Net Sales

 

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 drops dramatically in July and August, and European sales have accounted for a greater proportion of our total sales, this seasonal variation in our results has become even more pronouced.

 

Net sales for the three and nine months ended September 28, 2007 increased 2.4% and 4.7% to $13,629,000 and $43,478,000 compared with the $13,313,000 and $41,511,00 reported for the same periods of 2006. The favorable impact of changes in currency for the three and nine month periods of 2007 was approximately $471,000 and $1,462,000, respectively.

International sales for the third quarter were $8,889,000, up 16.9% compared with $7,608,000 reported in the same period of last year. During the third quarter, international sales of refractive products grew 44.9% to $2,290,000 compared with the $1,581,000 reported for the third quarter of 2006. The increase in refractive product sales is due to increased sales of ICLs and TICLs which represented 97.8% of total refractive sales in international during the third quarter. International cataract sales for the third quarter were $6,532,000, up 9.6% compared with $5,959,000 reported in the same period of the prior year due to the favorable effect of currency and increased sales of the Company’s German subsidiary.

International sales for the first nine months of 2007 were $28,487,000, up 16.6% compared with the same period of 2006. During the first nine months of 2007, international sales of refractive products grew 41.7% to $7,783,000 compared with the $5,492,000 reported for the first nine months of 2006. The increase in refractive product sales is due to increased sales of ICLs and TICLs which represented 98.0% of total refractive sales in international during the period. International cataract sales for the first nine months of 2007 were $20,489,000, up 9.3% compared with $18,742,000 reported for the same period of 2006 due largely to the effect of currency, but also due to favorable effect of currency and increased sales of the Company’s German subsidiary.

 

Total U.S. sales for the third fiscal quarter of 2007 were $4,739,000, down 16.9% compared with $5,705,000 reported in the same period of 2006. Third quarter U.S. refractive product sales decreased 16.2% to $1,106,000, compared with the $1,321,000 reported for the third quarter of 2006. The decrease in refractive product sales is due primarily to decreased sales of ICLs which represented 95.0% of total refractive sales in the U.S. during the quarter and to decreased sales of other refractive products.

Total U.S. sales for the first nine months of 2007 were $14,991,000, down 12.2% compared with $17,080,000 in the same period of 2006. U.S. refractive products sales during the first nine months of 2007 were $3,276,000, down 4.6% compared with the same period of 2006. The decrease in refractive product sales is due to decreased sales of ICLs which represented 94.6% of total refractive sales in the U.S. during the period and to decreased sales of other refractive products. U.S. cataract product sales for the first nine months of 2007 were $11,467,000, down 14.1% compared with $13,341,000 reported for the same period of 2006. The decline in U.S. cataract sales is due, in part, to a shift in market preference from spherical IOLs to aspheric IOLs. The Company introduced its first aspheric IOL made of Collamer during the second quarter and anticipates introducing a silicone aspheric IOL in the fourth quarter of 2007 which should allow the Company to compete more effectively in this market segment. Additionally, the Company believes that disruption in sales activity in the period before two sales representative agreements expired on July 31, 2007 may have had some impact on cataract sales in their regions for both the three and nine month periods of 2007.

 

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Gross Profit Margin

Gross profit margin for the three and nine months ended September 28, 2007 was 49.7% and 49.0%, compared with 47.6% and 47.3% for the three and nine months ended September 29, 2006. The increase in gross profit margin was principally due to an increase in high margin refractive sales.

General and Administrative

General and administrative expenses for the three months ended September 28, 2007 were up 10.4% or $270,000 over the three months ended September 29, 2006 and up 17.8% or $1,446,000 for the same year-to-date period. The increase in general and administrative expenses for the quarter was primarily due to increased international travel associated with increased oversight of foreign subsidiaries and increased bank charges associated with the termination of the Wells Fargo credit line. The increase in general and administrative expenses for the nine month period was primarily due to costs associated with the Domilens investigation, increased international travel associated with increased oversight of foreign subsidiaries, increased bank charges associated with the termination of the Wells Fargo credit line and increased insurance costs.

Marketing and Selling

Marketing and selling expenses for the three months ended September 28, 2007 increased 13.5% or $686,000 compared with the three months ended September 29, 2006 and increased 10.3% or $1,613,000 compared with the nine months ended September 29, 2006. The increase for both periods is primarily due to increased salaries and benefits due to increased headcount globally, the unfavorable effect of currency on expenses, partially offset by decreased U.S. commissions. Marketing and selling expense for the nine month period was also impacted by increased travel costs.

Research and Development

Research and development expenses, including regulatory and clinical expenses, for the third quarter of 2007, increased 4.4% or $73,000 compared with the three months ended September 29, 2006 due to increased salaries and benefits including severance costs. Research and development expenses for the nine months ended September 28, 2007 decreased 3.8% primarily due to lower activity associated with regulatory submissions.

