STAAR Surgical Company (STAA)

 

HICL – a Visian ICL product used to treat hyperopia (farsightedness).

 

ICL >– an abbreviation for “implantable Collamer lens,” the Visian ICL is a folding lens implanted in the eye to correct refractive errors like myopia that have traditionally been corrected with eyeglasses or contact lenses.  The ICL is within a product category referred to as phakic IOLS or phakic implants because they work  with the patient’s natural lens, or phakos, rather than replacing it.

 

intraocular – within the eye.

 

iris> – the muscular curtain located behind the cornea, which opens and closes to regulate the amount of light entering the eye through the pupil, which is an opening at the center of the iris. The iris carries the blue or brown pigment that gives the eye its color.

 

injector or injector system> – a device, in the form of a syringe, that is used to deliver a foldable IOL into the eye through a slender nozzle in minimally invasive cataract surgery.

 

laser eye surgery – a generic term for LASIK and PRK.

 

LASIK> – an acronym for laser-assisted in-situ keratomileusis, a surgical operation that reshapes the cornea to correct nearsightedness, farsightedness, or astigmatism.  LASIK involves first the cutting of a hinged flap to separate the surface layer of the cornea, using a microkeratome (a special blade) or a laser.  An excimer laser is then used to burn tissue away and reshape the inner cornea, after which the flap is returned to position.

 

multifocal IOL >– a type of IOL that creates zones in the visual field for distance, far and near vision, similar to the near and far zones in bifocal glasses.

 

myopia> – the refractive disorder also known as nearsightedness, which occurs when the eye’s lens focuses images in front of the retina rather than on the retinal surface.  A person with myopia cannot clearly see distant objects without glasses or contact lenses.

 

nanoFLEX – >a single-piece Collamer aspheric IOL that can be implanted through a 2.2 mm incision with the complementary nanoPOINT injector system.

 

ophthalmologist> – a surgeon who specializes in the diseases and disorders of the eye and the visual pathway related to it.  Sometimes confused with optometrist, a doctor who diagnoses disorders of the eye and prescribes eyeglasses and contact lenses for refractive disorders, but does not perform surgery.

 

ophthalmic – of or related to the eye.

 

optic> – the central part of an IOL, the part that functions as a lens and focuses images on the retina.

 

phakic IOL or phakic implant> – an artificial lens that is implanted to work along with the patient’s natural lens is called a phakic IOL or phakic implant, from the Greek word for lens, phakos.  This is the product class to which the Visian line of products belongs.  IOLs that treat cataracts are sometimes called aphakic IOLs because they are implanted in patients whose natural lenses have been removed.

 

phacoemulsification> is a small-incision procedure used to remove a cataract patient’s cloudy lens before implantation of an IOL.  Phacoemulsification uses ultrasound to break up the tissue of the crystalline lens, and then uses suction to draw the tissue out through the small incision.

 

posterior chamber is the space in eye behind the iris.

 

NTIOL> – an abbreviation for New Technology Intraocular Lens.  The Centers for Medicare and Medicaid Services (CMS) will grant NTIOL status to IOLs that can demonstrate improved visual performance over conventional IOLs, allowing an extra $50 reimbursement per lens implanted in an ASC (ambulatory surgical center). The majority of IOL purchases in the U.S. are implanted at ASCs and reimbursed through Medicare.

 

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Preloaded Injector> -  a silicone or acrylic IOL packaged and shipped in a pre-sterilized, disposable injector ready for use in cataract surgery.  The conventional method of packaging IOLs requires the surgeon or an assistant to manually load each lens into an injector before surgery.

 

presbyopia >– an age-related condition in which the crystalline lens loses its ability to focus on both near and far objects.  People who have had normal vision will typically begin to need glasses for reading or other close tasks at some point after age 40 due to presbyopia.

 

presbyopic IOLs >are IOLs that can restore some degree of near and far visual acuity after cataract surgery. 

 

PRK> – an abbreviation for photorefractive keratectomy, a surgical operation that reshapes the surface of the cornea to correct nearsightedness, farsightedness and astigmatism.  PRK involves the use of an excimer laser to ablate, or burn, small amounts of tissue from the cornea.  PRK differs from LASIK, which employs a flap to gain access to the corneal bed, then uses the excimer laser to shape the corneal bed rather than the surface of the cornea.

 

refractive disorders> are visual disorders that affect the ability of the eye’s optical system to create a sharply focused image.  Refractive disorders include myopia (nearsightedness), hyperopia (farsightedness), astigmatism and presbyopia.  These are the visual disorders that have traditionally been treated with eyeglasses and contact lenses, and more recently with refractive surgery.  Glaucoma, cataracts and macular degeneration are examples of visual impairment that are not refractive disorders.

 

refractive market >– as used in this report “refractive market” means the overall market volume for refractive surgical procedures of all kinds, including LASIK, PRK, the Visian product family and other phakic IOLs.  As used in this report, the term does not does not include sales of non-surgical products like eyeglasses and contact lenses.

 

refractive surgery> – operative procedures intended to correct or reduce refractive disorders.  In addition to the implantation of the Visian ICL, common refractive surgeries include LASIK and PRK.

 

retina> - a layer of nerve tissue at the back of the eye consisting of millions of light receptors called rods and cones, which receive the light image and transmit it to the brain via the optic nerve.

 

silicone> – a type of plastic often used in implantable devices that is inert, generally flexible and water-repelling.

 

single-piece IOL> – in a single piece IOL the haptics and the optic are fashioned from a single piece of lens material.  The two principal design categories of IOLs are three-piece IOLs and single-piece IOLs.

 

spheric lenses> – a spheric lens has surfaces that are shaped like sections of a sphere.  The sphere is not an ideal shape for an optically accurate lens, but spherical surfaces have historically been the simplest lens shape to make.  Spheric lenses have spheric aberrations – small errors in focus that become more pronounced at the edge of the lens  When a spheric IOL is placed in the human eye, these aberrations can reduce night vision and contrast sensitivity.

 

three-piece IOL> – a three-piece IOL has a central, disk-shaped optic and two spring-like plastic haptics attached at either side.  The haptics are positioned against structures of the eye to hold the IOL in place.

 

toric – refers to the shape of a lens designed to correct astigmatism, which has greater refractive power in some sections of the lens than others.

 

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TICL> – an abbreviation for “Toric implantable Collamer lens,” a variant of the ICL that corrects both myopia and astigmatism.

 

Visian> – STAAR’s brand name for its family of phakic intraocular lenses, including the Visian ICL, Visian TICL and Visian HICL.

 

Item 1A.  Risk Factors

 

Our short and long-term success is subject to many factors that are beyond our control. Investors and prospective investors should consider carefully the following risk factors, in addition to other information contained in this report. This Annual Report on Form 10-K contains forward-looking statements, which are subject to a variety of risks and uncertainties.  We have identified our known, significant risk factors below.

 

Risks Related to Our Business

 

We have a history of losses which could continue in the future.

 

We have reported losses in each of the last several fiscal years and have an accumulated deficit of $132.1 million as of January 1, 2010.  There can be no assurance that we will report net income in any future period.

 

We have only limited working capital and limited access to financing.

 

We began generating cash from operations in 2009 after six consecutive years when our cash requirements exceeded the level of cash generated by operations.  We may not be able to sustain positive cash flow, and unexpected cash needs could exceed the amount of cash we generate.  Among our challenges in maintaining and increasing positive cash flow is the March 2, 2010 sale of Domilens, in which we divested one of our historical sources of cash.  While we believe our capital resources and funds generated by operations are sufficient to operate our business and satisfy our obligations, if unexpected events increase our expenses or harm the performance of our business we may need to seek additional financing.  We may also be presented with opportunities to expand our business that require additional financing.  Should we need additional working capital, our ability to raise financing through sales of equity securities depends on general market conditions and the demand for STAAR’s common stock. We may be unable to raise adequate capital through sales of equity securities, and if our stock has a low market price at the time of such sales our existing stockholders could experience substantial dilution.  Because of our history of losses STAAR may also have difficulty obtaining debt financing on acceptable terms.  An inability to secure additional financing if it is needed in the future could require us to forego opportunities for expansion, reduce exiting operations, or even jeopardize our ability to continue operations.

 

Our defined benefit pension plans are currently underfunded and we may be subject to significant increases in pension benefit obligations under those pension plans.

 

We sponsor two defined benefit pension plans through our wholly owned Swiss and Japanese subsidiaries. Both plans are underfunded and may require significant cash payments. We contributed $238,000 to our Swiss Plan and $76,000 to our Japan Plan during 2009.

 

Beginning October 1, 2009, as part of the Amendment of the Japan Plan discussed in Note 12 to the consolidated financial statements included in this report, STAAR Japan will maintain and administer the Japan Plan, including paying the pension benefits as they are due solely from its continuing operations. STAAR Japan is not required to, and does not expect to make any contributions to the Japan Plan in order to meet future pension benefit obligations. Therefore, STAAR Japan has no plan assets now and does not expect to have any in the future.

 

STAAR determines its pension benefit obligations and funding status using many assumptions, such as inflation, investment rates, mortality, turnover and interest rates, as applicable, any of which could prove to be different than projected. If the investment performance does not meet our expectations, or if other actuarial assumptions are modified, or not realized, we may be required to contribute more than we currently expect and increase our future pension benefit obligations to be funded from our operations.

 

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Our pension plans in the aggregate are underfunded by approximately $2.0 million ($0.9 million for the Japan Plan and $1.1 million for the Swiss Plan) as of January 1, 2010 (based on the actuarial assumptions used for FASB ASC 715-30, “Defined Benefits Plans — Pensions” purposes and comparing our projected benefit obligation to the fair value of plan assets).

 

If our cash flow from operations is insufficient to fund our worldwide pension obligations, we may be materially and adversely harmed and have to seek additional capital.

 

The divestiture of Domilens will reduce our sales.

 

Domilens GmbH, our former German subsidiary, was profitable and provided a significant part of our sales.  In 2009, Domilens accounted for $24,286,000, or 32% of our total sales. While sales from STAAR’s remaining business generate higher gross profit margins than the sales generated from Domilens, STAAR will have to significantly increase its sales from its core IOL and ICL business, or significantly reduce its expenses, to achieve its target of positive cash flow in 2010.  If STAAR does not achieve positive cash flows in 2010, it may need to seek additional sources of financing to maintain operations.

 

We may have limited ability to fully use our recorded tax loss carryforwards.

 

We have accumulated approximately $120.9 million of federal net operating loss carryforwards as of January 1, 2010 to be used in future quarters if we become profitable. If we were to experience a significant change in ownership, Internal Revenue Code Section 382 may restrict the future utilization of these tax loss carryforwards even if we become profitable and these tax loss carryforwards will begin to expire between 2020 and 2029.

 

FDA compliance issues have delayed approvals and we expect to devote significant resources to maintaining compliance in the future.

 

The Office of Compliance of the FDA’s Center for Devices and Radiological Health regularly inspects STAAR’s facilities to determine whether we are in compliance with the FDA Quality System Regulations relating to such things as manufacturing practices, validation, testing, quality control, product labeling and complaint handling, and in compliance with FDA Medical Device Reporting regulations and other FDA regulations. The FDA also regularly inspects for compliance with regulations governing clinical investigations.

 

Based on the results of regularly scheduled inspections of the Nidau, Switzerland facility between June 2 and June 5, 2009 and of the Monrovia, California facility, between February 23 and March 4, 2009, STAAR believes that it is substantially in compliance with the FDA’s Quality System Regulations and Medical Device Reporting regulations. However, between December 29, 2003 and July 5, 2005 we received Warning Letters and other correspondence indicating that the FDA found STAAR’s Monrovia, California facility in violation of applicable regulations, warning of possible enforcement action and suspending approval of new implantable devices. The FDA’s findings of compliance deficiencies during that period delayed FDA approval of the ICL.

 

On June 26, 2007 STAAR received a Warning Letter from the FDA citing four areas of noncompliance noted by the FDA’s Bioresearch Monitoring branch during its inspection of STAAR’s clinical study procedures, practices, and documentation related to the TICL.  The Office of Device Evaluation cited the same deficiencies in a letter placing integrity hold on the TICL application.  On July 21, 2009, the FDA indicated that it was satisfied with corrective actions taken by STAAR to resolve these deficiencies, and removed the integrity hold.

 

STAAR’s ability to continue its U.S. business depends on the continuous improvement of its quality systems and its compliance with FDA regulations. Accordingly, for the foreseeable future STAAR’s management expects to continue to devote significant resources and attention to those efforts. STAAR cannot ensure that its efforts will be successful. Any failure to demonstrate substantial compliance with FDA regulations can result in enforcement actions that terminate, suspend or severely restrict our ability to continue manufacturing and selling medical devices. Please see the related risks discussed under the headings “We are subject to extensive government regulation, which increases our costs and could prevent us from selling our products” and “We are subject to federal and state regulatory investigations.”

 

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FDA approval of the Toric ICL, which could have a significant U.S. market, has been considerably delayed.

 

Part of STAAR’s strategy to increase U.S. sales of refractive products has been a plan to introduce the Toric ICL, or TICL, a variant of the ICL that corrects both astigmatism and myopia in a single lens and that is currently marketed outside the U.S. STAAR believes the TICL also has a significant potential market in the U.S. and could accelerate growth of the overall refractive product line.  STAAR submitted a supplemental premarket approval application (PMA) for the TICL in April 2006.  In August 2007 the FDA placed an integrity hold on the PMA and suspended its consideration of the PMA until STAAR completed specified actions to satisfy FDA concerns regarding deficiencies in STAAR’s oversight of past clinical activities.  The integrity hold was removed, and consideration of the application resumed on July 21, 2009.  On February 3, 2010, STAAR received a letter of deficiency from the FDA outlining additional questions and requesting labeling changes related to the TICL application.  The letter provides that STAAR has 180 days to present its response to the FDA.  STAAR cannot predict when or if the Toric ICL may be approved.

