IRIDEX CORP 10-K

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters, and Issuer Purchases of Equity Securities Market Information for Common Equity Our common stock is currently quoted on the Nasdaq Global Market under the symbol “IRIX”. As of March 15, 2021, there were approximately 33 holders of record (not in street name) of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of our stockholders, we are unable to estimate the total number of stockholders represented by these record holders. 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. Sales of Unregistered Securities None. Purchases of Equity Securities by the Issuer and Affiliated Purchasers Not applicable. Item 6. Selected Financial Data 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. 35 I tem 7. 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 laser 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 recently patented MicroPulse P3 ® Probe, G-Probe ® and G-Probe Illuminate ® ; 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 ORs and ambulatory surgical centers (“ASCs”), as well as their offices and clinics. In ORs and ASCs, ophthalmologists use our laser systems with either an indirect laser ophthalmoscope or a consumable, single use MicroPulse P3 Probe, G-Probe , G-Probe Illuminate or EndoProbe. In 2020 and 2019, our products were sold in the United States and Germany predominantly through a direct sales force and internationally (aside from Germany) primarily through independent distributors. Total revenues in 2020 and 2019 were $36.3 million and $43.4 million, respectively. We generated net losses of $6.3 million and $8.8 million in 2020 and 2019, respectively. Cost of revenues consists primarily of 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. 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. 36 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 2020 , following shelter-in-place orders, the Company operated with limited personnel at our facilities to continue essential 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. We will continue to actively monitor 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 local authorities. Our total revenues decreased $7.1 million or 16.3% from $43.4 million in 2019 to $36.3 million in 2020. 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 our business, the availability of elective surgical procedures and customers’ ability to make capital purchases directly impacts our 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 I. Results of Operations - 2020 and 2019 Our fiscal year ends on the Saturday closest to December 31. Fiscal 2020 ended on January 2, 2021 and fiscal 2019 ended on December 28, 2019. Fiscal years 2020 and 2019 included 53 weeks and 52 of operations, respectively. The following table sets forth certain operating data as a percentage of revenue for the periods indicated. Percentage of Revenue Years Ended FY 2020 FY 2019 January 2, 2021 December 28, 2019 Revenues 100.0 % 100.0 % Cost of revenues 57.2 % 58.7 % Gross margin 42.8 % 41.3 % Operating expenses: Research and development 9.0 % 8.5 % Sales and marketing 33.7 % 34.2 % General and administrative 18.2 % 19.3 % Total operating expenses 60.9 % 62.0 % Loss from operations (18.1 %) (20.7 %) Other income, net 0.8 % 0.5 % Loss from operations before provision for income taxes (17.3 %) (20.2 %) Provision for income taxes 0.1 % 0.1 % Net loss (17.4 %) (20.3 %) Comparison of 2020 and 2019 Revenues. (in thousands) FY 2020 FY 2019 Change in $ Change in % G6 $ 11,273 $ 13,070 $ (1,797 ) (13.7 %) Retina 18,087 22,879 (4,792 ) (20.9 %) Other 6,987 7,498 (511 ) (6.8 %) Total revenues $ 36,347 $ 43,447 $ (7,100 ) (16.3 %) 37 Our total revenues decreased $7.1 million or 16.3% from $43.4 million in 2019 to $36.3 million in 2020. Our business was impacted by the onset of the COVID-19 pandemic at the beginning of the year with sales of our retina products most impacted. Revenues from G6 products decreased 13.7% with a decrease in both Cyclo G6 systems and probes sales. Revenues from retina products decreased by 20.9% driven by a decrease in both domestic and international sales as capital equipment sales were especially impacted by the pandemic. Other revenues, comprised of service, royalty, freight and legacy G probes, decreased 6.8% due mainly to a decrease in legacy G probes and royalty revenues . While we believe that demand for our products remains and our revenue will recover, overall capital expenditures within hospitals, surgi-centers and physician offices has been impacted by the general level of uncertainty brought about by COVID-19. Until this stabilizes, we anticipate capital expenditures may continue to be deferred. Gross Profit . Gross profit decreased $2.4 million or 13.3% from $17.9 million in 2019 to $15.5 million in 2020. Gross margin increased 1.5% from 41.3% in 2019 to 42.8% in 2020. The increase in gross margin was primarily attributable to favorable geographic and product mix, partially offset by 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 continue to fluctuate due to changes in the relative proportions of domestic and international sales, the product mix of sales, manufacturing variances, total unit volume changes that lead to greater or lesser production efficiencies, sales return and a variety of other factors. Research and Development . R&D expenses decreased $0.4 million or 10.9% from $3.7 million in 2019 to $3.3 million in 2020. The decrease was attributable primarily to a decrease in consulting expenses and a decrease in personnel costs due to reduction in headcount. Sales and Marketing. Sales and marketing expenses decreased $2.6 million or 17.6%, from $14.9 million in 2019 to $12.2 million in 2020. 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 $1.8 million or 21.0% from $8.4 million in 2019 to $6.6 million in 2020. The decrease 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 $0.3 million in 2020 and $0.2 million in 2019. Other income, net, consisted primarily of interest income or expense, foreign currency gain or loss and the change in expense associated with the re-measurement of contingent liabilities. Income Taxes. We recorded a provision for income taxes of $26 thousand for the year ended January 2, 2021 compared to $48 thousand for the year ended December 28, 2019. The effective tax rate for the year ended December 2, 2021 was negative 0.41% compared to an effective tax rate of negative 0.46% for the year ended December 28, 2019. The income tax valuation allowance was $18.8 million at the end of 2020 compared to $17.4 million at the end of 2019. 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. Comparison of 2020 and 2019 As of January 2, 2021, we had cash and cash equivalents of $11.6 million and working capital of $16.7 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 $3.2 million in 2020 compared to $7.9 million in 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. 