Other Expense

Other expense for the three and nine month periods of 2007 was $409,000 and $880,000, compared with income reported for the same periods in 2006 of $104,000 and $99,000. Other expense increased in both periods due to inventory reserves and sales allowances recorded by the Company’s Japanese joint venture in connection with Canon Marketing’s decision to discontinue distribution of one of the joint venture’s products, increased interest expense from capital lease transactions and foreign exchange losses partially offset by an increase in interest income. For the nine-month period, other expense also increased due to the write-off of deferred financing costs and losses from the extinguishment of the Broadwood Partners L.P. note. These expenses were partially offset by $148,000 fair value adjustment upon revaluation of the Broadwood warrant obligation at September 28, 2007.

Income Tax Provision (Benefit)

During the quarter the Company reached a settlement with the German Ministry of Finance related to taxes assessed in connection with unreported sales of a company controlled by the former President of Domilens, GmbH. As a result of the settlement, the Company reversed approximately $460,000 in income tax expense originally recorded in the fourth quarter of 2006, based on the best information available to management at that time.

Liquidity and Capital Resources

The Company has funded its activities over the past several years principally from cash flow generated from operations, credit facilities provided by domestic and foreign lenders, the sales of Common Stock, the repayment of former directors’ notes, and the exercise of stock options.

 

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As of September 28, 2007 and December 29, 2006, the Company had $14.2 million and $7.8 million, respectively, of cash and cash equivalents.

Cash used in operating activities was $8.5 million for the nine months ended September 28, 2007 versus $6.9 million for the nine months ended September 29, 2006. The increase in cash used for operating activities was primarily due to payments associated with the Domilens investigation, costs incurred in evaluating financing options, interest expense of the Broadwood note, and increased salaries and travel.

Cash used in investing activities was $0.2 million for the nine months ended September 28, 2007 versus $0.7 million for the nine months ended September 29, 2006. Cash used in investing activities was primarily the result of purchases of property, plant and equipment, the effect of which was partially offset by dividends received from the Company’s Japanese joint venture.

Net cash provided by financing activities was $15.0 million for the nine months ended September 28, 2007 versus $2.9 million for the nine months ended September 29, 2006. Cash provided by financing activities for the nine months ended September 28, 2007 principally resulted from $16,613,000 in net proceeds from the private placement of 3,600,000 shares of common stock, partially offset by the repayment of a $1.8 million bank loan.

Accounts receivable at September 28, 2007 decreased $0.6 million relative to December 29, 2006. The decrease in accounts receivable relates primarily to decreased sales. Day’s sales outstanding (DSO) were 40 days at September 28, 2007 compared to 39 days at December 29, 2006. The Company expects to maintain DSO within a range of 40 to 45 days during the course of the 2007 fiscal year.

 

Public Equity Offering

To provide additional working capital, STAAR completed a public offering of its common stock on May 1, 2007. In the offering, STAAR sold 3,600,000 shares of common stock at price to the public of $5 per share, which yielded approximately $16.6 million net proceeds to STAAR. All shares of the common stock offered by STAAR were sold pursuant to a shelf registration statement that was declared effective by the SEC on August 8, 2006 as supplemented by an additional registration statement filed on April 25, 2007 pursuant to Rule 462(b) under the Securities Act of 1933. After the June 20, 2007 repayment of $4 million in indebtedness incurred under a Promissory Note with Broadwood Partners, L.P., which is discussed below, the remaining proceeds of the public offering will be used for working capital and other general corporate purposes. STAAR believes that with the proceeds of the public offering, along with expected cash from operations, it has sufficient cash to meet its funding requirements over the next year. The public offering included all of the securities available for issuance under STAAR’s previously filed shelf registration.

 

STAAR’s liquidity requirements arise from the funding of its working capital needs, primarily inventory, work-in-process and accounts receivable. While STAAR’s international business generates positive cash flow and represents approximately 66% of consolidated net sales, we have reported losses on a consolidated basis for several years due to a number of factors, including eroding sales of cataract products in the U.S. and FDA compliance issues that consumed additional resources while delaying the introduction of new products in the U.S. market. As a result, during recent periods cash flow from operations has not been sufficient to satisfy our need for working capital and STAAR has relied on additional sources, including proceeds of the private placement of equity securities, proceeds of option exercises and borrowings on our lines of credit.

STAAR’s management believes that in the near term its best prospect for achieving profitability in its U.S. and consolidated operations is to significantly increase U.S. sales of the ICL. To date, sales growth of ICLs has been slower than expected. In the longer term STAAR seeks to develop and introduce products in the U.S. cataract market to stop further erosion of its market share and resume growth in that sector. Nevertheless, success of these strategies is not assured and, even if successful, STAAR is not likely to achieve positive cash flow on a consolidated basis during fiscal 2007 or 2008.