 

Continued effects of the global recession could reduce sales of our refractive products.

 

The global economy has been affected by a severe recession.  Since at least mid-2008 consumer spending has decreased in the U.S. as credit has become less available, unemployment has increased, and consumer confidence has declined.  Despite indications that the U.S. economy has resumed growth, employment, consumer spending and consumer confidence have not recovered to pre-recession levels in the U.S.  Many regions of the world remain severely affected, including Spain, which has been a significant market for the ICL and TICL.

 

Refractive surgery is an elective procedure generally not covered by health insurance.  Patients must pay for the procedure, frequently through installment financing arrangements.  They can defer the choice to have refractive surgery if they lack the disposable income to pay for it or do not feel their income is secure in the current economic climate.  Laser refractive surgery has experienced a significant decrease in demand globally.  STAAR believes that seven of the top ten refractive markets experienced a decline in total refractive procedures during 2009.  The U.S. market, where we believe procedures have declined to approximately 50% of their level two years ago, appears to be the worst affected.  Visian ICL sales have not been as badly affected, and grew worldwide in 2009.  If the economic recovery does become stronger, or if the global economy falls back into recession, Visian ICL sales could continue to grow slowly or decline.  Because the Visian ICL is STAAR’s fastest growing and highest gross margin product, restricted growth or a decline in its sales could materially harm STAAR’s business.

 

Negative publicity concerning complications of laser eye surgery could reduce the demand for our refractive products as well.

 

Negative publicity about laser eye surgery has appeared in the U.S. and some other refractive surgery markets.  For example, on April 25, 2008, the FDA Ophthalmic Devices Panel held a public meeting to discuss reports of medical complications and customer satisfaction following refractive surgery.  The resulting publicity broadened public awareness of the potential complications of refractive surgery and potential patient dissatisfaction, in particular as a result of LASIK and other corneal laser-based procedures.  These concerns may have, in part, been a factor in the steep decline in demand for such procedures during 2008 and 2009.  Concerns about complications of refractive laser eye surgery could encourage more patients and doctors to select the Visian ICL as an alternative, but could also decrease patient interest in all refractive surgery, including Visian ICL. Depending on the nature and severity of future negative publicity about refractive surgery, the growth of ICL sales in the U.S. could be limited or sales could decline as a result. Because nearly all candidates for refractive surgery can achieve acceptable vision through the use of spectacles or contact lenses, for most patients the decision to have refractive surgery is a lifestyle choice that depends on high confidence in achieving a satisfactory outcome.

 

Strikes, slow-downs or other job actions by doctors can reduce sales of cataract-related products.

 

In many countries where STAAR sells its products, doctors, including ophthalmologists, are employees of the government, government-sponsored enterprises or large health maintenance organizations. In recent years employed doctors who object to salary limitations, working rules, reimbursement policies or other conditions have sought redress through strikes, slow-downs and other job actions. These actions often result in the deferral of non-essential procedures, such as cataract surgeries, which affects sales of our products. For example, in fiscal year 2006, strikes and slow-downs by doctors in Germany were partly responsible for a drop in sales by our then wholly owned subsidiary Domilens GmbH, which distributes ophthalmic products in Germany. Such problems could occur again in Germany or other regions and, depending on the importance of the affected region to STAAR’s business, the length of the action and its pervasiveness, job actions by doctors can materially reduce our sales and earnings.

 

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Our sales are subject to significant seasonal variation.

 

We generally experience lower sales during the third quarter due to the effect of summer vacations on elective procedures. In particular, because sales activity in Europe and Japan drops dramatically in July and August, and these sales have recently accounted for a greater proportion of our total sales, this seasonal variation in our results has become even more pronounced.

 

We could experience losses due to product liability claims.

 

We have been subject to product liability claims in the past and may experience such claims in the future.  Product liability claims against us may exceed the coverage limits of our insurance policies or cause us to record a loss in excess of our deductible. A product liability claim in excess of applicable insurance could have a material adverse effect on our business, financial condition and results of operations. Even if any product liability loss is covered by an insurance policy, these policies have retentions or deductibles that provide that we will not receive insurance proceeds until the losses incurred exceed the amount of those retentions or deductibles. To the extent that any losses are below these retentions or deductibles, we will be responsible for paying these losses. The payment of retentions or deductibles for a significant amount of claims could have a material adverse effect on our business, financial condition, and results of operations.

 

Any product liability claim would divert managerial and financial resources and could harm our reputation with customers. We cannot assure you that we will not have product liability claims in the future or that such claims would not have a material adverse effect on our business.

 

We compete with much larger companies.

 

Our competitors, including Alcon, Abbot Medical Optics and Bausch & Lomb have much greater financial resources than we do and some of them have large international markets for a full suite of ophthalmic products. Their greater resources for research, development and marketing, and their greater capacity to offer comprehensive products and equipment to providers, make it difficult for us to compete. We have lost significant market share to some of our competitors.

 

The global nature of our business may result in fluctuations and declines in our sales and profits.

 

Our products are sold in approximately 50 countries. Sales from international operations make up a significant portion of our total sales. For the fiscal year ended January 1, 2010, sales from international operations were 79% of our total sales. The results of operations and the financial position of certain of our foreign operations are reported in the relevant local currencies and then translated into U.S. dollars at the applicable exchange rates for inclusion in our consolidated financial statements, exposing us to translation risk. In addition, we are exposed to transaction risk because some of our expenses are incurred in a different currency from the currency in which our sales are received. Our most significant currency exposures are to the Japanese Yen, Euro, and the Swiss Franc. The exchange rates between these and other local currencies and the U.S. dollar may fluctuate substantially. We have not attempted to offset our exposure to these risks by investing in derivatives or engaging in other hedging transactions.

 

Economic, social and political conditions, laws, practices and local customs vary widely among the countries in which we sell our products. Our operations outside of the U.S. are subject to a number of risks and potential costs, less stringent protection of intellectual property and economic, political and social uncertainty in some countries, especially in emerging markets. Our continued success as a global company depends, in part, on our ability to develop and implement policies and strategies that are effective in anticipating and managing these and other risks in the countries where we do business. These and other risks may have a material adverse effect on our operations in any particular country and on our business as a whole. We price some of our products in U.S. dollars, and as a result changes in exchange rates can make our products more expensive in some offshore markets and reduce our sales. Inflation in emerging markets also makes our products more expensive there and increases the credit risks to which we are exposed.

 

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The success of our international operations depends on our successfully managing our foreign subsidiaries.

 

We conduct most of our international business through wholly owned subsidiaries. Managing distant subsidiaries and fully integrating them into STAAR’s business is challenging. While STAAR seeks to integrate its foreign subsidiaries fully into its operations, direct supervision of every aspect of their operations is impossible, and as a result STAAR relies on its local managers and staff. Cultural factors, language differences and the local legal climate can result in misunderstandings among internationally dispersed personnel, and increase the risk of failing to meet U.S. and foreign legal requirements, including with respect to the Sarbanes-Oxley Act of 2002 and the U.S. Foreign Corrupt Practices Act. These risks increased after we completed the acquisition of STAAR Japan Inc., and, notwithstanding the March 2, 2010 sale of Domilens, our German distribution subsidiary, these risks remain significant. The risk that unauthorized conduct may go undetected will always be greater in foreign subsidiaries.

 

Our activities involve hazardous materials and emissions and may subject us to environmental liability.

 

Our manufacturing, research and development practices involve the use of hazardous materials. We are subject to federal, state and local laws and regulations in the various jurisdictions in which we have operations governing the use, manufacturing, storage, handling and disposal of these materials and certain waste products. We cannot completely eliminate the risk of accidental contamination or injury from these materials. Remedial environmental actions could require us to incur substantial unexpected costs, which would materially and adversely affect our results of operations. If we were involved in an environmental accident or found to be in substantial non-compliance with applicable environmental laws, we could be held liable for damages or penalized with fines.

 

We depend on key employees.

 

We depend on the continued service of our senior management and other key employees. The loss of a key employee could hurt our business. We could be particularly hurt if any key employee or employees went to work for competitors. Our future success depends on our ability to identify, attract, train, motivate and retain other highly skilled personnel. Failure to do so may adversely affect our results.

 

Changes in accounting standards could affect our financial results.

 

The accounting rules applicable to public companies like STAAR are subject to frequent revision. Future changes in accounting standards could require us to change the way we calculate income, expense or balance sheet data, which could result in significant change to our reported results of operation or financial condition.

 

We are subject to international tax laws that could affect our financial results.

 

STAAR conducts international operations through its subsidiaries. Tax laws affecting international operations are highly complex and subject to change. STAAR’s payment of income tax in the different countries where it operates depends in part on internal settlement prices and administrative charges among STAAR and its subsidiaries. These arrangements require judgments by STAAR and are subject to risk that tax authorities will disagree with those judgments and impose additional taxes, penalties or interest on STAAR. In addition, transactions that STAAR has arranged in light of current tax rules could have unforeseeable negative consequences if tax rules change.

 

If we suffer loss to our facilities due to catastrophe, our operations could be seriously harmed.

 

We depend on the continuing operation of our manufacturing facilities in California, Japan and Switzerland, which have little redundancy or overlap among their activities. Our facilities are subject to catastrophic loss due to fire, flood, earthquake, terrorism or other natural or man-made disasters. Our California and Japanese facilities are in areas where earthquakes could cause catastrophic loss. If any of these facilities were to experience a catastrophic loss, it could disrupt our operations, delay production, shipments and revenue and result in large expenses to repair or replace the facility. Our insurance for property damage and business interruption may not be sufficient to cover any particular loss, and we do not carry insurance or reserve funds for interruptions or potential losses arising from earthquakes or terrorism.

 

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Most of our products have single-site manufacturing approvals, exposing us to risks of business interruption.

 

We manufacture all of our products at our facilities in California, Switzerland, and Japan. Most of our products are approved for manufacturing only at one of these sites. Before we can use a second manufacturing site for an implantable device we must obtain the approval of regulatory authorities. Because this process is expensive we have generally not sought approvals needed to manufacture at an additional site. If a natural disaster, fire, or other serious business interruption struck one of our manufacturing facilities, it could take a significant amount of time to validate a second site and replace lost product. We could lose customers to competitors, thereby reducing sales, profitability and market share.

 

If we are unable to protect our information systems against data corruption, cyber-based attacks or network security breaches, our operations could be disrupted.

 

We are significantly dependent on information technology networks and systems, including the Internet, to process, transmit and store electronic information. In particular, we depend on our information technology infrastructure for electronic communications among our locations around the world and between our personnel and our subsidiaries, customers, and suppliers. Security breaches of this infrastructure can create system disruptions, shutdowns or unauthorized disclosure of confidential information. If we are unable to prevent such security breaches, our operations could be disrupted or we may suffer financial damage or loss because of lost or misappropriated information.

 

Risks Related to the Ophthalmic Products Industry

 

If we recall a product, the cost and damage to our reputation could harm our business.

 

Medical devices must be manufactured to the highest standards and tolerances, and often incorporate newly developed technology. From time to time defects or technical flaws in medical devices may not come to light until after the products are sold or consigned. In those circumstances, like others in our industry, we have voluntarily recalled our products.  Similar recalls could take place again. We may also be subject to recalls initiated by manufacturers of products we distribute. Courts or regulators can also impose mandatory recalls on us, even if we believe our products are safe and effective.  STAAR believes that in recent years it has been less affected by recalls than most of its U.S. competitors, but cannot eliminate the risk of a material recall in the future.  Recalls can result in lost sales of the recalled products themselves, and can result in further lost sales while replacement products are manufactured, especially if the replacements must be redesigned. If recalled products have already been implanted, we may bear some or all of the cost of corrective surgery. Recalls may also damage our professional reputation and the reputation of our products. The inconvenience caused by recalls and related interruptions in supply, and the damage to our reputation, could cause professionals to discontinue using our products.

 

If we fail to keep pace with advances in our industry or fail to persuade physicians to adopt the new products we introduce, customers may not buy our products and our sales may decline.

 

Constant development of new technologies and techniques, frequent new product introductions and strong price competition characterize the ophthalmic industry. The first company to introduce a new product or technique to market usually gains a significant competitive advantage. Our future growth depends, in part, on our ability to develop products to treat diseases and disorders of the eye that are more effective, safer, or incorporate emerging technologies better than our competitors’ products. Sales of our existing products may decline rapidly if one of our competitors introduces a superior product, or if we announce a new product of our own. If we fail to make sufficient investments in research and development or if we focus on technologies that do not lead to better products, our current and planned products could be surpassed by more effective or advanced products. In addition, we must manufacture these products economically and market them successfully by persuading a sufficient number of eye-care professionals to use them.

 

Resources devoted to research and development may not yield new products that achieve commercial success.

 

We spent about 8% of our sales on research and development during the fiscal year ended January 1, 2010, and we expect to spend approximately 10% of our sales for this purpose in future periods. Development of new implantable technology, from discovery through testing and registration to initial product launch, is expensive and typically takes from three to seven years. Because of the complexities and uncertainties of ophthalmic research and development, products we are currently developing may not complete the development process or obtain the regulatory approvals required for us to market the products successfully. Any of the products currently under development may fail to become commercially successful.

 

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Changes in reimbursement for our products by third-party payors could reduce sales of our products or make them less profitable.