38 During 20 20 , net cash used in investing activities was $0. 1 million , which consisted of capital expenditures. Net cash used in investing activities during 201 9 was $0. 5 million, which consisted of $0. 1 million for capital expenditures and $0.4 million for payment of the contingent earn-out liability. During 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. Net cash used in financing activities during 2019 was $0.2 million, which consisted of payroll taxes related to net share settlement of equity awards. We have historically funded our operations primarily through sales of our products to customers, and through common stock and borrowing arrangements. As of January 2, 2021, 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 January 2, 2021, have an accumulated deficit of approximately $56.9 million. We expect to continue to incur operating losses and negative cash flows from operations at least through January 1, 2022. 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. Critical Accounting Policies Revenue Recognition . Our revenues arise from the sale of laser consoles, delivery devices, consumables, service, and support activities. We also derive revenue from royalties from third parties which are typically based on licensees’ net sales of products that utilize our technology. Our revenue is recognized in accordance with Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers.” We have the following revenue transaction types: (1) Product Sale Only, (2) Laser Advantage Program (LAP), (3) Service Contracts, (4) System Repairs (outside of warranty) and (5) Royalty Revenue. (1) Product Sale Only: Our products consist of laser consoles, delivery devices and consumable instrumentation, including laser probes. Our products are currently sold for use by ophthalmologists specializing in the treatment of glaucoma and retinal diseases. Inside the United States and Germany the products are sold directly to the end users. In other countries outside of the United States and Germany, we utilize independent, third-party distributors to market and sell our products. There is no continuing obligation subsequent to the shipment to these distributors . We recognize revenue from product sale at a point in time. When a system or disposables are sold without any additional deliverables, we recognize revenue using the five-step model: (1) identifying the contract with the customer, (2) identifying the performance obligations in the contract, (3) determining expected transaction price, (4) allocating the transaction price to the distinct performance obligations in the contract, and (5) recognizing revenue when (or as) the performance obligations are satisfied . (2) LAP Program (Discontinued in the second quarter of fiscal year 2019): We entered into LAP contracts with certain customers. Under the LAP program, the system is given away free of charge and title is transferred after the customer purchases the minimum required number of boxes of probes (classified as disposables). Customers with older machines have the ability to trade in their old machines for the most current laser equipment offered in the program (Cyclo G6 Laser) and receive a discount on the program’s minimum purchase requirements. Under ASC 606, this non-cash consideration must be included in the transaction price. However, we have determined that there is no value associated with the old machines and the trade-in is essentially offered to encourage customers to purchase more consumables under the program . We recognize revenue from product sales under the LAP program at a point in time. We allocate the transaction price of the distinct performance obligations in the contract by determining stand-alone selling price using historical pricing net of any variable consideration or discounts to specifically allocate to a particular performance obligation . (3) Service Contracts: We offer a standard two-year warranty on all system sales. We also offer a service contract which is sold to customers in incremental, one-year periods which begin subsequent to the expiration of the standard two-year warranty. The customer can opt to purchase the service contract at the time of the system sale or after the initial system sale. We recognize revenue from service contracts ratably over the service period. Revenue recognition for the sale of a service contract is largely dependent on the timing of the sale as follows: 39 a. Service Contract Sale in Conjunction with System Sale: If the customer opts to purchase a service contract at the time of the system sale, we allocate the transaction price of the distinct performance obligations in the contract by determining stand-alone selling price using historical pricing net of any variable consideration or discounts to specifically allocate to a particular performance obligation . b. Service Contract Sale Subsequent to System Sale: If the customer opts to purchase a service contract after the initial system sale, we determine the amount of time that has elapsed since the initial system sale. If the service contract is purchased within 60 days of the initial sale, we consider this sale to be an additional element of the original sale and allocates the transaction price of the distinct performance obligations in the contract by determining stand-alone selling price using historical pricing net of any variable consideration or discounts to specifically allocate to a particular performance obligation. If the service contract is purchased subsequent to sixty days after the initial sale, the sale of the service contract is deemed a separate contract and is deferred at the selling price and recognized ratably over the extended warranty period as the performance obligation is satisfied . (4) System Repairs (outside of warranty): Customers will occasionally request repairs from us subsequent to the expiration of the standard warranty and outside of a service contract . We recognize revenue from system repairs (outside of warranty) at a point in time. When the customer requests repairs from us subsequent to the expiration of the standard warranty and outside of a service contract, these repair contracts are considered separate from the initial sale, and as such, revenue is recognized as the repair services are rendered and the performance obligation satisfied . (5) Royalty Revenue: We have royalty agreements with two customers related to sale of our intellectual property. Under the terms of these agreements, the customer is to remit a percentage of sales to us. Since these arrangements are for sales-based licenses of intellectual property, for which the guidance in paragraph ASC 606-10-55-65 applies, we recognize revenue only as the subsequent sale occurs. However, we note that