 

Credit Facilities

The Company and its subsidiaries have credit facilities with different lenders to support operations in the U.S., and Germany, respectively.

On June 8, 2006 the Company signed a Credit and Security Agreement with Wells Fargo Bank for a revolving credit facility. The credit facility provided for borrowings of 85% of eligible accounts receivable with a maximum of $3.0 million, carried an interest rate of prime plus 1.5%, and was secured by substantially all of the assets of the Company’s U.S. operations. The term of the agreement was three years and it contained certain financial covenants, among others, relating to minimum calculated net worth, net loss, liquidity and restrictions on Company investments or loans to affiliates and investments in capital expenditures. On September 27, 2007 STAAR terminated the Wells Fargo Bank facility in accordance with the terms of the Credit and Security Agreement.

 

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On March 21, 2007, STAAR entered into a loan arrangement with Broadwood Partners, L.P. (“Broadwood”). The note was fully repaid on June 20, 2007.

As additional consideration for the loan STAAR also entered into a Warrant Agreement (the “Warrant Agreement”) with Broadwood granting the right to purchase up to 70,000 shares of Common Stock at an exercise price of $6, exercisable for a period of six years. The warrant agreement provided that STAAR will register the stock for resale with the SEC.

The Company’s lease agreement with Farnam Street Financial, Inc., as amended on October 9, 2006, provided for purchases of up to $1,500,000 of property, plant and equipment. In accordance with the requirements of SFAS 13 “Accounting for Leases,” purchases under this facility are accounted for as capital leases and have a three-year term. Under the agreement, the Company has the option to purchase any item of the leased property, at the end of the respective items lease terms, at a mutually agreed fair value. On April 1, 2007, the Company signed an additional leasing schedule with Farnam, which provides for additional purchases of $800,000 during the next fiscal year. The terms of this new schedule conform to the amended agreement dated October 9, 2006. Approximately $491,000 in borrowings was available under this facility as of September 28, 2007.

 

The Company’s lease agreement with Mazuma Capital Corporation, as amended on August 16, 2006, provided for purchases of up to $301,000 of property, plant and equipment. In accordance with the requirements of SFAS 13 “Accounting for Leases,” purchases under this facility are accounted for as capital leases and have a two-year term. The Company was required to open a certificate of deposit as collateral in STAAR Surgical Company’s name at the underwriting bank for 50% of the assets funded by Mazuma. As of September 28, 2007, the Company had a certificate of deposit for approximately $150,000 recorded as “short-term investment — restricted” with a 12-month term at a fixed interest rate of 4.5%. The agreement also provides that the Company may elect to purchase any item of the leased property at the end of its lease term for $1. No borrowings were available under this facility as of September 28, 2007.

The Company’s German subsidiary, Domilens, entered into a credit agreement at August 30, 2005. The renewed credit agreement provides for borrowings of up to 100,000 EUR ($141,000 at the rate of exchange on September 28, 2007), at a rate of 8.5% per annum and does not have a termination date. The credit agreement may be terminated by the lender in accordance with its general terms and conditions. The credit facility is not secured. There were no borrowings outstanding as of September 28, 2007 and December 29, 2006 and the full amount of the line was available for borrowing as of September 28, 2007. The Company was in compliance with all terms of the agreements as of September 28, 2007.

 

As of September 28, 2007, the Company had a current ratio of 2.7:1, net working capital of $23.1 million and net equity of $39.1 million compared to December 29, 2006 when the Company’s current ratio was 2.0:1, its net working capital was $14.2 million, and its net equity was $31.8 million.

 

The Company believes through effective cost management it has sufficient cash on hand to finance its current operations through 2008 and into 2009 and has taken measures aimed at reducing the global use of cash to approximately $2.0 million per quarter, or $8.0 million per year. Improvement in US sales, particularly growth in US ICL sales, could improve cash flow further, as could continued growth in international markets which we expect. However, the pending acquisition of the remaining 50% equity interest in Canon Staar will obligate the Company to pay $4.0 million at closing. To conserve existing cash for operations, we may elect to finance all or a portion of the purchase price and costs associated with the acquisition.