 

Many of our products, in particular IOLs and products related to the treatment of glaucoma, are used in procedures that are typically covered by health insurance, HMO plans, Medicare, Medicaid, or other governmental sponsored programs in the U.S. and Europe. Third party payors in both government and the private sector continue to seek to manage costs by restricting the types of procedures they reimburse to those viewed as most cost-effective and by capping or reducing reimbursement rates. Whether they limit reimbursement prices for our products or limit the surgical fees for a procedure that uses our products, these policies can reduce the sales volume of our reimbursed products, their selling prices or both. For example, the Centers for Medicaid and Medicare have recently reduced the reimbursement rate for glaucoma procedures such as the implantation of our AquaFlow Device.  Future cost cutting initiatives could result in unexpected reductions in the reimbursement rates for IOLs and related products.  In some countries government insurers have sought to control costs by limiting the total number of procedures they will reimburse.  The U.S. Congress is currently considering legislative proposals that would significantly change the system of public and private health care reimbursement, and will likely consider such changes again in the future. We are not able to predict whether new legislation or changes in regulations will take effect at the state or federal level, but if enacted these changes could significantly and adversely affect our business.

 

We are subject to extensive government regulation worldwide, which increases our costs and could prevent us from selling our products.

 

STAAR is regulated by regional, national, state and local agencies.  In the U.S our regulators include the Food and Drug Administration, the Department of Justice, the Federal Trade Commission, the Office of the Inspector General of the U.S. Department of Health and Human Services and other regulatory bodies, as well as governmental authorities in those foreign countries in which we manufacture or distribute products. The Federal Food, Drug, and Cosmetic Act, the Public Health Service Act and other federal and state statutes and regulations govern the research, development, manufacturing and commercial activities relating to medical devices, including their pre-clinical and clinical testing, approval, production, labeling, sale, distribution, import, export, post-market surveillance, advertising, dissemination of information and promotion.

 

We are subject to similar regulatory regimes in other key regions of Europe and Asia, in particular Japan.   Regulations worldwide are becoming more stringent.  We have described in detail the regulations governing approval of medical devices and their manufacturing in the “Business – Regulatory Matters” section of this Report.  We are also subject to government regulation over the prices we charge and any rebates we may offer to customers. Complying with government regulation substantially increases the cost of developing, manufacturing and selling our products.

 

Competing in the ophthalmic products industry requires us to introduce new or improved products and processes continuously, and to submit these to the FDA for approval. Obtaining FDA approval is a long and expensive process, and approval is never certain. In addition, our operations are subject to periodic inspection by the FDA and international regulators. An unfavorable outcome in an FDA inspection may result in the FDA ordering changes in our business practices or taking other enforcement action, which could be costly and severely harm our business.

 

Our new products could take a significantly longer time than we expect to gain regulatory approval and may never gain approval. If a regulatory authority delays approval of a potentially significant product, the potential sales of the product and its value to us can be substantially reduced. Even if the FDA or another regulatory agency approves a product, the approval may limit the indicated uses of the product, or may otherwise limit our ability to promote, sell and distribute the product, or may require post-marketing studies. If we cannot obtain timely regulatory approval of our new products, or if the approval is too narrow, we will not be able to market these products, which would eliminate or reduce our potential sales and earnings.

 

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Investigations and allegations, whether or not they lead to enforcement action or litigation, can materially harm our business and our reputation.

 

Failure to comply with the requirements of the FDA or other regulators can result in civil and criminal fines, the recall of products, the total or partial suspension of manufacture or distribution, seizure of products, injunctions, whistleblower lawsuits, failure to obtain approval of pending product applications, withdrawal of existing product approvals, exclusion from participation in government healthcare programs and other sanctions. Any threatened or actual government enforcement action can also generate adverse publicity and require us to divert substantial resources from more productive uses in our business. Enforcement actions could affect our ability to distribute our products commercially and could materially harm our business.

 

From time to time STAAR is subject to formal and informal inquiries by regulatory agencies, which could lead to investigations or enforcement actions. Even when an inquiry results in no evidence of wrongdoing, is inconclusive or is otherwise not pursued, the agency generally is not required to notify STAAR of its findings and may not inform STAAR that the inquiry has been terminated.

 

STAAR maintains a hotline for employees to report any violation of laws, regulations or company policies anonymously, which is intended to permit STAAR to identify and remedy improper conduct. Nevertheless, present or former employees may elect to bring complaints to regulators and enforcement agencies. The relevant agency will generally be obligated to investigate such complaints to assess their validity and obtain evidence of any violation that may have occurred. In response to reports that its policies or applicable laws or regulations have been violated, STAAR may find it necessary to conduct its own intense investigations, which may be extensive. Even without a finding of misconduct, negative publicity about investigations or allegations of misconduct could harm our reputation with professionals and the market for our common stock. Responding to investigations or conducting internal investigations can be costly, time-consuming and disruptive to our business.

 

We depend on proprietary technologies, but may not be able to protect our intellectual property rights adequately.

 

We rely on patents, trademarks, trade secrecy laws, contractual provisions and confidentiality procedures and copyright laws to protect the proprietary aspects of our technology. These legal measures afford limited protection and may not prevent our competitors from gaining access to our intellectual property and proprietary information. Any of our patents may be challenged, invalidated, circumvented or rendered unenforceable. Any of our pending patent applications may fail to result in an issued patent or fail to provide meaningful protection against competitors or competitive technologies. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of our proprietary rights. Any litigation could result in substantial expense, may reduce our profits and may not adequately protect our intellectual property rights. In addition, we may be exposed to future litigation by third parties based on claims that our products infringe their intellectual property rights. This risk is exacerbated by the fact that the validity and breadth of claims covered by patents in our industry may involve complex legal issues that are open to dispute. Any litigation or claims against us, whether or not successful, could result in substantial costs and harm our reputation. Intellectual property litigation or claims could force us to do one or more of the following:

 

·

cease selling or using any of our products that incorporate the challenged intellectual property, which would adversely affect our sales;

·

negotiate a license from the holder of the intellectual property right alleged to have been infringed, which license may not be available on reasonable terms, if at all; or

·

redesign our products to avoid infringing the intellectual property rights of a third party, which may be costly and time-consuming or impossible to accomplish.

 

We may not successfully develop and launch replacements for our products that lose patent protection.

 

Most of our products are covered by patents that, if valid, give us a degree of market exclusivity during the term of the patent. We have also earned revenue in the past by licensing some of our patented technology to other ophthalmic companies. Generally, the legal life of a patent in the U.S. is 20 years from application. Patents covering our products will expire from this year through the next 20 years. Upon patent expiration, our competitors may introduce products using the same technology.  Key patents covering the Collamer formulation and essential design features of the Visian ICL and TICL will expire between 2014 and 2016.   As a result of this possible increase in competition, we may need to reduce our prices to maintain sales of our products, which would make them less profitable. If we fail to develop and successfully launch new products prior to the expiration of patents for our existing products, our sales and profits with respect to those products could decline significantly. We may not be able to develop and successfully launch more advanced replacement products before these and other patents expire.

 

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Risks Related to Ownership of Our Common Stock

 

Our charter documents could delay or prevent an acquisition or sale of our company.

 

Our Certificate of Incorporation empowers the Board of Directors to establish and issue a class of preferred stock, and to determine the rights, preferences and privileges of the preferred stock. These provisions give the Board of Directors the ability to deter, discourage or make more difficult a change in control of our company, even if such a change in control could be deemed in the interest of our stockholders or if such a change in control would provide our stockholders with a substantial premium for their shares over the then-prevailing market price for the common stock. Our bylaws contain other provisions that could have an anti-takeover effect, including the following:

 

·

stockholders have limited ability to remove directors;

·

stockholders cannot act by written consent;

·

stockholders cannot call a special meeting of stockholders; and

·

stockholders must give advance notice to nominate directors.

                   

Anti-takeover provisions of Delaware law could delay or prevent an acquisition of our company.

 

We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our common stock or prevent changes in our management.

 

Future sales of our common stock could reduce our stock price.

 

Our Board of Directors could issue additional shares of common or preferred stock to raise additional capital or for other corporate purposes without stockholder approval. In addition, the Board of Directors could designate and sell a class of preferred stock with preferential rights over the common stock with respect to dividends or other distributions. Sales of common or preferred stock could dilute the interest of existing stockholders and reduce the market price of our common stock. Even in the absence of such sales, the perception among investors that additional sales of equity securities may take place could reduce the market price of our common stock.

 

The market price of our common stock is likely to be volatile.

 

Our stock price has fluctuated widely, ranging from $0.79 to $4.26 per share during the year ended January 1, 2010 and was $3.63 on March 9, 2010.  Our stock price could continue to experience significant fluctuations in response to factors such as market perceptions, quarterly variations in operating results, operating results that vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations. Also, general political and economic conditions such as recession or interest rate fluctuations may adversely affect the market price of our stock.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

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Item 2.  Properties

 

Our operations are conducted in leased facilities throughout the world. Our executive offices, manufacturing, warehouse and distribution, and primary research facilities are located in Monrovia, California. STAAR Surgical AG maintains office, manufacturing, and warehouse and distribution facilities in Nidau, Switzerland. The Company has one additional facility in Aliso Viejo, California for raw material production and research and development activities. STAAR Japan maintains executive offices and distribution facilities in Shin-Urayasu, Japan and a manufacturing and R&D facility in Ichikawa City, Japan. The Company leases an additional sales and distribution facility in Australia. We believe our manufacturing facilities in the U.S., Switzerland and Japan are suitable and adequate for our current and future planned requirements. The Company could increase capacity by adding additional shifts at our existing facilities.

 

Item 3.  Legal Proceedings

 

Two lawsuits against STAAR, Parallax Medical Systems v. STAAR Surgical Company (California Superior Court, County of Orange, Case No. 07CC10136) and Moody v. STAAR Surgical Company; (California Superior Court, County of Orange, Case No. 07CC10132) were settled on March 30, 2010.  On that date STAAR and all other parties to the matters entered into a Stipulation for Settlement that globally resolves all pending disputes among them.  This settlement satisfies in full the $4.9 million judgment against STAAR in the Parallax matter and the $6.5 million judgment against STAAR in the Moody matter.  In exchange for complete mutual releases, the Stipulation provides for payment by STAAR of $4 million as its contribution to the global settlement.  STAAR’s contribution will be paid from the $7.4 million restricted deposit that STAAR placed with the Court on June 22, 2009.  The balance of those funds, approximately $3.4 million, will be returned to STAAR.  In connection with the settlement, STAAR will voluntarily dismiss its appeals in both cases.  The cases are described in greater detail below.

The Parallax Case.

The California Superior Court, County of Orange, rendered final judgment in the Parallax case on May 11, 2009, in accordance with a March 2, 2009 jury verdict finding that STAAR was liable for approximately $2.2 million in actual damages and $2.7 million in punitive damages to Parallax Medical Systems, Inc. for intentional and negligent interference with prospective business advantage. Parallax is a former independent regional manufacturer’s representative (“RMR”) of STAAR. Parallax promoted sales of STAAR products in the southeastern region of the U.S. under a contract that expired on July 31, 2007.  The jury found that STAAR had interfered with Parallax’s prospective economic advantage when it informed a regional IOL distributor that Parallax had a covenant restricting the sale of competing products.  On July 14, 2009, the Court in part granted STAAR’s motion to strike or reduce Parallax’s claim for approximately $109,000 in trial-related costs, of which approximately $56,000 was awarded to Parallax. On August 18, 2009, the Court amended its final judgment to include these costs and approximately $20,000 in pre-judgment interest, for a total judgment of $4,966,000.

On October 22, 2009, STAAR’s general liability insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for the appeal in the Parallax case. The insurer’s agreement to defend was subject to a full reservation of its rights and defenses.

STAAR filed notice of appeal of the Parallax judgment, and on June 22, 2009, deposited $7.3 million into a restricted account with the Court to assure payment of the judgment, thereby staying any enforcement of the judgment pending the appeal.  The deposit account bears interest, and as of the date of this Report the account balance is approximately $7.4 million.  STAAR filed its appellate Opening Brief on January 22, 2010.  Pursuant to the March 30, 2010 global settlement of the Parallax and Moody matters STAAR will voluntarily dismiss its appeal of the Parallax judgment;  $4 million of the funds deposited with the Court will be disbursed as directed by counsel for the Parallax and Moody plaintiffs.  The balance of approximately $3.4 million will be refunded to STAAR.

The Moody Case

The California Superior Court, County of Orange, rendered judgment in the Moody case against STAAR on December 8, 2009 in accordance with a December 1, 2009 jury verdict finding that STAAR was liable for $4 million in actual damages and $2.5 million in punitive damages to Scott C. Moody, Inc. (“SMI”) for intentional and negligent interference with prospective business advantage.  SMI, also a former RMR of STAAR, filed a complaint against STAAR on the same day that Parallax filed its complaint.  Moody promoted sales of STAAR products in the southwestern region of the U.S., under a contract that, like Parallax’s, expired on July 31, 2007.  The jury found that STAAR had interfered with SMI’s prospective economic advantage when it informed a regional IOL distributor that SMI had a covenant restricting the sale of competing products. Notice of judgment on post-trial motions in the case was served on February 8, 2010.  In post-trial motions the court granted the plaintiff’s motions for costs of $24,842 and for approximately $130,000 in legal fees and other assessments that STAAR has already paid separately from the funds to be contributed to the March 30, 2010 global settlement.

On October 14, 2009, STAAR’s general liability insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for its defense of the Moody case.  The insurer’s agreement to defend was subject to a full reservation of its rights and defenses.

 

On January 29, 2010, attorneys representing STAAR and SMI signed a stipulation extending the date for potential enforcement and execution of the $6.5 million Moody judgment to April 30, 2010.   The purpose of the extension was to allow the parties involved, including certain insurers, to attempt to negotiate a global settlement, along with the Parallax matter, in a mediation that took place on March 29-30, 2010, and to avoid the necessity of STAAR posting an appeal bond during the term of the stipulation.