such sales being reported by the licensee with a quarter in arrears, such revenue is recognized at the time it is reported and paid by the licensee given that any estimated variable consideration would have to be fully constrained due to the unpredictability of such estimate and the unavoidable risk that it may lead to significant revenue reversals . We elected the practical expedient allowing it to not recognize as a contract asset the commission paid to its salesforce on the sale of its products as an incremental cost of obtaining a contract with a customer but rather recognize such commission as expense when incurred as the amortization period of the asset that we would have otherwise recognized is one year or less. Inventories. Inventories are stated at the lower of cost or net realizable value and include on-hand inventory physically held at our facility, sales demo inventory and service loaner inventory. Cost is determined on a standard cost basis which approximates actual cost on a first-in, first-out (“FIFO”) method. Lower of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolete or impaired inventory and are charged to cost of revenues. Once the cost of the inventory is reduced, a new lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Factors influencing these adjustments include changes in demand, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates. Sales Returns Allowance and Allowance for Doubtful Accounts. We estimate future product returns related to current period product revenue. We analyze historical returns, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowance. Significant management judgment and estimates must be made and used in connection with establishing the sales returns allowance in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. Our provision for sales returns is recorded net of the associated costs. Similarly, management must make estimates regarding the uncollectibility of accounts receivable. We are exposed to credit risk in the event of non-payment by customers to the extent of amounts recorded on the consolidated balance sheets. As sales increase the level of accounts receivable would likely also increase. In addition, in the event that customers were to delay their payments to us, the levels of accounts receivable would likely also increase. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for 40 doubtful accounts is based on past payment history with the customer, analysis of the customer’s current financial condition, the aging of the accounts receivable balance, customer concentration and other known factors. Warranty. We provide reserves for the estimated cost of product warranties at the time revenue is recognized based on historical experience of known product failure rates and expected material and labor costs to provide warranty services. We generally provide a two-year warranty on our products. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Alternatively, if estimates are determined to be greater than the actual amounts necessary, we may reverse a portion of such provisions in future periods . Our warranty policy is applicable to products which are considered defective in their performance or fail to meet the product specifications. Warranty costs are reflected in the consolidated statements of operations as cost of revenues. Income Taxes. We account for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Under ASC 740, the liability method is used in accounting for income taxes. Deferred tax assets and liabilities are determined based on the differences between financial reporting and the tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. We annually evaluate the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. As of January 2, 2021, based on our recent history of losses and its forecasted losses, management believes on the more likely than not basis that a full valuation allowance is required. Accordingly, as of January 2, 2021, we provided a full valuation allowance on our federal and state deferred tax assets. Accounting for Uncertainty in Income Taxes. We account for uncertain tax positions in accordance with ASC 740. ASC 740 seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax provision that an entity takes or expects to take in a tax return. Additionally, ASC 740 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. Under ASC 740, an entity may only recognize or continue to recognize tax positions that meet a "more-likely-than-not" threshold. In accordance with our accounting policy, we recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. There was no accrued interest and penalties during the year ended January 2, 2021. Accounting for Stock-Based Compensation . We account for stock-based compensation granted to employees and directors, including employees’ stock option awards and restricted stock units at grant date, based on the fair value of the award. Stock-based compensation is recognized as expense on a ratable basis over the requisite service period of the award. We value options using the Black-Scholes option pricing model. Time-based restricted stock units are valued at the grant date fair value of the underlying common shares. Performance-based restricted stock units without market conditions are valued at grant date fair value of the underlying common shares. Performance-based RSUs granted with market conditions and performance-based stock options with market conditions are valued using the Monte Carlo simulation model. The Black-Scholes option pricing model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. The Monte Carlo simulation model incorporates assumptions for the holding period, risk-free interest rate, stock price volatility and dividend yield. 41 Leas es. We determine if an arrangement is a lease at inception. Operating leases are included in Operating lease right-of-use (“ROU”) assets, net and Operating lease liabilities in our consolidated balance sheets. As of January 2, 2021, we were not a party to finance lease arrangements. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Under the available practical expedient, we account for the lease and non-lease components as a single lease component. Recent Accounting Standards Not Yet Adopted. In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” as part of its initiative to reduce complexity in the accounting standards. The standard eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies and simplifies other aspects of the accounting for income taxes. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently evaluating the impact that this guidance will have on its financial position and results of operations, if any. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements. Item 7A. Quantitative and Qualitative Disclosures 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.