during the pandemic. In April and May , following shelter-in-place orders, the Company operated with limited personnel at our facilities to continue ess ential operations . In June 2020, we implemented return-to-work phases in conjunction with a social distancing protocol to safely continue essential operations to best meet customer demands in light of the pandemic. The Company will continue to actively mon itor the situation and may take further actions altering our business operations that we determine are in the best interests of our employees, customers, communities, business partners, suppliers, and shareholders, or as required by federal, state, or loca l authorities. It is not clear what the potential effects any such alterations or modifications may have on our business, including the effects on the Company's customers, employees, and prospects, or on our financial results for the remainder of fiscal ye ar 2020. In the second quarter of 2020, revenue decreased approximately 40% as compared to the same period in 2019. This decrease was primarily attributed to the decrease in surgical elective procedures using our products, in part caused by limitations on the availability of such procedures and hospitals’ capacities to provide them and delays in capital purchases caused by the general uncertainty in the near term business environment. The extent to which our operations will be impacted by the outbreak will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including new information which may emerge concerning the severity of the outbreak and actions by government authorities, hospitals and private businesses to contain the outbreak or recover from its impact, among other things. Due to the nature of the Company’s business, the availability of elective surgical procedures and customers’ ability to make capital purchases directly impacts the Company’s revenue and operations. We are actively monitoring the ongoing impact of the COVID-19 pandemic and its impact on elective surgical procedures throughout the U.S. We expect our results of operations to be impacted for so long as the COVID-19 pandemic continues. For more information on risks associated with the COVID-19 outbreak, see the section titled “Risk Factors” in Item 1A of Part II. Results of Operations The following table sets forth certain operating data as a percentage of revenues: Three Months Ended Six Months Ended June 27, 2020 June 29, 2019 June 27, 2020 June 29, 2019 Revenues 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenues 61.3 % 56.4 % 58.5 % 58.1 % Gross margin 38.7 % 43.6 % 41.5 % 41.9 % Operating expenses: Research and development 13.0 % 8.9 % 10.0 % 9.0 % Sales and marketing 43.3 % 33.2 % 38.4 % 35.9 % General and administrative 27.2 % 25.2 % 22.2 % 23.2 % Total operating expenses 83.5 % 67.3 % 70.6 % 68.1 % Loss from operations (44.8 %) (23.7 %) (29.1 %) (26.2 %) Other income (expense), net 0.2 % 0.6 % 0.1 % 0.3 % Loss from operations before provision for income taxes (44.6 %) (23.1 %) (29.0 %) (25.9 %) Provision for income taxes 0.1 % 0.1 % 0.1 % 0.1 % Net loss (44.7 %) (23.2 %) (29.1 %) (26.0 %) The following comparisons are between the three months ended June 27, 2020 and June 29, 2019: Revenues. Three Months Ended Three Months Ended (in thousands) June 27, 2020 June 29, 2019 Change in $ Change in % Cyclo G6 $ 2,113 $ 3,351 $ (1,238 ) (36.9 %) Retina 2,608 5,248 (2,640 ) (50.3 %) Other 1,498 1,827 (329 ) (18.0 %) Total revenues $ 6,219 $ 10,426 $ (4,207 ) (40.4 %) 22 Our total revenues decreased by $ 4 . 2 million, or 40 . 4 %, from $10. 4 million to $ 6 . 2 million. The decrease is primarily due to a decrease in sales of our retina products, Cyclo G 6 products and other revenues as our business was impacted by the COVID-19 pandemic . Revenues from retina products decreased 50 . 3 %, driven by a decrease in both domestic and international as capital equipment sales were especially impacted by the pandemic . Revenues from Cyclo G6 products decreased 36 .9%, driven primarily by a decrease in Cyclo G6 probes sales. Other revenues, comprised of service, royalty, freight and legacy G probes, de creased 18.0 % due mainly to a de crease in legacy G probes and royalty r evenues. Gross Profit and Gross Margin. Gross profit decreased by $2.1 million, or 47.1%, from $4.5 million to $2.4 million. Gross margin decreased by 4.9 percentage points from 43.6% to 38.7%. The decrease in gross margin was primarily attributable to an increase in manufacturing overhead rate as a result of fixed overhead expenditures being absorbed over a lower sales volume. Gross margins are expected to fluctuate due to changes in the relative proportion of domestic and international sales, the product mix of sales, introduction of new products, manufacturing variances, total unit volume changes that lead to greater or lesser production efficiencies and other factors. Research and Development. Research and development (“R&D”) expenses decreased by $0.1 million, or 13.1%, from $0.9 million to $0.8 million. The decrease in spending was primarily attributable to a decrease in personnel costs due to a reduction in headcount . Sales and Marketing. Sales and marketing expenses decreased by $0.8 million, or 22.2%, from $3.5 million to $2.7 million. The decrease was primarily attributable to a decrease in personnel costs as a result of a reduction in headcount, lower commission expense due to lower sales, lower travel expenses and lower marketing program expenses as a consequence of the COVID-19 pandemic reducing business activity. General and Administrative. General and administrative expenses decreased by $0.9 million, or 35.6%, from $2.6 million to $1.7 million. The decrease in spending was primarily attributable to a decrease in personnel costs as a result of a reduction in headcount and lower legal expenses . Management anticipates operating with the reduction in headcount and consequently lower costs for the foreseeable future as it continues to focus on managing expenses. Other Income, Net. Other income, net amounted to $9 thousand, compared to other income, net of $58 thousand. Other income, net, consisted primarily of interest income and the change in expense associated with the re-measurement of contingent liabilities. Income Taxes. We recorded an income tax provision of $5 thousand and $9 thousand, respectively. The following comparisons are between the six months ended