STAAR filed notice of its appeal of the Moody judgment on March 8, 2010.  Pursuant to the March 30, 2010 global settlement of the Parallax and Moody matters STAAR will voluntarily dismiss its appeal of the Moody judgment.

From time to time the Company is subject to various claims and legal proceedings arising out of the normal course of our business. These claims and legal proceedings relate to contractual rights and obligations, employment matters, and claims of product liability. STAAR maintains insurance coverage for product liability claims. While the Company does not believe that any of the claims known is likely to have a material adverse effect on its financial condition or results of operations, new claims or unexpected results of existing claims could lead to significant financial harm.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

There were no matters submitted to a vote of security holders during the quarter ended January 1, 2010.

 

PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

 

Our Common Stock is traded on the Nasdaq Global Market under the symbol “STAA.” The following table sets forth the reported high and low bid prices of the Common Stock as reported by Nasdaq for the fiscal quarters indicated:

Period		High				Low
2009
Fourth Quarter		$	4.24			$	2.47
Third Quarter			4.26				1.90
Second Quarter			3.44				0.79
First Quarter			2.78				0.80
2008
Fourth Quarter		$	4.71			$	1.16
Third Quarter			5.98				2.98
Second Quarter			3.89				2.23
First Quarter			2.68				2.00

On March 9, 2010, the closing price of the Company’s Common Stock was $3.63 per share. Stockholders are urged to obtain current market quotations for the Common Stock.

 

As of March 11, 2010, there were approximately 504 record holders of our Common Stock.

 

We have not paid any cash dividends on our Common Stock since our inception. We currently expect to retain any earnings for use to further develop our business and not to declare cash dividends on our Common Stock in the foreseeable future. The declaration and payment of any such dividends in the future depends upon the Company’s earnings, financial condition, capital needs and other factors deemed relevant by the Board of Directors and may be restricted by future agreements with lenders.

 

As of March 10, 2010, options to purchase 3,145,281 shares of Common Stock were exercisable.

 

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Stock Performance Graph

 

The following graph compares the yearly and cumulative return on an investment in STAAR’s common stock over the last five fiscal years to the yearly and cumulative return of the following over the same time period: (1) the composite of all United States and foreign companies listed on the Nasdaq Stock Market (the “Nasdaq Index”); and (2) the composite of all United States and foreign companies listed on the Nasdaq Stock Market that operate in the surgical, medical and dental instrument and supply industries (the “Peer Index”), based on Standard Industrial Classification (“SIC”) codes in the range of 3840 through 3849. The Company’s SIC code is 3845. The comparison assumes $100 was invested on December 31, 2004 in STAAR’s common stock and in each of those indices, and that dividends were reinvested. The Center for Research in Security Prices of the University of Chicago’s Graduate School of Business compiled the Peer Index and produced the graph. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

In any of our filings under the Securities Act or Exchange Act that incorporate this Proxy Statement by reference, this graph will be considered excluded from the incorporation by reference and it will not be deemed a part of any such other filing unless we expressly state that the graph is so incorporated.

 

CRSP Total Returns Index for:			12/2004				12/2005				12/2006				12/2007				1/2009				1/2010
STAAR SURGICAL CO			100.0				126.00				111.82				42.11				37.97				49.44
Nasdaq Stock Market (US & Foreign)			100.0				102.27				112.80				124.68				59.76				86.89
NASDAQ Stocks (SIC 3840 – 3849 US + Foreign) Surgical, Medical, and Dental Instruments and Supplies			100.0				109.81				115.73				147.16				79.25				115.55

 

Notes:

 

           A. The lines represent monthly index levels derived from compounded daily returns that include all dividends.

 

           B. The indexes are reweighted daily, using the market capitalization on the previous trading day.

 

           C. If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used.

 

           D. The index level for all series was set to $100.0 on December 31, 2004.

 

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Item 6.  Selected Financial Data

 

The following table sets forth selected consolidated financial data with respect to the five most recent fiscal years ended January 1, 2010, January 2, 2009, December 28, 2007, December 29, 2006 and December 30, 2005. The selected consolidated statement of operations data set forth below for each of the three most recent fiscal years, and the selected consolidated balance sheet data set forth below at January 1, 2010 and January 2, 2009, are derived from our consolidated financial statements, which have been audited by BDO Seidman, LLP, independent registered public accounting firm, whose report is included in this Form 10-K. The selected consolidated statement of operations data set forth below for each of the two fiscal years in the periods ended December 29, 2006 and December 30, 2005, and the consolidated balance sheet data set forth below at December 28, 2007, December 29, 2006 and December 30, 2005 are derived from audited consolidated financial statements of the Company not included in this Annual Report. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of the Company, and the Notes thereto, included in this Annual Report, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

		Fiscal Year Ended
		January 1, 2010				January 2, 2009				December 28, 2007				December 29, 2006				December 30, 2005
		(In thousands except per share data)
Statement of Operations
Net sales		$	75,345			$	74,894			$	59,363			$	56,951			$	51,303
Cost of sales			33,452				34,787				30,097				30,801				27,517
Gross profit			41,893				40,107				29,266				26,150				23,786
Selling, general and administrative expenses
General and administrative			15,710				15,730				12,951				10,891				9,727
Marketing and selling			24,257				27,053				23,723				22,112				18,552
Research and development			5,893				7,938				6,711				7,080				5,573
Other operating expenses (recovery), net			(238	)			9,773				—				(331	)			746
Total selling, general and administrative expenses			45,622				60,494				43,385				39,752				34,598
Operating loss			(3,729	)			(20,387	)			(14,119	)			(13,602	)			(10,812	)
Total other (expense) income, net			(979	)			(1,285	)			(1,037	)			95				854
Loss before income taxes and non-controlling interest			(4,708	)			(21,672	)			(15,156	)			(13,507	)			(9,958	)
Income tax provision			1,492				1,523				843				1,537				1,239
Non-controlling interest			—				—				—				—				(22	)
Net loss		$	(6,200	)		$	(23,195	)		$	(15,999	)		$	(15,044	)		$	(11,175	)
Basic and diluted net loss per share		$	(0.19	)		$	(0.79	)		$	(0.57	)		$	(0.60	)		$	(0.47	)
Weighted average number of basic and diluted shares			32,498				29,474				28,121				25,227				23,704
Balance Sheet Data
Working capital		$	13,466			$	10,807			$	21,006			$	14,363			$	22,735
Total assets			58,681				52,582				54,179				47,770				52,755
Notes payable, net of discount			—	*			4,414				4,166				1,802				1,676
Other long-term liabilities			3,887				3,910				2,500				1,079				854
Stockholders’ equity			21,070				16,027				36,225				31,760				40,366

___________________

*   included in current liabilities

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The matters addressed in Management’s Discussion and Analysis of Financial Condition and Results of Operations that are not historical information constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Readers can recognize forward-looking statements by the use of words like “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will,” “target,” “forecast” and similar expressions in connection with any discussion of future operating or financial performance. In particular, these include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, and financial results.

 

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Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, such statements are inherently subject to risks and the Company can give no assurance that its expectations will prove to be correct. Actual results could differ from those described in this report because of numerous factors, many of which are beyond the control of the Company. These factors include, without limitation, those described in this Annual Report in “Item 1A — Risk Factors.” The Company undertakes no obligation to update these forward-looking statements after the date of this report to reflect future events or circumstances or to reflect actual outcomes.

 

The following discussion should be read in conjunction with the audited consolidated financial statements of STAAR, including the related notes, provided in this report.

 

Overview

 

Strategy

 

Performance Against 2009 Key Operational Metrics

 

During 2009, STAAR focused on the following key operational metrics:

 

·

to improve cash flow from operations;

·

to increase gross profit margin;

·

to continue cost reduction efforts;

·

to secure key regulatory approvals;

·

to increase the ICL’s share of the refractive market in key territories.

 

Achievement against these goals is discussed below.

 

Improve cash flow from operations. For several years prior to 2009 STAAR had not generated enough cash to sustain its operations.  STAAR has steadily reduced its use of cash significantly in recent quarters primarily through cost reductions, and in the second quarter of 2009 generated $286,000 in cash from operations, its first positive cash flow from operations after six consecutive negative years.  In the fourth quarter of 2009 STAAR generated $1,125,000 in cash from operating activities, compared to $991,000 used for operating activities in the fourth quarter of 2008.  During fiscal year 2009 STAAR generated $1.4 million in cash from operating activities, compared to $8.2 million in cash used for operating activities in 2008.

 

Improving cash flow and achieving profitability remain key goals of STAAR during 2010.  The sale of Domilens in the first quarter of 2010 will present a challenge in meeting these goals, because Domilens has historically been profitable and generated cash for STAAR.  STAAR’s objectives for earnings growth and continued positive cash flow, and risks related to their achievement, are discussed in detail below under “2010 Operational Goals.”

 

STAAR exited 2009 with cash, cash equivalents, and restricted cash of $13.7 million, compared with $5.2 million at January 2, 2009.  STAAR’s cash position was enhanced by the $8.5 million net cash proceeds of a registered direct offering of common stock completed on June 17, 2009.  STAAR also received approximately $12.5 million in net cash proceeds from the sale of Domilens in the first quarter of 2010.  The adequacy of cash we expect to generate from operations in 2010, along with the recently obtained capital, to satisfy STAAR’s needs is discussed below under “Liquidity and Capital Resources”

 

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During fiscal year 2008 and 2009 STAAR’s cash flow has been significantly affected by the cost of defending the Parallax and Moody lawsuits.  Both lawsuits were settled on March 30, 2009.  As a result, STAAR expects its legal costs to be approximately $1.5 million lower in 2010 than in 2009.

 

Increase gross profit margins.  In recent quarters STAAR has generally experienced increased sales in ICL and IOL sales.  While growth in sales remains an important goal, STAAR believes that the key to achieving sustainable profitability is to increase its gross profit margins.  Despite a number of initiatives to improve gross profit margins, STAAR’s gross profit margin for 2009 was 55.6%, up 200 basis points only because 2008 gross profit margins of 53.6% were negatively impacted by $1.5 million in purchase accounting charges recorded in the first quarter of 2008 related to the acquisition of STAAR Japan.

 

Several initiatives of STAAR helped gross profit margins in 2009, in particular increased worldwide sales of ICLs and TICLs, increased average selling prices of IOLs in the U.S., and de-emphasis on selling non-lens products.   However, a number of unexpected challenges offset these improvements:  reduced manufacturing yields; decreased average selling prices of IOLs and ICLs outside the U.S., and increased cost of goods in Germany, primarily as a result of changes in exchange rates.  Decreased average selling prices for IOLs primarily resulted from unusually strong price competition in Japan.  Decreased average selling prices for ICLs and TICLs primarily resulted from a pricing concession we made to our Korean distributor to enable the distributor to invest in intensified marketing efforts. We believe we have addressed most of the issues negatively impacting gross profit margins and that those efforts resulted in higher gross profit margins in the fourth quarter of 2009 compared with the third quarter of 2009.

 

The March 2, 2010 sale of Domilens GmbH is expected to significantly improve STAAR’s gross profit margins.  This and other initiatives to improve gross profit margin in 2010 are discussed below under “2010 Operational Goals.”

 

Continue Cost Reduction Efforts.  Achieving greater operating and administrative efficiency through reduced costs has been a key goal of STAAR, and is a significant element in achieving our goal of profitability.  In particular, while STAAR’s international operations have generally generated cash or have been cash flow neutral in recent quarters, losses from U.S. operations have been the principal cause of cash use and losses on a consolidated basis.  During 2009 STAAR continued cost reduction initiatives that began in the fourth quarter of 2007, yielding a combined reduction in marketing and selling and research and development expenses of $4.8 million in 2009 compared to 2008.  This included the following:

 

·

a 10.3% reduction in marketing and selling expense year-over-year, from $27.1 million to $24.3 million, principally as a result of decrease salaries, travel, consulting, promotional activities and commissions in the U.S; and

·

a 25.8% reduction R&D expenses year-over-year, from $7.9 million to $5.9 million, principally as a result of decreased salaries, reduced consulting fees and general cost containment.

 

STAAR believes that the global settlement of the Parallax and Moody litigation on March 30, 2010 will eliminate much of the litigation defense expense that STAAR experienced in 2008 and result in much lower legal expenses in 2010 compared to 2009.  Prior to the settlement, the availability of reimbursement for our legal fees from our insurance carrier, along with the transition of the lawsuits from trial to appeal, had already begun to reduce legal defense expense.   On October 14, 2009, STAAR’s general liability insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for its defense of the Moody case.  On October 22, 2009 the insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for the appeal in the Parallax case.  STAAR received $780,000 in reimbursement payments related to the Moody case in 2009, and through the date of this report has received $342,000 in 2010.  In connection with the global settlement of the Parallax and Moody cases STAAR will voluntarily dismiss its appeals, and except for minor post-settlement matters legal expenditures related to the cases will cease.

 

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Secure Key Regulatory Approvals.  Regulatory approvals of high gross profit margin products in significant markets can yield rapid growth in sales and improvements in profitability.  During 2009 the most significant approvals sought by STAAR were for sale of the Visian ICL and TICL in Japan and the TICL in the U.S.

 

As a result of progress made during 2009, Japan’s Ministry of Health, Labor and Welfare (MHLW) approved the sale of the ICL on February, 2, 2010, making it the first phakic IOL approved for the Japanese market.  STAAR intends to file a partial change application for approval of the VISIAN Toric ICL, and is currently in discussions with the Pharmaceuticals and Medical Device Agency (PMDA) regarding that process. MHLW generally requires up to one year to fully process a partial change application, although that timeline can change based on the nature of the product under review.  Following a two-year process in which STAAR addressed a number of agency concerns, on July 21, 2009, the U.S. Food and Drug Administration (“FDA”) notified STAAR that as a result of STAAR’s corrective actions the FDA had removed an integrity hold on our application for approval of the TICL, and would resume its consideration of the application.  Substantive discussions with the FDA regarding the application resumed at that time. On February 3, 2010 STAAR received a letter of deficiency from the FDA requesting additional analysis of data supporting the safety and effectiveness of the TICL and requesting changes in proposed labeling for the product.  STAAR is preparing a comprehensive response to the items in this letter.