 

The Company’s liquidity requirements arise from the funding of its working capital needs, primarily inventory, work-in-process and accounts receivable. In addition, STAAR’s cash resources maybe affected by the $4,000,000 cash consideration that will be paid at the anticipated closing of the Canon Staar buy-out on or soon after December 28, 2007. The Company’s primary sources for working capital and capital expenditures are cash flow from operations, which are largely dependent on the success of the ICL, proceeds of the public offering of common stock completed in the second fiscal quarter, and proceeds from option exercises. The Company’s liquidity also depends, in part, on customers paying within credit terms, and any extended delays in payments or changes in credit terms given to major customers may have an impact on the Company’s cash flow. In addition, any abnormal product returns or pricing adjustments may also affect the Company’s short-term funding. Changes in the market price of our common stock affect the value of our outstanding options, and lower market prices could reduce our expected revenue from option exercises. Given the Company’s history of losses and negative cash flows, it is possible that the Company could find it necessary to supplement its sources of capital with additional financing to sustain operations until the Company returns to profitability.

 

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The business of the Company is subject to numerous risks and uncertainties that are beyond its control, including, but not limited to, those set forth above and in the other reports filed by the Company with the Securities and Exchange Commission. Such risks and uncertainties could have a material adverse effect on the Company’s business, financial condition, operating results and cash flows.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements, as that term is defined in the rules of the SEC, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no material changes in the Company’s qualitative and quantitative market risk since the disclosure in the Company’s Annual Report on Form 10-K for the year ended December 29, 2006.

ITEM 4. CONTROLS AND PROCEDURES

Attached as exhibits to this Quarterly Report on Form 10-Q are certifications of STAAR’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications.

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

The Company’s management, with the participation of the CEO and the CFO, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this Form 10-Q. Based on that evaluation and the identification of the material weakness in internal controls over financial reporting described below, the CEO and the CFO concluded that, as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s disclosure controls and procedures were not effective.

Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f) and for assessing the effectiveness of its internal control over financial reporting. Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

As discussed in our Annual Report on Form 10-K for the fiscal year ended December 29, 2006, the Audit Committee of the Company’s Board of Directors commenced in January 2007 an independent investigation into reports to the Company’s management that Guenther Roepstorff, president of Domilens GmbH, a subsidiary of STAAR located in Germany, had admitted to the German Federal Ministry of Finance that without STAAR’s knowledge he had diverted property of Domilens with a book value of approximately $400,000 to a company under his control over a four-year period between 2001 and 2004. Mr. Roepstorff made this admission in connection with an audit conducted by the Ministry in 2006, which examined the financial records of Mr. Roepstorff, Domilens and the company to which he diverted the property, Equimed GmbH (currently known as eyemaxx GmbH), covering the four-year period. During the course of the investigation, the Company found that in addition to the diversions of property admitted by Mr. Roepstorff, payments were made to Mr. Roepstorff disguised as prepayments to suppliers and unauthorized borrowing occurred.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. In connection with the assessment described above, management identified a material weakness as of December 29, 2006 which was discussed in the Company’s Annual Report on Form 10-K filed with the Commission on March 29, 2007. Because the Company’s remediation efforts remained in progress, management identifies the same material weakness as of September 28, 2007, the end of the period covered by this report, as described below:

 

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Failure to design and maintain controls over and in its German subsidiary sufficient to detect and prevent management override and fraud

	•	Control Environment The Company did not maintain an effective control environment because of the following: (a) the Company did not adequately and consistently reinforce the importance of adherence to controls and the Company’s code of conduct; (b) the Company failed to institute all elements of an effective program to help prevent and detect fraud by Company employees; and (c) the Company did not maintain effective corporate and regional management oversight and monitoring of operations to detect managements’ override of established financial controls and accounting policies, execution of improper transactions and accounting entries to impact revenue and earnings, and reporting of these transactions to the appropriate finance personnel or the Company’s independent registered public accounting firm.

 

Because of the material weakness described above, management concluded that our internal control over financial reporting was not effective. We have been implementing improvements to our internal controls to address the aforementioned material weakness and lack of effectiveness in our disclosure controls and internal controls, and continue to do so. As of the date of this report we have not been able to conclude that the material weakness identified above has been rectified. The Company has taken the following corrective actions:

 

	•	obtained the immediate resignation of the president of Domilens GmbH
	•	hired a new president of Domilens in October 2007
	•	enhanced monitoring and oversight from STAAR’s Swiss and U.S. operations
	•	held meetings to discuss the Company’s Code of Ethics and whistleblower policies with subsidiary employees as a bridge to more formal training
	•	assigned oversight of corporate compliance programs and training to its corporate legal counsel
	•	terminated the Director of Finance of our Swiss subsidiary, who was responsible for oversight of financial affairs and internal reporting at Domilens
	•	hired a new international controller based at Domilens re-educated employees in STAAR’s Code of Ethics
	•	enhanced whistleblower program for international operations of STAAR
	•	reinforced the certification process to emphasize senior manager’s accountability for maintaining an ethical environment
	•	sent a team of managers from the corporate IT and Finance departments to evaluate the adequacy of the controls and procedures at Domilens
	•	conducted a visit by members of the Audit Committee to Domilens’ facility in early August to interview employees, reinforce policies and assess the effectiveness of remedial actions.