June 27, 2020 and June 29, 2019: Revenues. Six Months Ended Six Months Ended (in thousands) June 27, 2020 June 29, 2019 Change in $ Change in % Cyclo G6 $ 5,036 $ 6,457 $ (1,421 ) (22.0 %) Retina 6,742 10,847 (4,105 ) (37.8 %) Other 3,462 3,717 (255 ) (6.9 %) Total revenues $ 15,240 $ 21,021 $ (5,781 ) (27.5 %) Our total revenues decreased by $5.8 million, or 27.5%, from $21.0 million to $15.2 million. The decrease is primarily due to a decrease in sales of our retina products, Cyclo G6 products and other revenues as our business was impacted by the COVID-19 pandemic. Revenues from retina products decreased 37.8%, driven by a decrease in both domestic and international as capital equipment sales were especially impacted by the pandemic . Revenues from Cyclo G6 products decreased 22.0%, driven primarily by a decrease in Cyclo G6 probes sales. Other revenues, comprised of service, royalty, freight and legacy G probes, decreased 6.9% due mainly to a decrease in legacy G probes revenues. Gross Profit and Gross Margin. Gross profit decreased by $2.5 million, or 28.2%, from $8.8 million to $6.3 million. Gross margin decreased by 0.4 percentage points from 41.9% to 41.5%. The decrease in gross margin was primarily attributable to an increase in manufacturing overhead rate as a result of fixed overhead expenditures being absorbed over a lower sales volume. 23 Gross margins are expected to fluctuate due to changes in the relative proportion of domestic and international sales, the product mix of sale s, introduction of new products, manufacturing variances, total unit volume changes that lead to greater or lesser production efficiencies and other factors. Research and Development. Research and development (“R&D”) expenses decreased by $0.4 million, or 19.1%, from $1.9 million to $1.5 million. The decrease in spending was primarily attributable to a decrease in personnel costs due to a reduction in headcount . Sales and Marketing. Sales and marketing expenses decreased by $1.7 million, or 22.6%, from $7.6 million to $5.8 million. The decrease was primarily attributable to a decrease in personnel costs as a result of a reduction in headcount, lower commission expense due to lower sales, lower travel expenses and lower marketing program expenses as a consequence of the COVID-19 pandemic reducing business activity. General and Administrative. General and administrative expenses decreased by $1.5 million, or 30.4%, from $4.9 million to $3.4 million. The decrease in spending was primarily attributable to a decrease in personnel costs as a result of a reduction in headcount and lower legal expenses . Management anticipates operating with the reduction in headcount and consequently lower costs for the foreseeable future as it continues to focus on managing expenses. Other Income, Net. Other income, net amounted to $18 thousand, compared to other income, net of $52 thousand. Other income, net, consisted primarily of interest income and the change in expense associated with the re-measurement of contingent liabilities. Income Taxes. We recorded an income tax provision of $12 thousand and $15 thousand, respectively. Liquidity and Capital Resources. Liquidity is our ability to generate sufficient cash flows from operating activities to meet our obligations and commitments. In addition, liquidity includes the ability to obtain appropriate financing or to raise capital. As of June 27, 2020, we had cash and cash equivalents of $11.6 million and working capital of $18.1 million compared to cash and cash equivalents of $12.7 million and working capital of $20.8 million as of December 28, 2019. Net cash used in operating activities was $3.4 million in the six months ended June 27, 2020 compared to $5.2 million in the six months ended June 29, 2019. The decrease in net cash used in operating activities, expressed in direct cash flow terms, was primarily due to lower vendor payments and lower employee compensation, partially offset by a reduction in cash receipts from customers. For the six months ended June 27, 2020, net cash used in investing activities was $0.1 million, which consisted of capital expenditures. Net cash used in investing activities for the six months ended June 29, 2019 was $0.3 million, which consisted of $0.1 million on capital expenditures and $0.2 million for payment of the contingent earn-out liability. For the six months ended June 27, 2020, net cash provided by financing activities was $2.5 million, primarily from the proceeds from a U.S. Small Business Association Loan (the “SBA Loan”) pursuant to the Payroll Protection Program (“PPP”) established under the CARES Act. For the six months ended June 29, 2019, net cash used in financing activities was $0.1 million, which consisted of payroll taxes related to net share settlement of equity awards. W e have historically funded our operations primarily through sales of our products to customers, and through common stock and borrowing arrangements. As of June 27, 2020, our principal sources of liquidity consisted of cash and cash equivalents of $11.6 million. We have incurred net losses over the last several years, and as of June 27, 2020, have an accumulated deficit of approximately $55.0 million. We expect to continue to incur operating losses and negative cash flows from operations through July 3, 2021. We believe our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs over the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of our spending to support research and development activities, the timing and cost of establishing additional sales and marketing capabilities, the introduction of new and enhanced products and our costs to implement new manufacturing technologies. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. Any debt financing obtained by us in the future could also involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. Additionally, if we raise additional funds through further issuances of equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to grow or support our business and to respond to business challenges could be significantly limited. 24 Off-Balance Sheet Arrangements. We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Item 3. Quantitative and Qualitative Disclosure about Market Risk As a “smaller reporting company,” as defined in Rule 12b-2 of the Exchange Act, we are not required to provide the information called for by this Item.