 

Increase the ICL’s Share of the Refractive Market in Key Territories.  After introducing the ICL in international markets in 1996 STAAR has secured approval for sale in over 40 countries.  While sales have increased as new territories were added, we have achieved significant sales and increased share of the refractive surgical market in a select number of territories:  in particular, the U.S., Korea, China, India, Spain, Germany, and Latin America.  In order to increase ICL sales most effectively, in 2009 STAAR adopted a strategy of focusing on increasing the ICL’s share of the refractive market in those territories.  Based on growth in STAAR’s sales in those countries, and statistics indicating a general decline in the overall refractive market, STAAR believes it succeeded in increasing market share in each of those territories in 2009.  The most significant growth took place in the Korean market, where sales reported by STAAR’s independent distributor indicate that the Visian products exceeded a 10% share of the overall refractive market.  Along with its new opportunity in Japan, STAAR intends to continue to focus its Visian ICL marketing efforts on this group of key markets in 2010.

 

Key Operational Metrics for 2010

 

During 2010, STAAR is focused on the following key operational metrics which are designed to enable the company to pursue new growth strategies:

 

·

Double digit growth in sales from core ICL and IOL products;

·

Improvement in gross profit margins to the mid-60% level for the year;

·

Progress toward profitability throughout the year, with a goal of achieving net income for the full year;

 

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·

Continued generation of cash;

·

Improve financial condition by retiring obligations and strengthening the balance sheet.

 

Double digit growth in sales from core ICL and IOL products.  To continue generating cash from operations and reach profitability, STAAR must significantly improve sales derived from its higher value products.   The sale of Domilens, which has significantly reduced the portion of STAAR’s sales derived from lower gross profit margin sales such as third party products, disposables and surgical kits, provides an opportunity for STAAR to focus on its core ICL and IOL products.

 

STAAR achieved approximately 15% growth in worldwide ICL sales during 2009, and believes similar growth is achievable in 2010, especially with expansion into the Japanese market following the February 2, 2010 approval of the ICL.  However, the rate of growth in Visian ICL sales will partly depend on continued improvement in worldwide economic conditions.  ICL surgery is a relatively expensive elective procedure and is seldom reimbursed by insurers or government agencies.  STAAR believes that that global recession has reduced overall demand for refractive surgery.

 

STAAR will continue to focus its ICL marketing efforts in the key territories where it has established significant market share, based on the success of this strategy in 2009.  Japan will be added to the list in 2010; like other Asian countries, Japan has a high mean rate of myopia, which makes it a promising new market.  The key territories in which STAAR will seek to enhance Visian sales during 2010 are the U.S., Japan, Korea, China, India, Spain, Germany, U.K., and France.  STAAR believes that the singular success of Visian products in Korea, where STAAR believes it has exceed a 10% penetration rate among all refractive surgical procedures, may provide a model of best practices to increase market share in other key territories.

 

U.S. military forces currently represent the largest single customer for ICLs in the U.S.  Military purchases of ICLs accounted for most of STAAR’s 2.5% growth in 2009 U.S. ICL sales over 2008.  STAAR does not believe that private sector purchases of ICLs will resume growing significantly until consumer confidence improves, which depends on continued recovery in the U.S. economy.

 

During 2009 STAAR’s international IOL sales increased by 7.6% and U.S. IOL sales decreased by 8.3%.  Challenges faced by STAAR in selling IOLs in 2009 included stronger than usual price competition in Japan, where average IOL selling prices are typically higher than in other countries.  To maintain gross profit margins of STAAR Japan, STAAR has chosen not to the match deep discounts offered by some competitors, which may limit opportunities to increase Preloaded Injector sales in Japan until economic conditions improve.

 

STAAR has seen its U.S. IOL sales volume decline steadily for the last several years.  However, the rate of decline has recently decreased and STAAR’s introduction of aspheric IOLs with NTIOL status in 2008 and 2009 has resulted in higher average selling price for STAAR’s IOLs in the U.S., further reducing erosion in sales.  STAAR introduced three new products in the U.S. in 2009 to drive growth in its IOL market, the nanoFLEX IOL, the nanoPOINT injection system, and the advanced Epiphany injector for STAAR’s three-piece Collamer aspheric lens.  These products did not have a significant impact on sales within 2009 due to timing of introduction, but STAAR believes they will have greater impact in 2010, especially the nanoFLEX IOL.  STAAR believes its recent product introductions have given the company a very competitive IOL product line with unique features and benefits, and offer an opportunity to regain lost IOL market share.  STAAR intends to support these products with sales and marketing growth based  initiatives in 2010.

 

STAAR also expects to obtain FDA approval to sell its silicone Preloaded Injectors in the U.S. during 2010.  STAAR believes this product will further enhance its U.S. IOL offering, and will help STAAR maintain or increase its market share in the silicone IOL segment.

 

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Improvement in gross profit margins to the mid-60% level for the year.  As noted above, STAAR did not make the progress it had planned towards increasing gross profit margin in 2009.   However, in 2008 STAAR had significantly improved gross profit margin from 49.3% in 2007 to 53.6% in 2008, and STAAR believes it has an opportunity to again increase gross profit margins significantly in 2010.  An important factor in this expected improvement is the March 2, 2010 sale of Domilens, which will remove some of the lowest gross profit margin sales from STAAR’s product mix:  third party products, supplies and disposables like surgical drapes, and assembly of custom surgical kits.  STAAR will seek to further increase gross profit margin through the following:

·

Increasing ICL sales as a percentage of STAAR’s overall product mix.  Visian ICLs and TICLs generally yield an 80% gross profit margin.  The Visian product line is STAAR’s most profitable product family and the largest contributor to enhanced gross profit margins.  During 2010 we expect the launch of ICL sales in Japan, and expanding market share in existing markets, to improve STAAR’s profitability.  The sale of Domilens, whose products were overwhelmingly in the cataract area and included many non-lens products, has significantly increased the portion of our sales derived from the Visian product line.

·

Reducing Cost of Preloaded Injectors.  In Japan IOLs enjoy higher average selling prices than in most countries, and as a result the Japan IOL business can yield significant gross profit margins and contribute significantly to STAAR’s improvement in gross profit margins.  However, price competition has recently increased in the Japan IOL market, indicating that STAAR must reduce the cost of producing Preloaded Injectors to sustain or improve IOL gross profit margins in Japan.  STAAR believes opportunities exist to further reduce manufacturing costs for its products sold in Japan, which could better enable STAAR to maintain profits in the face of such competition.

·

Increase sales of Higher Value IOLs in the U.S. In 2007 and 2008 STAAR began converting its U.S. IOL product offering from lower value legacy products to newer aspheric designs that are eligible for enhanced CMS reimbursement as NTIOLs.  With the introduction of the nanoFLEX IOL in 2009, STAAR has introduced aspheric versions for both of its IOL product platforms.  As STAAR’s customers switch to aspheric lenses, and STAAR sells down its inventories of non-aspheric lenses, U.S. IOL gross profit margins have increased.  This process will continue in 2010.  In addition, early results of marketing efforts for the nanoFLEX lens suggest that this product may attract new customers to STAAR IOLs and rebuild U.S. IOL market share, further enhancing gross profit margins.

·

Continue to Implement Centers of Excellence Program.  STAAR believes that it has an opportunity to reduce costs while continuing its history of innovation by rationalizing its business among its worldwide operations through its Centers of Excellence program.  During 2009 STAAR moved the production of silicone IOLs for use in Preloaded Injectors from Japan to the U.S., centralizing all silicone lens production in the U.S., thereby reducing STAAR’s overall IOL costs.  During 2010 STAAR intends to complete the transfer of IOL and ICL injector system manufacturing and R&D from the U.S. to Japan, which is expected to lead to cost savings and a greater focus on STAAR Japan’s more advanced lens injector designs.  STAAR also intends to take further efforts to improve silicone manufacturing efficiency in the U.S., based in part on the efficiencies of scale made possible by centralized manufacturing.

 

Progress toward profitability throughout the year, with a goal of achieving net income for the full year.  STAAR has reported net losses in each period since 1999.  Having achieved positive cash flow from operations in 2009, STAAR is now focused on the goal of delivering net income for fiscal year 2010.  Achieving this goal will require further reductions in STAAR’s expenses and success in the initiatives to improve profitability contained in our other 2010 objectives.

 

Continued generation of cash flow from operations.  STAAR achieved positive cash flow from operations in 2009, and intends to continue its initiatives to improve cash flow in 2010.  To be successful, cash previously generated by Domilens, which accounted for $1.8 million of STAAR’s cash from operations in 2009, will need to be replaced with increased cash from STAAR’s remaining operations, although it is anticipated that reduced legal fees should offset a significant portion of the lost cash flow from Domilens. STAAR has been especially challenged to meet its cash flow goals in the first quarter.  The first quarter of each fiscal year tends to have the lowest cash flow of the year because of accounting fees related to the annual audit of our financial statements, professional fees for our consultant on internal controls pursuant to the Sarbanes-Oxley Act of 2002, and holiday closures of facilities during December that reduce the processing and payment of invoices by STAAR during the last weeks of the fourth quarter, resulting in a significant increase in cash payments by STAAR as it catches up during the first month of the first quarter.

 

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Improve financial condition by retiring obligations and strengthening the balance sheet. Although the $12.5 million in cash raised from the sale of Domilens significantly improved the cash position of the Company, as discussed below under “Liquidity and Capital Resources,” some of the cash may be needed to meet current financial obligations in 2010 as follows:

·

repayment of the $5 million principal balance on the Broadwood Note due on December 14, 2010;

·

the right of the holders of 1.7 million shares of our Series A Convertible Preferred stock to redeem them at $4 per share or $6.8 million in aggregate beginning on December 29, 2010.

 

STAAR’s goal is resolve all of its major obligations with existing capital reserves and cash generated from operations.  It also seeks to reserve any future capital raising efforts for initiatives to expand its business, rather than meeting existing obligations.  Nevertheless, depending on STAAR’s cash position during the remainder of 2010, it may find it necessary to seek additional financing.  See “Financing Strategy” below.

 

Other Highlights

 

Divestiture of Domilens.

 

On March 2, 2010 we completed the divestiture of all of our interest in our former German distribution subsidiary, Domilens GmbH through a management buyout led by funds managed by Hamburg-based Small Cap Buyout Specialist BPE Unternehmensbeteiligungen GmbH (“BPE”).  STAAR’s financial advisor in the transaction was Berenberg Bank, a German investment bank headquartered in Hamburg.

 

The decision to divest Domilens resulted primarily from a need to raise working capital.

 

STAAR originally purchased Domilens in a series of stock purchases from the founder of the business between 1998 and 2003.  STAAR originally intended to use Domilens as a channel for increased sales in the German market.  However, by 2009 sales of STAAR product accounted for only approximately 7.6% of Domilens sales.  The majority of Domilens sales have been third party products, including IOLs of other manufacturers, disposables and other supplies such as surgical drapes, and the assembly of custom surgical kits containing a package of mostly third party products needed for a single procedure.  While profitable, this business operates at gross profit margins that are significantly lower than STAAR’s overall average.

 

A distribution agreement between STAAR and Domilens provides that Domilens will continue to purchase STAAR products at the unit sales volume previously projected for 2010 through 2012.  Because of the nature of the Domilens business and the promise of continued distribution in Germany and Austria at projected levels, STAAR determined that the sale of Domilens would not impede its core business, and would permit management to focus on higher value core business of developing, manufacturing and selling its own advanced ophthalmic products.

 

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STAAR also determined that the gross purchase price for Domilens, at approximately 6.9 times Domilens’ earnings before income taxes, represented a reasonable value for its investment in Domilens, and that these funds were of greater use to STAAR as working capital.  The Stock Purchase Agreement provides for a Purchase Price of €10,512,100 (approximately $14.3 million at currently prevailing exchange rates).  After adjusting for €800,000 in cash dividends received by STAAR from Domilens in December 2009 and January 2010, and the exclusion of expenses related to compliance with the Sarbanes-Oxley Act of 2002, at closing on March 2, 2010 Domilens Akquisitions paid a cash Net Purchase Price of €9,685,700 (approximately $13.2 million at currently prevailing exchange rates).  €100,000 of the Net Purchase Price was paid into an escrow account, to be held against payment of any unaccrued taxes assessed for periods prior to December 31, 2009.  Funds remaining after the resolution of such potential liabilities, if any, will be distributed to STAAR from the escrow account, no later than December 31, 2011.

 

After expenses of €358,000 (~$485,000) related to investment banking fees, and excluding the escrowed funds and any earn-out payments, STAAR received net cash proceeds of approximately €9.2 million from the Transaction (approximately $12.5 million at the Closing Date foreign exchange rate).  The Company will pay a $64,000 marketing allowance in 2010 for Domilens to market STAAR’s products post the Transaction.  Taxes related to the disposition of Domilens were estimated to be insignificant.

 

Based on the performance of Domilens in fiscal years 2010, 2011 and 2012, STAAR may earn up to an additional €675,000 (approximately $920,000 at currently prevailing exchange rates).  These additional “earn-out” payments will be paid on achievement of specified earnings before income tax (“EBIT”) as set forth below.  If a target is missed in any year, but in the following year Domilens achieves the target and also makes up for the earlier shortfall, the payments for both years will be earned and paid.