 

There was no change during the fiscal quarter ended September 28, 2007 that has materially affected, or is reasonably likely to materially affect the Company’s internal control over financial reporting.

While we continue to devote significant resources to meeting the internal control over financial reporting requirements of the rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we cannot assure you that the policies and procedures we have adopted and our continued efforts will successfully remediate the material weakness we have identified and any control deficiencies or material weaknesses that we or our outside auditors may identify before the end of our fiscal year.

Our management, including the CEO and the CFO, do not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material errors. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations on all internal control systems, our internal control system can provide only reasonable assurance of achieving its objectives and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of internal control is also based in part upon certain assumptions about the likelihood of future events, and can provide only reasonable, not absolute, assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in circumstances, or the degree of compliance with the policies and procedures may deteriorate.

 

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Moody v. STAAR Surgical Company; Parallax Medical Systems, Inc. v. STAAR Surgical Company. On September 21, 2007, Scott C. Moody, Inc. and Parallax Medical Systems, Inc. filed substantially identical complaints against STAAR in the Superior Court of California, County of Orange. Moody and Parallax are former independent regional manufacturer’s representatives (“RMRs”) of STAAR whose contracts with STAAR expired on July 31, 2007. They claim, among other things, that STAAR interfered with the plaintiffs’ contracts when it caused some of their current or former subcontractors to enter into new agreements to represent STAAR products, and that STAAR interfered with the plaintiffs’ prospective economic advantage when it informed a regional IOL distributor that each of the RMR’s contracts had a covenant restricting the sale of competing products. Moody claims general and compensatory damages of $32 million and Parallax claims general and compensatory damages of $48 million, and both plaintiffs request punitive damages. At this early stage of the litigation, STAAR is unaware of any facts that substantiate these claims and believes them to be without merit. It intends vigorously to oppose the claims and intends to assert claims for affirmative relief against both plaintiffs. The plaintiffs offer no factual basis for the magnitude of their claims; STAAR believes there is no such basis and that it should not be liable for any amount of damages. Nevertheless, the outcome of litigation is never certain and the possibility that the plaintiffs will recover under their claims cannot be eliminated at this time. STAAR has not reserved funds against a negative outcome in the lawsuits. An unexpected negative outcome in these cases or litigation costs that are much greater than anticipated could result in material harm to STAAR’s business.

 

The Company has asserted its right under the California Code of Civil Procedure to early discovery of any evidence supporting the plaintiffs’ claims. In its sworn testimony, Parallax failed to provide evidence that supported the amount of damages claimed. As a result, STAAR continues to believe that Parallax’s claims for damages are without merit. STAAR expects to obtain sworn testimony from the other plaintiff in the near future.

 

The disclosure of the Moody and Parallax lawsuits in this Item 1 of Part II of its Quarterly Report on Form 10-Q is not intended to imply that these lawsuits, either individually or in aggregate, are material to STAAR.

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. We do not believe that any of the claims known to us is likely to have a material adverse effect on our financial condition or results of operations.

 

ITEM 1A.  RISK FACTORS

Investment in securities of STAAR Surgical Company involves a high degree of risk. You should carefully consider the risks described below before making a decision to invest in the common stock. These risks are not the only ones we face.

Risks Related to Our Business

We have a history of losses and anticipate future losses.

We have reported losses in each of the last several fiscal years and have an accumulated deficit of $98.4 million as of September 28, 2007. 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.

Our cash requirements continue to exceed the level of cash generated by operations and we expect to continue to seek additional resources to support and expand our business, such as debt or equity financing. Because of our history of losses and negative cash flows, our ability to obtain adequate financing on satisfactory terms is limited. 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. An inability to secure additional financing could prevent the expansion of our business and jeopardize our ability to continue operations.

 

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

We have accumulated approximately $89.4 million of tax loss carryforwards as of December 29, 2006 to be used in future periods 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.

FDA compliance issues have harmed our reputation 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 the FDA inspections of STAAR’s Monrovia, California facilities in 2005 and 2006, 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 harmed our reputation in the ophthalmic industry, affected our product sales and delayed FDA approval of the ICL. 

On June 26, 2007 the Company 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. STAAR provided its written response to the Warning Letter to the FDA on July 31, 2007. If the FDA does not find the Company’s response adequate, further administrative action could follow, including actions that could restrict STAAR as a sponsor of clinical investigations or preclude approval of the application for approval of the TICL. The deficiencies cited in the Warning Letter have also been cited by the Office of Device Evaluation in a letter placing an integrity hold on the TICL application. While BIMO’s oversight covers clinical research, rather than the manufacturing, quality and device reporting issues that have been STAAR’s greatest focus in its recent compliance initiatives, STAAR believes that the negative publicity from the BIMO observations and Warning Letter has made it more difficult for STAAR to overcome the harm to its reputation resulting from past FDA proceedings.