 

Fiscal Year		Domilens EBIT		Earn-Out Payment
2010		€2,500,000 (~ $3.4 million)		€200,000 (~$273,000)
2011		€2,900,000 (~ $3.9 million)		€225,000 (~$307,000)
2012		€3,500,000 (~ $4.7 million)		€250,000 (~$340,000)

 

The benefits expected to be achieved from the Domilens divestiture include the following: approximately $12.5 million in net cash proceeds; greater focus on STAAR’s core business; significantly enhanced gross profit margins; and a contractual commitment to meet projected sales levels for STAAR products in Germany and Austria through 2012.

 

The earn-out payments will be earned only if Domilens significantly improves its performance over levels it has historically been able to achieve. Domilens may not be able to achieve these improvements.  The escrow account will be used to pay any additional unaccrued taxes that the German tax authorities may assess after their next tax audit, which the Company cannot predict and may leave little or no funds in the escrow account remaining for distribution to the Company.

 

U.S. ICL Sales.

 

U.S. ICL Sales. We consider ICL sales growth in the U.S. market to be important because of the size of the U.S. refractive surgery market and the perceived worldwide leadership of the U.S. in adopting innovative medical technologies. The Visian ICL was approved by the FDA for treatment of myopia on December 22, 2005.

 

Visian ICL sales in the U.S. grew by 2.5% during 2009 compared to prior year, and grew 18% in 2008 when compared to 2007 levels.  Most of the U.S. growth in ICL sales has been in sales to the military, while most of the private sector suffered similar declines to the overall refractive market in the U.S.  Despite these continuing challenges to the LASIK market the Visian ICL has continued to grow market share.

 

 

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In order to significantly increase U.S. sales of the ICL, private sector sales must also resume growth.  STAAR believes that the continued global recession represents the largest challenge to increased growth in U.S. private sector ICL sales. Refractive surgery is an elective procedure generally not covered by health insurance. Patients must pay for the procedure, frequently through installment financing arrangements.  STAAR believes that the lack of growth in private sector ICL sales in the U.S. results from the significantly lower volume of patients seeking refractive surgery in the last two years, which has reduced the number of patients to whom the ICL is offered. While ICL sales have been much more resistant to the recession than laser-based procedures, unless the recent economic recovery continues and consumer spending levels also recover, private sector ICL sales will not grow significantly and may decline.  STAAR believes that its share of the U.S. refractive market has grown during the past two years, which will position the ICL for strong sales growth when conditions improve. By contrast, the U.S. refractive market has declined by approximately 50% during the past two years.

 

The ICL has continued to benefit from positive media coverage during 2009 and early 2010.  For example, in February 2010, it was widely reported that Steve Holcomb, who won a gold medal in 2010 Winter Olympics as pilot of the U.S. four-man bobsled team, had been able to continue his successful athletic career only because he had receive ICLs to correct his severe myopia approximately two years ago.

 

In addition to poor conditions in the general economy and in particular the refractive surgery market, other challenges to sustained growth in U.S. Visian ICL sales include the following:

 

·       the U.S. refractive surgery market has been dominated by corneal laser-based techniques, which continue to be better known than the Visian ICL among potential refractive patients;

 

·       other newly introduced surgical products will continue to compete with the Visian ICL for the attention of surgeons seeking to add new, high value surgical products, in particular multifocal and accommodating IOLs;

 

·       negative publicity about complications of LASIK could reduce interest in all refractive surgical procedures; and

 

·       FDA approval of the TICL, which STAAR sells in international markets for treating patients affected by both myopia and astigmatism, has been delayed.

 

On April 25, 2008, the FDA Ophthalmic Devices Panel held a public meeting to discuss issues of medical complications and customer satisfaction following refractive surgery. While the panel also discussed phakic IOLs such as the Visian ICL, most of its discussions centered on LASIK and testimony regarding customer dissatisfaction following LASIK surgery. The Panel recommended enhanced patient warnings of possible complications for LASIK and created a task force to study methods of better identifying those patients who are more likely to have an unsatisfactory outcome from laser vision correction. On October 15, 2009, the FDA announced a three-phase collaborative study on the potential impact of LASIK surgery on a patient’s quality of life, and also issued warning letters to seventeen ambulatory surgery centers citing inadequate systems for reporting adverse events resulting from LASIK. These FDA activities have been widely reported in the U.S. While it is difficult to assess precisely the impact that the FDA’s increased scrutiny on LASIK has had on patient attitudes or the recommendations of practicing surgeons, it is possible that reduced demand for laser eye surgery observed in 2008 and 2009 was caused in part by concerns regarding complications and potential patient dissatisfaction. Patient concerns about LASIK could increase interest in the Visian ICL as an alternative for patients who have a greater risk of complications from LASIK. The fact that the Visian ICL is removable if a patient is dissatisfied with the outcome may also be appealing to some patients with new concerns about risks of refractive surgery. However, STAAR believes the negative publicity concerning LASIK has decreased patient interest in all refractive surgery, including Visian ICL. Because nearly all candidates for refractive surgery can achieve acceptable vision through the use of spectacles or contact lenses, for most patients the decision to have refractive surgery is a lifestyle choice that depends on high confidence in achieving a satisfactory outcome.

 

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STAAR makes the ICL available to selected surgeons only after completion of a training program that includes proctoring of selected supervised surgeries. STAAR believes that this carefully guided method of product release is essential to help ensure the consistent quality of patient outcomes and the high levels of patient satisfaction needed to establish wide acceptance of the ICL as a primary choice for refractive surgery.

 

As the U.S. market for ICLs has matured, STAAR has placed less emphasis on increasing its overall customer base and devoting more attention to identifying and supporting those practices that show potential for significant repeat business through a professional commitment to the ICL technology.

 

Because the refractive surgery market has been dominated by corneal laser-based techniques, STAAR faces special challenges in introducing an intraocular refractive implant. STAAR has developed a number of marketing tools and practice support programs to increase the use of the ICL and awareness of its advantages in refractive surgery centers throughout the U.S. and around the world.

 

U.S. IOL Sales.

 

For several years STAAR has experienced a decline in U.S. market share of IOLs. The rate of decline has slowed as STAAR has begun replacing older lens designs with higher priced NTIOL lenses. During 2009 U.S. IOL sales declined 8% compared to rates of decline of 16% 2008 and 20% in 2007. Factors contributing to long-term decline in U.S. IOL sales include the slow pace of product improvement and enhancement during a period when we devoted most of our research and development resources to introducing the ICL and to resolving the regulatory and compliance issues raised by the FDA. This long-term trend was intensified in 2007 by disruption in STAAR’s independent sales force when STAAR was unable to reach a new contract with regional manufacturer’s representatives in the third quarter of 2007. In addition the trend was exacerbated by STAAR’s lagging behind its competitors in the introduction of IOLs with advanced aspheric optics, and by the entry of Alcon as a competitor in the Toric IOL market.

 

STAAR’s strategy to achieve its gross profit margin target in its U.S. IOL business is to rationalize its product offering around its higher value products, including recently introduced products and products planned for introduction in the near future. This has included aspheric optics across all IOL platforms, approval of higher reimbursement from Medicare for these lenses, improved delivery systems for Collamer IOLs to broaden their appeal and preloaded delivery systems for silicone lenses. Successful implementation of this strategy is subject to risks, including the risk of delays in developing new products or securing regulatory approval.

 

STAAR’s initiatives to enhance its IOL product line have resulted in the following recent developments:

 

·

the introduction of STAAR’s aspheric three-piece Collamer IOL in April 2007;

 

·

the introduction of STAAR’s aspheric three-piece silicone IOL November 2007;

 

·

the April 2008 introduction of the nanoPOINT injector, which delivers STAAR’s single-piece Collamer IOL, through a 2.2 mm incision;

 

·

the grant of New Technology IOL (“NTIOL”) status for the aspheric three-piece Collamer IOL in March 2008;

 

·

the grant of NTIOL status for the nanoFLEX aspheric single-piece Collamer IOL and the aspheric three-piece silicone IOL in July 2008;

 

·

the introduction of the nanoFLEX aspheric single-piece Collamer IOL in the second quarter of 2009, which brings advanced aspheric optics to the micro-incision nanoPOINT platform; and

 

·

the launch of the Epiphany injector for the Collamer three-piece lens in the third quarter of 2009 which brings smoother and more controlled delivery to one of STAAR’s most advanced lenses and paves the way for U.S. introduction of the silicone preloaded injector.

 

 

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The addition of aspheric optics to STAAR’s IOL designs has been a primary focus of STAAR’s recent development efforts. Aspheric IOLs use advanced optical designs intended to provide a clearer image than traditional spherical lenses, especially in low light, which has led to significant market share gains for aspheric designs. In recognition of these advantages the Centers for Medicare and Medicaid Services (“CMS”) will grant NTIOL status to aspheric IOLs that can demonstrate improved visual performance over conventional IOLs, allowing an extra $50 reimbursement per lens implanted in an ASC (ambulatory surgical center). This additional reimbursement expires on February 26, 2011 for all IOLs in this class. Because the majority of IOL purchases in the U.S. are implanted at ASCs and reimbursed through Medicare, NTIOL status significantly increases STAAR’s potential margin on qualifying lenses.

 

All of STAAR’s aspheric lenses sold in the U.S. feature a proprietary optical design (patent pending) that is optimized for the naturally curved surface of the retina and certain other anatomical features of the human eye, and provides outstanding image quality even if decentered.

 

STAAR intends to continue to focus on the following projects designed to make our IOL product offering more competitive:

 

·

Complete the development of the Collamer Toric IOL to complement our pioneering silicone Toric IOL and better compete with the Alcon acrylic Toric IOL. The Collamer Toric IOL should provide a product with advanced optic materials and rotational stability to provide superior outcomes for cataract patients with astigmatism;

 

·

Gain approval for a preloaded silicone IOL injector system in the U.S. in 2010;

 

·

Develop a preloaded injector system for our Collamer IOLs;

 

·

Initiate a formal post-market clinical evaluation to support a possible submission to the FDA of claims that the lens offers patients less spectacle dependence or accommodation; and

 

·

Initiate a clinical study of a new IOL we have designed to enhance the accommodating properties of Collamer.

 

STAAR cautions that the successful development and introduction of new products is subject to risks and uncertainties, including the risk of unexpected delays and, in some cases, approval of regulatory authorities.

 

STAAR’s development efforts aim to realize the full market potential for Collamer IOLs by continuously improving lens delivery systems and differentiating STAAR’s silicone IOL offering through the Preloaded Injector. Approximately one-half of IOLs sold by STAAR in the U.S. are made of silicone, which was the original material used for foldable IOLs. Physician preferences in the U.S. have shifted to toward acrylic IOLs and silicone IOLs now account for approximately 18% of the U.S. IOL market. STAAR believes that its Collamer lenses have outstanding optical qualities and superior biocompatibility, and should be capable of competing with any of our competitor’s acrylic lens products in the advanced material sector. In addition, increasing use of the ICL, which relies on the outstanding optical properties of Collamer, has also introduced the advantages of the Collamer material to a growing number of surgeons. However, growth of the Collamer IOL market has been limited by the difficulty of perfecting delivery systems for the soft Collamer material. Although acrylic lenses do not have the same level of optical performance in the eye as Collamer and often introduce glare or glistening into the visual field, the stiffness and toughness of the acrylic material makes design of delivery systems less difficult. STAAR has completed a number of development projects in place intended to make Collamer lenses easier to deliver and broaden customer appeal. The nanoPOINT injector system, which delivers the nanoFLEX one-piece Collamer IOL through a 2.2 mm incision, was the first of these projects to reach market and was launched in April 2008. In addition the launch of the Epiphany injector for the Collamer three-piece lens in the third quarter of 2009 brings smoother and more controlled delivery to one of STAAR’s most advanced lenses.

 

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Over the past several years surgeons implanting the nanoFLEX IOL have reported that their cataract patients have better than expected near vision. In late 2008, STAAR organized the Collamer Accommodating Study Team or “CAST.” The CAST consists of eight prominent physicians across the U.S. who are implanting the recently launched nanoFLEX IOL and are checking both near and intermediate vision approximately one month post operation. Feedback from the group indicates that the near vision achieved is better than that of any conventional IOL where we have comparative data. The feedback also indicates that the intermediate vision is better than “presbyopia correcting” IOLs that have been studied and near vision approaches that of presbyopia correcting IO that are already on the market.

 

While introduction of the nanoFLEX lens did not result in increased U.S. IOL sales in 2009, STAAR believes that surgeon interest in the product is growing and that it represents a significant opportunity to increase STAAR’s U.S. IOL market share.  To further pursue this opportunity, in the first quarter of 2010 STAAR initiated a program called the “nanoFLEX challenge” which is intended to facilitate an interested surgeon’s evaluation of the visual outcomes for patients receiving nanoFLEX IOLs compared with the outcomes from any other standard IOL currently used by the surgeon.

 

The 2009 introduction of the Epiphany injector, an advanced system which makes delivery of the three-piece Collamer aspheric IOL more reliable and predictable, has not resulted in increased sales of this advanced lens. Based on surgeon feedback, STAAR has developed an easier loading mechanism for this injector, which it intends to introduce in the first half of 2010.  STAAR believes that this lens also has the potential to improve STAAR’s market share, particularly among surgeons who prefer loop haptics to the plate haptic design of the nanoFLEX.   It plans concerted marketing efforts for the three-piece Collamer aspheric lens once the improved Epiphany injector becomes available.

 

While the market share of silicone IOLs has been slowly declining overall, a significant number of surgeons continue to select silicone lenses for their patients. Among U.S. IOL sales, STAAR believes that its recently introduced aspheric, three-piece silicone IOL offers outstanding optical performance and with its recently granted NTIOL status could enable STAAR to retain or possibly increase its market share within the silicone IOL sector, especially if STAAR’s efforts are successful in securing FDA approval to make it available in a Preloaded Injector.

 

Reversing the decline in U.S. IOL sales will require STAAR to overcome several short and long-term challenges, including successfully meeting its objectives to develop new and enhanced products, organizing, training and managing a specialized cataract sales force, managing independent local sales representatives, and competing with much larger companies. We cannot assure that this strategy will ultimately be successful.

 

Medical Device Regulatory Compliance, Clinical Oversight and TICL Approval.  As discussed above under the caption “Business — Regulatory Matters,” STAAR’s ability to develop, manufacture and distribute its products depends heavily on maintaining good standing with the FDA and other regulatory agencies. Based, in part, on the results of the FDA inspections of STAAR’s California facilities in 2009 and 2006 and STAAR’s Nidau, Switzerland facility in 2009, STAAR believes that it is substantially in compliance with the FDA’s Quality System Regulations and Medical Device Reporting regulations.  STAAR has invested significant resources in maintaining regulatory compliance and expects to continue to do so in the future.

 

Financing Strategy

 

STAAR has reported losses and negative cash flows on a consolidated basis over the last several years, primarily as a result of losses in the U.S. business. During this period STAAR has raised additional funds to support operations through sales of equity and debt securities. As cash flow improved in recent quarters, STAAR has sought to avoid further financings and to operate exclusively on self-generated cash. This strategy was challenged in the first quarter of 2009, when cash reserves were drawn down to low levels, positive cash flow had not yet been achieved, and the Company suffered an adverse litigation judgment in the amount of approximately $4.9 million. At the time the judgment became final, STAAR did not have adequate cash or cash equivalents either to satisfy the judgment or to deposit $7.3 million with the court to obtain a stay of enforcement of the judgment while the appeal was pending.

 

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On June 17, 2009, the Company completed a registered public offering (the “Offering”) with certain existing institutional investors, raising a total of $8.5 million in cash by issuing 4.6 million shares of Company’s common stock. The proceeds were primarily applied to posting the required $7.3 million deposit with the Superior Court of California, County of Orange, while the Parallax verdict is on appeal. On June 22, 2009, following the receipt of proceeds from the Offering, STAAR timely posted this deposit with the Court just before the expiration of a temporary stay of enforcement that had been granted by the court.

 Avoiding a similar short-term cash shortfall was a principal consideration in STAAR’s divestiture of Domilens on March 2, 2010.  Among the expected demands on STAAR’s capital resources underlying this decision, the most pressing was the $6.5 million verdict rendered in the Moody case, and the potential need to post a $9.8 million appeal bond on or before April 30, 2010.  The Domilens divestiture yielded a total of approximately $12.5 million in net cash proceeds to STAAR.  The potential need to post an appeal bond was eliminated by the global settlement of the Parallax and Moody cases on March 30, 2010.  STAAR’s $4 million contribution to the global settlement will be paid from the $7.4 million restricted deposit that STAAR already had placed with the Court on June 22, 2009 in connection with the Parallax case.  As a result, STAAR will be able to apply the entire $12.5 million in net cash proceeds from the Domilens sale to working capital, along with approximately $3.4 million that will be refunded to STAAR from the restricted deposit.

 

Other recent financing activity includes the December 14, 2007 borrowing by STAAR of $5 million from Broadwood Partners, L.P., at an interest rate of 7% per annum, primarily to fund the acquisition of STAAR’s remaining interest in the Canon Staar Joint Venture. On April 2, 2009, after preliminary judgment was entered in the Parallax case, Broadwood and the Company entered into a Temporary Waiver Agreement with respect to any event of default that may occur, or may be deemed to have occurred, under the Broadwood note as a result of the judgment. In consideration of the Temporary Waiver Agreement, STAAR agreed to amend the Original Note to grant to Broadwood a security interest in substantially all of STAAR’s assets to secure STAAR’s obligations under the Original Note. To effectuate this grant of a security interest, as of April 13, 2009, the Company and Broadwood entered into an Amended and Restated Senior Secured Promissory Note and Security Agreement. The Temporary Waiver Agreement had provided that no such default was deemed to have occurred until June 23, 2009, when a temporary stay of judgment expired.

 

On June 24, 2009, following the posting of the deposit and satisfaction of conditions of the Temporary Waiver, Broadwood and STAAR again amended the Note by replacing the Temporary Waiver with a provision stating that because the Company secured a stay of enforcement of judgment until the completion of the appeal by posting the required deposit with the Court, any default that may have otherwise resulted from the Parallax judgment is cured. Broadwood remained entitled to receive interest at the rate of 20% per annum beginning on June 23, 2009, as would have been applicable in the event a default had occurred under the original terms of the Note.  Under the terms of the amended Note, the final resolution of the Parallax and Moody cases results in the interest rate on the loan returning to the 7% pre-default level.  Such final resolution occurred on March 30, 2010.

 

 The Broadwood Note prohibits STAAR and its subsidiaries from disposing of any of its assets without prior written consent of Broadwood.  On February 23, 2010, Broadwood provided written consent to the sale of all of STAAR’s interests in Domilens.

 

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On October 14, 2009, STAAR’s general liability insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for its defense of the Moody case.  On October 22, 2009 the insurer agreed to pay a portion of the legal fees incurred by STAAR after July 1, 2009 for the appeal in the Parallax case.  The insurer’s agreement to defend these cases was subject to a full reservation of its rights and defenses.  STAAR received $780,000 in reimbursement payments related to the Moody in 2009, and through the date of this report has received $342,000 in 2010.   Prior to the March 31, 2010 global settlement of the Parallax and Moody cases, the availability of reimbursement for our legal fees from our insurance carrier, along with the transition of the lawsuits from trial to appeal, began to reduce our legal defense expenses significantly.  In connection with the global settlement, STAAR will voluntarily dismiss its appeals, and except for minor post-settlement matters legal expenditures related to the cases will cease. 

 

STAAR’s need for working capital, and the terms on which financing may be available, will depend in part on its degree of success in achieving and maintaining positive cash flow and earnings through the strategies described above under the caption “Strategy.” STAAR cannot assure that such financing will be available on acceptable terms, if at all, if the need arises.

 

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Results of Operations

 

The following table sets forth the percentage of total sales represented by certain items reflected in the Company’s consolidated statement of operations for the period indicated and the percentage increase or decrease in such items over the prior period.

		Percentage of Net Sales												Percentage Change
		January 1, 2010				January 2, 2009				December 28, 2007				2009 vs. 2008				2008 vs. 2007
Net sales			100.0	%			100.0	%			100.0	%			0.6	%			26.2	%
Cost of sales			44.4	%			46.4	%			50.7	%			(3.8	)%			15.6	%
Gross profit			55.6	%			53.6	%			49.3	%			4.5	%			37.0	%
General and administrative			20.9	%			21.0	%			21.8	%			(0.1	)%			21.5	%
Marketing and selling			32.2	%			36.1	%			40.0	%			(10.3	)%			14.0	%
Research and development			7.8	%			10.6	%			11.3	%			(25.8	)%			18.3	%
Other operating expenses (recovery), net			(0.3	)%			13.1	%			—				—	*			—	*
Operating loss			(5.0	)%			(27.2	)%			(23.8	)%			(81.7	)%			44.4	%
Total other (expense) income, net			(1.3	)%			(1.7	)%			(1.7	)%			(23.8	)%			23.9	%
Loss before income taxes			(6.3	)%			(28.9	)%			(25.5	)%			(78.3	)%			43.0	%
Provision for income taxes			2.0	%			2.0	%			1.4	%			(2.0	)%			80.7	%
Net loss			(8.3	)%			(30.9	)%			(26.9	)%			(73.3	)%			45.0	%

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*  Denotes change is greater than 100%

   

2009 Fiscal Year Compared to 2008 Fiscal Year

 

Net sales

 

Net product sales for 2009 were $75.3 million, a 1% increase over the $74.9 million reported for 2008. Increased sales of ICLs and IOLs were largely offset by a 15% decrease in non-lens sales. Non-lens sales decreased, as expected, as a result of the Company’s decision to deemphasize lower gross profit margin product.

 

International sales for 2009 were $59.3 million, up 6% from $56.0 million in 2008.  International Visian ICL sales were $17.0 million, up 19.6% over the $14.2 million reported in 2008.  The increase in sales was led by strong international sales of ICLs, primarily in Korea, China, and France. Visian ICL unit volume was up 33% while dollar sales increased by 20%.  International IOL sales were $25.2 million, up 7.6% over the $23.4 million reported in 2008.  International IOL unit volume increased by 6% while dollar sales increased by 8% despite relatively unchanged average selling price per unit (ASP).

 

U.S. sales for 2009 were $16.1 million, down 15% from $18.9 million in 2008.  U.S. Visian ICL sales were $5.0 million, up 2.5% over $4.9 million in 2008 mainly due to higher ASP as units were flat compared to 2008.  U.S. IOL sales were $8.7 million compared to $9.5 million in the prior year, an 8% decrease mostly due to 16% lower volumes in 2009 compared to 2008 offset by an increase in average selling prices of 9% in 2009.

 

Gross profit margin

 

Gross profit margin for 2009 was 55.6%, compared with 53.6% for 2008, which included purchase accounting charges recorded in the first quarter of 2008 of $1.5 million. A number of factors favorably impacted gross profit margin including increased mix of ICL sales, increased ASPs of US IOLs and decreased sales of low margin non-lens product sales.  The impact of these positive factors was offset by negative factors that reduced gross profit margin such as manufacturing yield issues, decreased IOL ASPs in Japan and decreased ICL ASPs in Korea, and increased cost of goods in Germany due to fluctuating exchange rates.

 

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General and administrative

 

General and administrative expense in 2009 and 2008 was $15.7 million.  STAAR expects general and administrative expense to decrease by approximately $1.5 million in 2010 due to decreased legal fees as a result of the settlement of all outstanding litigation on March 30, 2010 (see “Item 3 – Legal Proceedings”).

 

Marketing and selling

 

Marketing and selling expense for 2009 was $24.2 million, a 10.4% decrease over the $27.1 million incurred in 2008 due to decreased salaries, travel, consulting fees, promotional activities and commissions in the U.S.  STAAR expects marketing and selling expenses to decrease approximately $9 million as a result of the divestiture of Domilens.

 

Research and development

 

Research and development expense for 2009 was $5.9 million, a 25.8% decrease over the $7.9 million incurred in 2008.  The decrease is due primarily to decreased salaries, consulting fees and general cost containment efforts in the U.S.  The Company expects to spend approximately 10% of sales in fiscal 2010 on its research and development activities.

 

Other operating expenses (recovery), net

 

Other operating expenses (recovery), net of $0.2 million for fiscal year 2009 include the reversal of $0.8 million in accrued judgment costs resulting from the settlement of litigation in the matters involving Scott C. Moody, Inc. and Parallax Medical Systems  (see “Item 3 – Legal Proceedings”). The reversal of accrued judgment costs were largely offset by a $0.6 million charge associated with certain patents that were determined to have shorter useful lives than originally estimated.

 

Income taxes

 

The Company recorded an income tax provision of $1.5 million for both fiscal years 2009 and 2008. The tax provision is primarily related to the Company’s current and deferred foreign taxes due to pre-tax profits generated by STAAR Surgical AG and unremitted foreign earnings due to STAAR’s intent to repatriate all of its foreign earnings.

 

2008 Fiscal Year Compared to 2007 Fiscal Year

 

Net sales

 

Net sales for the year ended January 2, 2009 (“fiscal 2008”) were $74.9 million, an increase of 26.2% compared with net sales for the year ended December 28, 2007 (“fiscal 2007”) of $59.4 million. Changes in currency exchange rates had a favorable $1.6 million impact on net sales for fiscal 2008.   During fiscal 2008, global sales of ICLs and TICLs grew 24.1% to $19.1 million compared with $15.4 million in fiscal 2007; global sales of IOLs increased 40.8% to $32.9 million compared with $23.4 million in fiscal 2007 as a result of the acquisition of STAAR Japan, which contributed $12.2 million in 2008 in total IOL sales.  Sales of other surgical products, generally used during cataract surgery, increased 11.1%.

 

U.S. net sales for fiscal 2008 decreased 4.0% to $18.9 million compared with fiscal 2007, due to a 16.0% decrease in IOL sales which was largely offset by a 17.9% increase in ICL sales and a 6.4% increase in other product sales.  Although IOL sales declined 16% for the full year, the year over year rate of decline has slowed from 26% in the fourth quarter of 2007 to 5% in the fourth quarter of 2008.

 

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International net sales for fiscal 2008 were $56 million, an increase of 41.2% compared with fiscal 2007.  International IOL sales were $23.5 million, up 93.8%, compared with $12.1 million in 2007.  The significant increase in IOL sales is due to the acquisition of STAAR Japan at the beginning of 2008, partially offset by a decrease in IOL sales in international markets outside of Japan. During 2008, international sales of ICLs increased 26.3% to $14.2 million, compared with $11.2 million in fiscal 2007 and other surgical product sales increased 12.3% to $18.3 million, compared with $16.3 million in fiscal 2007.

 

Gross profit margin

 

Gross profit margin for the fiscal 2008 was 53.6% compared with 49.3% for fiscal 2007. The increase in gross profit margin is due to sales of preloaded IOLs in Japan which yield higher average selling prices than in other countries, increased sales of ICLs, particularly in the U.S. where prices are higher, and increased sales of TICLs.  The improvement in gross profit margin was partially offset by the STAAR Japan acquired inventory, which was recorded at fair value in accordance with purchase accounting rules. This higher valued inventory was sold during 2008 resulting in $1.5 million in additional cost of goods sold.