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 its strategy to include devoting 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.” 

Our strategy to restore profitability in the near term relies on successfully penetrating the U.S. refractive market.

While products to treat cataracts continue to account for the majority of our revenue, we believe that increased income generated by sales of our Visian ICL refractive products, especially in the U.S., presents a near term opportunity for a return to profitability. The FDA approved the Visian ICL for treatment of myopia on December 22, 2005. Selling and marketing the ICL has presented a challenge to our sales and marketing staff and to our independent manufacturers’ representatives. In the U.S. patients who might benefit from the ICL have already been exposed to a great deal of advertising and publicity about laser refractive surgery, but have little if any awareness of the ICL. In addition, established refractive surgeons frequently have large and well developed practices that are oriented entirely toward the delivery of laser procedures. In countries where the ICL has been approved, our sales have grown steadily but slowly, and the U.S. appears to be following this pattern. A surgeon interested in implanting the ICL must first schedule training and certification and invest time in the training process. While STAAR has sufficient resources to make training available to qualified surgeons with minimal delay, the need to undergo training continues to limit the pace at which interested surgeons can begin providing the ICL to their patients. STAAR employs advertising and promotion targeted to potential patients through providers, but has limited resources for these purposes. Failure to successfully market the ICL in the U.S. will delay and may prevent growth and profitability.

 

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FDA Approval of the Toric ICL, which could have a significant U.S. market, may be significantly 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 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 premarket approval application (PMA) supplement for the TICL to the FDA on April 28, 2006, and received comments from the Office of Device Evaluation (ODE) on November 20, 2006 requesting that STAAR amend parts of the submission. On August 3, 2007 STAAR received a letter from ODE notifying STAAR that the TICL application would be placed on integrity hold until STAAR completed specified actions to the satisfaction of the FDA, including engaging an independent third party auditor to conduct a 100% data audit of patient records along with a clinical systems audit to ensure accuracy and completeness of data before submitting amendments to the application for the FDA’s review. Satisfying the requirements in the August 3 letter will likely delay any approval of the TICL. STAAR has engaged an independent auditor in order to satisfy the requirements of the August 3 letter. An independent audit will delay the approval of the TICL and STAAR cannot ensure that the auditor will ultimately be able to establish to the satisfaction of the FDA the accuracy and completeness of data supporting the TICL Application. If STAAR is required to conduct additional clinical studies, significant further delays and costs would likely result.

Our core domestic business has suffered declining sales, which sales of new products have only begun to offset.

The foldable silicone IOL was once our largest source of sales. Since we introduced the product, however, competitors have introduced IOLs employing a variety of designs and materials. Over the years these products have taken an increasing share of the IOL market, while the market share for STAAR silicone IOLs has decreased. In particular, many surgeons now choose lenses made of acrylic material rather than silicone for their typical patients. In addition, our competitors have begun to offer multifocal or accommodating lenses that claim to reduce the need for cataract patients to use reading glasses; the market for these “presbyopic” lenses is expected to grow as a segment of the cataract market. Our newer line of IOLs made of our proprietary biocompatible Collamer material, while intended to reverse the trend of declining domestic cataract product sales, may not permit us to recover the market share lost over the last several years.

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 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 revenue and earnings.

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 drops dramatically in July and August, and European sales have recently accounted for a greater proportion of our total sales, this seasonal variation in our results has become even more pronounced.

We may lose customers or sales as the result of the restructuring of our sales force and the non-renewal of agreements with regional manufacturers’ representatives.

In August 2007 STAAR began a comprehensive restructuring of its U.S. sales model and moved away from its historical reliance on independent regional manufacturers’ representatives to promote sales of its products. This coincides with STAAR’s election not to renew its last two long-term contracts with regional manufacturer’s representatives, which covered the southwestern and southeastern U.S. and expired on July 31, 2007. STAAR is organizing a direct sales force to sell its Visian ICL refractive products, and a mixed direct/independent sales force to sell cataract products. This transition results in a number of risks to STAAR and its business, including the following:

·	In the regions affected by contracts STAAR elected not to renew, a number of independent representatives will cease selling STAAR products. Customers, in particular long-time customers for cataract products, may not transfer their loyalty to STAAR’s new representatives.

·	Customers may be lost due to lack of service while replacement representatives are recruited and trained.

 

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·	Newly recruited sales representatives may initially be less familiar with our products and our customer base, and accordingly be less effective, than the representatives they replace.

·	STAAR’s restructured refractive sales force will be subject to the risks of direct sales, including the need to recruit and retain key personnel to establish and maintain customer relationships and manage local representatives.

·	If we do not properly implement the transition to our new sales model, we could lose customers, our U.S. refractive sales may fail to grow or decline and our U.S. cataract sales may continue to decline.

Product recalls have been costly and may be so in the future.

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 our products may not come to light until after the products are sold or consigned. In those circumstances, we have previously made voluntary recalls of 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. 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.

We could experience losses due to product liability claims.

We have been subject to product liability claims in the past and continue to be so. Our third-party product liability insurance coverage has become more expensive and difficult to procure. 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, Advanced 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.

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

We manufacture all of our products either at our facilities in California or at our facility in Switzerland. 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.

 

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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 three months ended September 28, 2007, sales from international operations were 65% of our total sales. The results of operations and the financial position of certain of our offshore 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 Euro, the Swiss Franc, and the Australian dollar. 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, including lower profit margins, 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.

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 and language differences can result in misunderstandings among internationally dispersed personnel. These risks will increase when the Canon Staar joint venture becomes a wholly owned subsidiary of STAAR at the completion of the pending buy-out. The risk that unauthorized conduct may go undetected will always be greater in foreign subsidiaries. For example, in early 2007 STAAR learned that the president of its German sales subsidiary, Domilens GmbH, had misappropriated corporate assets. Some countries may also have laws or cultural factors that make it difficult to impose uniform standards and practices. For example, while STAAR’s Code of Ethics requires all employees to certify they are not aware of code violations by others, German legal counsel has advised STAAR that in Germany it cannot legally compel ordinary employees (that is, non-supervisors) to notify STAAR of breaches by others. STAAR believes the absence of such a requirement in its Code of Ethics for German employees is a risk inherent to doing business in Germany that may be mitigated, but not entirely eliminated, by other controls.

We obtain some of the components of our products from a single source, and an interruption in the supply of those components could reduce our sales.

We obtain some of the components for our products from a single source. For example, only one supplier produces our viscoelastic product. The loss or interruption of any of these suppliers could increase costs, reducing our sales and profitability, or harm our customer relations by delaying product deliveries. Even when substitute suppliers are available, the need to certify regulatory compliance and quality standards of substitute suppliers could cause significant delays in production and a material reduction in our sales. Even when secondary sources are available, the failure of one of our suppliers could be the result of an unforeseen industry-wide problem, or the failure of our supplier could create an industry-wide shortage affecting secondary suppliers as well.

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 a major 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.

 

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We risk losses through litigation.

From time to time we are party 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. While we do not believe that any of the claims known to us is likely to have a material adverse effect on our financial condition or results of operations, new claims or unexpected results of existing claims could lead to significant financial harm.

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.

We have licensed our technology to our joint venture company, which could cause our joint venture company to become a competitor.

We have granted to our Japanese joint venture, Canon Staar Co. Inc., an irrevocable, exclusive license to make, have made and sell products using our technology in Japan. We have also granted Canon Staar an irrevocable, exclusive license to make and have made products using our technology in China and to sell such products made in China in China and Japan. In addition, we have granted Canon Staar an irrevocable, non-exclusive license to sell products using our technology in the rest of the world. It is the intent of the Joint Venture Agreement that products be marketed indirectly through Canon, Inc., Canon Marketing Japan Inc., their subsidiaries, STAAR, and other distributors that the Canon Staar Board approves. The grant of such licenses and rights under STAAR’s technology may result in Canon Staar becoming a competitor of STAAR, which could materially reduce STAAR’s revenues and profits. If the pending buy-out of the Canon companies’ interests in Canon Staar does not close as expected, STAAR will remain subject to these risks. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Canon Staar Joint Venture.” 

Our interest in Canon Staar may be acquired for book value on the occurrence of specified events, including a change in control of STAAR.

If STAAR becomes insolvent or enters bankruptcy, dissolves, enters into a merger or other reorganization, is the subject of a take-over attempt or experiences other events of default under the joint venture agreement, the other joint venture partners will have the right to acquire STAAR’s interest in Canon Staar at book value. Book value of STAAR’s 50% interest in Canon Staar was $3.6 million as of December 31, 2006. Book value may not represent the fair value of STAAR’s interest in Canon Staar, and depending on the future condition of Canon Staar’s business it may represent only a small fraction of fair value. STAAR’s interest in Canon Staar is valued in Japanese yen and its value in U.S. dollars may vary significantly with fluctuations in currency exchange rates. If the pending buy-out of the Canon companies’ interests in Canon Staar does not close as expected, STAAR will remain subject to these risks. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Canon Staar Joint Venture.” 