 

General and administrative

 

General and administrative expenses for fiscal 2008 were $15.7 million, representing a 21% increase over the $13.0 million reported in fiscal 2007, entirely due to $3.7 million incurred by STAAR Japan, offset by $0.9 million reduction in the rest of the Company despite significant legal costs associated with the sales representative litigation.

 

Marketing and selling

 

Marketing and selling expenses for fiscal 2008 were $27.1 million, representing a 14% increase over the $23.7 million reported in fiscal 2007. The increase in marketing and selling expenses for fiscal 2008 was due to the $4.1 million in costs associated with STAAR Japan.  Marketing and selling expenses in the U.S. decreased $2.4 million and this decrease was partially offset by a $1.6 million increase in international expenses outside of Japan and the U.S. to support the increase in ICL sales.

 

Research and development

 

Research and development expenses, including regulatory and clinical expenses, for fiscal 2008 were $7.9 million, representing an 18% increase over the $6.7 million reported in fiscal 2007. The increase is due to the $2.2 million in costs associated with STAAR Japan, offset by a decrease of $0.9 million as a result of cost reduction measures taken in the U.S. to improve cash flows.

 

Other operating expenses

 

Other operating expenses for fiscal 2008 were $9.8 million and consisted of the following:  1) loss on settlement of pre-existing distribution arrangement in the amount of $3.9 million recorded in connection with the Company’s acquisition of STAAR Japan and represented the portion of the consideration paid by STAAR for the termination of the pre-existing distribution arrangement that was deemed unfavorable to STAAR Japan and to STAAR when compared to an at market arrangement as of the closing date of the acquisition;  2) patent impairment charges in the amount of $1.0 million which was recorded in connection with certain patents that were determined to have minimal fair value to the Company pursuant to the annual impairment review; and 3) jury verdict in favor of Parallax Medical Systems, Inc. reached subsequent to year end in the amount of $4.9 million (see “Item 3 – Legal Proceedings”).

 

Income taxes

 

The Company recorded an income tax provision of $1.5 million and $0.8 million for fiscal 2008 and 2007 respectively. The increase in the provision of $0.7 million was primarily due to increases in the Company’s current foreign tax provision of $0.9 million due to pre-tax profits generated by STAAR Surgical AG, offset by a decrease in the foreign deferred tax provision of $0.2 million.

 

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Liquidity and Capital Resources

 

The Company has managed its liquidity through a series of debt and equity financing transactions and from its foreign operations, and recently, through a sale of a subsidiary.  Although the Company is now generating cash from operations and expects to continue to do so in 2010, after paying expected 2010 obligations its cash resources will continue to be limited.

 

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The Company intends to continue to manage its liquidity through certain planned cost reduction initiatives and operational goals.  The following is a summary of significant cost reduction and other planned actions contemplated by the Company:

 

The Company has previously disclosed certain key metrics that it intends to continue to make its priority to achieve in the forthcoming year in order to remain a going concern.

 

First, the Company must continue to generate cash from operations by continuing to drive cost reduction initiatives and vigilantly manage the Company’s spending.  Although no assurances can be made, this can be achieved by continuing recent trends coupled with the expected savings in legal fees in 2010 compared to 2009, despite the sale of Domilens in March 2010.

 

Second, the Company has to drive overall increase in sales and improvement in the gross profit margins by increasing sales of the Visian ICL products and higher margin IOLs.  In 2009, ICL sales globally increased by 15% globally in dollars and 26% in units compared to 2008 principally from the international markets.  In February 2010, the Japanese Ministry of Health, Labor and Welfare approved the sale of the ICL in Japan.

 

The success of the Company and management’s plans necessarily depends on several factors and events directly outside of its control including an improvement of global economic conditions and continuation of our operations in the normal course of business in our international markets.  The Company’s plans also assume that our trade suppliers will continue to conduct business with us on terms consistent with historical practice. The suppliers may request faster payment of invoices, new or increased deposits or other assurances.  If this were to happen, the Company’s need for cash would be intensified and we might be unable to make payments to our suppliers as they become due and the Company may need additional financing as necessary to continue normal operations and such financing may not be available at terms acceptable to the Company, if at all, which can jeopardize the operations of the Company.

 

Overview of changes in cash and cash equivalents and other working capital accounts.

 

Net cash provided by operations was $1.4 million in 2009 compared to net cash used in operating activities of $8.2 million and $11.2 million in fiscal 2008 and 2007, respectively. For fiscal 2009 the cash provided by operations was mainly due to lower net loss of $17 million in 2009 compared to 2008.  For fiscal 2008 and 2007 cash used in operations was the result of increased net losses, adjusted for depreciation, amortization, stock-based compensation expense, and other miscellaneous non-cash items, and net decreases in working capital.

 

Net cash used in investing activities was approximately $7.6 million in fiscal 2009 compared to $1.1 million cash provided by investing activities in 2008 and $4.7 million cash used in 2007.  In June 2009, STAAR posted a $7.3 million bond with the Court pending the appeal of the Parallax judgment.  The Court maintains full control of, and access to the deposit, including the ultimate disbursement of any and all amounts, plus interest.  STAAR has no access to these funds and limited information as to their investment status.  The Court will pay approximately 1% interest per annum on the deposit, which will be reinvested into the deposit account by the Court and is subject to the same restrictions as the principal amount.  STAAR has classified this restricted cash deposit and considers this deposit to be akin to a purchase of a temporary investment with the Court and any activity in this account from its inception to liquidation will be included as investing cash outflows and inflows STAAR’s consolidated statements of cash flows. Under the Stipulation for Settlement resolving the Parallax and Moody cases, STAAR will stipulate to the payment of $4.0 million from this deposit as its contribution to the settlement.  The remaining $3.4 million will be refunded to STAAR.  Other investing activities in 2009 include the purchase of property, plant and equipment of $0.6 million.  In fiscal year 2008 the net cash provided by investing was mainly due to $2.2 million of cash acquired in the STAAR Japan acquisition offset by $1.1 million of property and equipment purchases.  Included in cash used in investing activities for fiscal 2007, was the $4.0 million advance payment toward the purchase price for the 50% acquisition of Canon Staar and the acquisition of $0.7 million in property and equipment.

 

Net cash provided by financing activities was approximately $7.4 million, $1.0 million, and $18.7 million for fiscal 2009, 2008, and 2007, respectively.  In 2009, cash provided by financing activities resulted from the $8.5 million cash proceeds from the sale of STAAR common stock in order to fund the Parallax bond discussed above, which was offset by $1.1 million repayment of principal on capital lease obligations.  In 2008, cash provided by financing activities resulted from net proceeds of $2 million from a line of credit in Japan offset by payments made on assets under a capital lease of $1 million.  In 2007, cash provided by financing activities resulted from the receipt of net proceeds of $16.6 million from a public offering of 3.6 million shares of the Company’s common stock and $0.6 million received from the exercise of the stock options.  Additionally in 2007 the Company borrowed $9.0 million from Broadwood, of which $4 million was repaid in the second quarter and $5.0 million was intended to be used to fund the acquisition of the remaining 50% interest in the Canon joint venture and related transaction costs. In addition, the Company repaid $1.8 million outstanding on its Swiss line of credit and repaid $1 million related to the 2004 acquisition of the minority interest of our Australian subsidiary and $0.7 million in payments under capital lease lines of credit.

 

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Accounts receivable was $9.3 million as of January 1, 2010 and $8.4 million as of January 2, 2009.  The increase in accounts receivable is due to increased sales in the international markets during fiscal 2009. Days’ Sales Outstanding (“DSO”) were 43 days in 2009 and 42 days in 2008. The Company expects to maintain DSO within a range of 40 to 45 days during the course of fiscal 2010.

 

Inventories at the end of fiscal 2009 and 2008 were $14.8 million and $16.7 million, respectively. Days’ inventory on hand were 110 days in 2009 and 142 days in 2008 based on finished goods inventory as of January 1, 2010 and January 2, 2009.

 

Credit Facilities, Contractual Obligations and Commitments

 

Credit Facilities

 

The Company has credit facilities with different lenders to support operations in the U.S. and Japan.

 

On December 14, 2007, the Company borrowed $5 million from Broadwood Partners, L.P. (“Broadwood”), a stockholder in the Company, pursuant to a Senior Promissory Note between the Company and Broadwood, with a scheduled maturity of December 14, 2010.  Among the events of default under the Senior Promissory Note is any judgment against the Company in excess of $500,000 that “shall remain unpaid.”  On April 2, 2009, after preliminary judgment was entered in the Parallax case, Broadwood and STAAR entered into a Temporary Waiver Agreement with respect to any event of default that may occur, or may be deemed to have occurred, under the Note as a result of the judgment.  In consideration of the Temporary Waiver Agreement, STAAR agreed to amend the Senior Promissory Note to grant to Broadwood a security interest in substantially all of STAAR’s assets to secure STAAR’s obligations under the original Senior Promissory Note.  To effectuate this grant of a security interest, as of April 13, 2009, the Company and Broadwood entered into an Amended and Restated Senior Secured Promissory Note (the “Note”) and Security Agreement.  All other key terms of the Note remained unchanged.  The Temporary Waiver Agreement provided that if the Company secured a stay of enforcement of judgment prior to June 23, 2009 (the expiration date of a temporary stay granted by the Court), no default was deemed to have occurred with respect to the judgment.  On June 24, 2009, following the timely posting of the deposit and satisfaction of the provisions of the Temporary Waiver, Broadwood and STAAR again amended the Note by replacing the Temporary Waiver with a provision stating that because the Company secured a stay of enforcement of judgment until the completion of the appeal by posting the required deposit with the Court, any default resulting from the Parallax judgment is deemed to be cured.

 

Broadwood was entitled to receive interest at the rate of 20% per annum beginning on June 23, 2009, as would have been applicable in the event a default had occurred under the original terms of the Note.  However, the terms of the Note also provided that if the Company fully satisfies the judgments and finally resolves all material litigation, which occurred on March 30, 2010, the interest rate shall be reduced to 7% per annum from the date of such final resolution.  The Note may be pre-paid by the Company at any time without penalty, with prior notice, and is not subject to covenants based on financial performance or financial condition (except for insolvency).  The Note provides that, with certain exceptions, the Company will not incur indebtedness senior to or at parity with its indebtedness under the Note without the consent of Broadwood.  Based on publicly available information, as of June 23, 2009, Broadwood beneficially owned 6,028,638 shares of the Company’s common stock comprising approximately 17.4% of the Company’s issued and outstanding common stock.

 

 

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Capital Lease Agreements

 

The Company’s lease agreement with Farnam Street Financial, Inc. (“Farnam”), as amended on October 9, 2006, provided for purchases of up to $1,500,000 of property, plant and equipment.  Purchases under this facility are accounted for as capital leases and generally have a thirty-month to three-year term. Under the agreement, the Company has the option to purchase any item of the leased property at the end of that item’s lease term, at a mutually agreed-upon fair value.  If the Company decides not to purchase the equipment, it will continue to pay monthly rent on the equipment. On April 1, 2007, the Company signed an additional leasing schedule with Farnam, which provided for additional purchases of $800,000 during 2008. The terms of this new schedule conform to the amended agreement dated October 9, 2006.  There are no borrowings available under the agreement.

 

Line of Credit

 

The Company’s Japanese subsidiary, STAAR Japan, has an agreement, as amended on June 30, 2009, with Mizuho Bank which provides for borrowings of up to 300,000,000 Yen (approximately $3.2 million based on the rate of exchange on January 1, 2010), at an interest rate equal to the Tokyo short-term prime interest rate (approximately 1.475% as of January 1, 2010) plus 1.125% and terminates on April 20, 2010, but may be renewed annually.  The credit facility is not collateralized.  The Company had 200,000,000 Yen outstanding on the line of credit as of January 1, 2010 and January 2, 2009, (approximately $2.2 million based on the foreign exchange rates on January 1, 2010 and January 2, 2009, respectively).  If a default occurs, the interest rate will be increased to 14% per annum.

 

Our limited borrowing capacity could cause a shortfall in working capital or prevent us from making expenditures to expand or enhance our business. Although we were compliant with our line of credit covenants as of January 1, 2010, a default on our line of credit could cause an immediate termination and jeopardize our ability to continue operations.

 

Redeemable, convertible preferred stock

 

Under its Certificate of Incorporation the Company has had 10,000,000 shares of “blank check” preferred stock, which the Board of Directors is authorized to issue with such rights, preferences and privileges as the Board may determine. On October 22, 2007, the Board approved the designation of 1,700,000 shares of the preferred stock as Series A Redeemable Convertible Preferred Stock (“Preferred Stock”) to be issued in connection with the acquisition of the 50% interest in Canon Staar Co., Inc. which was consummated on December 29, 2007. On December 29, 2007, the Company issued the 1,700,000 shares of Preferred Stock to the Canon companies as partial consideration for their shares of Canon Staar Co., Inc. at an estimated fair value of $4.00 per share, or $6.8 million in the aggregate.

 

The Preferred Stock is redeemable by the Company at any time on or after the first anniversary of the issuance date at a price of $4.00 per share plus any accrued or declared but unpaid dividends (“Redemption Price”). The holders of the Preferred Stock have a right, exercisable at any time on or after the third anniversary (December 29, 2010) of the issuance date by a majority vote of the Preferred Stock holders with at least 30 days’ written notice, to require the Company to redeem the Preferred Stock at the Redemption Price.  If such a redemption is made, the Company would be obligated to pay the $6.8 million in cash.

 

The following table represents the Company’s known contractual obligations as of January 1, 2010 (in thousands):

<

		Payments Due by Period
Contractual Obligations		Total				Less Than 1 Year				1-3 Years				3-5 Years				More Than 5 Years
Note payable		$	5,000			$	5,000			$	—			$	—			$	—
Interest on note payable			988				988				—				—				—
Line of credit			2,160				2,160				—				—				—
Capital lease obligations			1,983				971				833				179				—