Our pending purchase of the Canon companies’ interests in the joint venture is subject to closing conditions and to integration challenges.

On October 25, 2007 STAAR entered into a Share Purchase Agreement with Canon Inc. and Canon Marketing Japan Inc. to acquire all of the Canon companies’ interests in the Canon Staar joint venture. The Share Purchase Agreement is subject to numerous risks and uncertainties, including the following:

 

·	the need of the parties to satisfy contractual conditions before the Share Purchase Agreement may close,

·	the risk that STAAR may elect to close the transaction even if some conditions are not met or it discovers negative information about Canon Staar prior to closing,

·	the risk that STAAR may not successfully integrate the Canon Staar business or its employees into its overall business,

·	the risk that key employees of Canon Staar may leave after closing,

·	the risk that removal of the Canon name from Canon Staar and its products may reduce its goodwill or the acceptance of its products,

·	the risk that Canon Staar may not sustain current or prior sales levels or achieve projected levels,

 

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·	the risk that STAAR's limited access to information has limited its ability to assess the projections provided to STAAR by Canon Staar's management,

·	the risk that Japanese regulators may not approve the sale of the ICL or Collamer,

·	the risk of operating a foreign subsidiary with limited direct oversight, the risk that applying U.S. accounting standards and controls and procedures over financial reporting may be more difficult, more expensive or more time-consuming than anticipated,

·	STAAR's need to rely on the completeness and accuracy of information provided during its investigation of Canon Staar's business, and

·	the risk that financing for the transaction or for additional working capital purposes may be more difficult to obtain than anticipated and may not be available on reasonable terms, if at all.

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 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 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.

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 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. For example, glaucoma requires ongoing treatment over a long period; thus, many doctors are reluctant to switch a patient to a new treatment if the patient’s current treatment for glaucoma remains effective. This has been a challenge in selling our AquaFlow Device.

 

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

We spent 11.5% of our sales on research and development during the nine months ended September 28, 2007, and we expect to spend approximately 10% 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.

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. In some countries government agencies control costs by limiting the number of surgical procedures they will reimburse. For example, a recent reduction in the number of authorized cataract procedures in Germany has affected the sales of our German subsidiary, Domilens. Similar changes could occur in our other markets. The U.S. Congress has considered 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, which increases our costs and could prevent us from selling our products.

STAAR is regulated by regional, national, state and local agencies, including 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 also subject to government regulation over the prices we charge and the rebates we offer to customers. Complying with government regulation substantially increases the cost of developing, manufacturing and selling our products.

In the U.S., we must obtain approval from the FDA for each product that we market. 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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Regulatory investigations and allegations, whether or not they lead to enforcement action, 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.

As a result of widespread concern about backdating of stock options and similar conduct among U.S. public companies, during 2006 and early 2007 STAAR conducted an investigation of its practices from 1993 to the present in granting stock options to employees, directors and consultants. STAAR’s investigation did not find evidence of fraud, deliberate backdating or similar practices. The investigation did uncover evidence of frequent administrative errors and delays, which STAAR investigated further and determined, would not have a material effect on its historical financial statements, either individually or in aggregate. STAAR believes that its investigation, while limited in scope, was reasonably designed to detect fraud and backdating and determine any material effect on its financial statements. However, STAAR cannot ensure that a more exhaustive investigation would not find additional errors or irregularities in option granting practices, the effect of which could be material.

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. 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 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 contractual provisions, confidentiality procedures and patent, trademark, copyright and trade secrecy 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. 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. 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 and contractual obligations 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 contractual obligations, including with respect to Canon Staar, could discourage a potential acquisition of our company. 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 preventing changes in our management.

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

Our stock price has fluctuated widely, ranging from $2.75 to $8.64 during the twelve month period ended September 28, 2007. Our stock price will likely continue to fluctuate in response to factors such as 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.

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.

ITEM 6.  EXHIBITS

 

Exhibits

 

3.1	Certificate of Incorporation, as amended to date.(1)

3.2	By-laws, as amended to date.(1)

10.65

Share Purchase Agreement dated October 25, 2007 by and between Canon Marketing Japan Inc. and Canon Inc. as Sellers and the Company as Buyer.(2)

31.1	Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(*)

31.2	Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(*)

32.1	Certification Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(*)

_____________________

(1)	Incorporated by reference from the Company’s Current Report on Form 8-K filed with the Commission on May 23, 2006.

(2)	Incorporated by reference to Exhibit 10.65 to the Company's Current Report on Form 8-K filed with the Commission on October 31, 2007.

(*)	Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		STAAR SURGICAL COMPANY
Date: November 7, 2007		By:  /s/ DEBORAH ANDREWS
		Deborah Andrews
		Chief Financial Officer (on behalf of the Registrant and as its chief accounting officer)

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