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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington D.C. 20549
 FORM 10-K
 þ
    
    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 for the fiscal year ended December 31, 2005
 or
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
 for the transition period from  to.
 Commission file number 0-27598
 IRIDEX CORPORATION
 (Exact name of registrant as specified in its charter)
 Delaware
(State or other jurisdiction
of incorporation or organization)
    
    77-0210467
(I.R.S. Employer
Identification Number)
 1212 Terra Bella Avenue, Mountain View CA 94043-1824
(Address of principal executive offices)
(Zip Code)
(650) 940-4700
(Registrants telephone number, including area code)
 Securities registered pursuant to Section 12(b) of the Act:
None
 Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
 o þ
 o þ
 þ o
 þ
  o o þ
 o þ
   
 DOCUMENTS INCORPORATED BY REFERENCE




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##### 



Page No.Part IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    17Item 3.
    
    Legal Proceedings
    
    
    17Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    17Part IIItem 5.
    
    Market for Registrants Common Equity and Related Stockholder Matters and Issuer
Purchases of Equity Securities
    
    
    18Item 6.
    
    Selected Financial Data
    
    
    20Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    22Item 7A.
    
    Quantitative and Qualitative Disclosure about Market Risk
    
    
    40Item 8.
    
    Financial Statements and Supplementary Data
    
    
    41Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
    
    
    64Item 9A.
    
    Controls and Procedures
    
    
    64Part IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    65Item 11.
    
    Executive Compensation
    
    
    65Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
    
    
    65Item 13.
    
    Certain Relationships and Related Transactions
    
    
    65Item 14.
    
    Principal Accountant Fees and Services
    
    
    65Part IVItem 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    66Signatures
    
    
    
    
    
    
    69EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2




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PART I
 This Annual Report on Form 10-K contains certain 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, such as statements relating to levels of future sales and
operating results; actual order rate and market acceptance of our products; opportunities in the
adjunctive visualization systems market and our efforts to provide total disease management
solutions; expectations for future sales growth, generally, including expectations of additional
sales from our new products and new applications of our existing
products; leveraging our core business and increasing recurring
revenues; broadening our product lines through product innovation;
our marketing programs, generally, including Valued IRIDEX Partner
Program; the innovation potential for
production cost decreases and higher gross estimate of the size of our markets; levels of future
investment in research and development efforts; our ability to develop and introduce new products
through strategic alliances, OEM relationships and acquisitions; results of clinical studies and risks associated
with bringing new products to market, general economic conditions and levels of international
sales. In some cases, forward-looking statements can be identified by terminology, such as may,
will, should, expects, plans, anticipates, believes, estimates, predicts,
intends, potential, continue, or the negative of such terms or other comparable terminology.
These statements involve known and unknown risks, uncertainties and other factors which may cause
our actual results, performance or achievements to differ materially from those expressed or
implied by such forward-looking statements. The reader is strongly urged to read the information
contained under the captions Part I, Item 1, Business, and Part II, Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations-Factors That May Affect
Future Results in this Annual Report on Form 10-K for a more detailed description of these significant risks
and uncertainties. The reader is cautioned not to place undue reliance on these forward-looking
statements, which reflect managements analysis only as of the date of this Form 10-K . We
undertake no obligation to update such forward-looking statements to reflect events or
circumstances occurring after the date of this report.
 
 Item 1. Business
 General
   -1-




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The IRIDEX Strategy
  1. Leverage our Core Business and Increase Recurring Revenues
  -2-




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2. Br oaden Product Lines through Product Innovation.
 3. Develop New Market Opportunities Through Strategic Alliances, OEM Relationships and
Acquisitions .
 -3-




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Products
  Consoles:
 Infrared Photocoagulator Consoles.
 Visible (or Green) Photocoagulator Consoles.
 -4-




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Combination Infrared/Visible Photocoagulator Consoles.
 Specialized Delivery Devices:
 Ophthalmic Delivery Devices
 TruFocus Laser Indirect Ophthalmoscope (LIO).
 Slit Lamp Adapter (SLA).
 Operating Microscope Adapter.
 EndoProbe.
 G-Probe.
 -5-




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DioPexy Probe.
 Dermatology Delivery Devices:
 DioLite Handpiece.
 VariLite Handpiece.
 ScanLite Scanner
  Ophthalmology Treatments:
 Condition
    
    Procedure
    
    Console
    
    Delivery DevicesAge-related Macular
Degeneration
    
    Retinal Photocoagulation
    
    Infrared & Visible
    
    Slit Lamp AdapterDiabetic RetinopathyMacular Edema
    
    Grid Retinal Photocoagulation
    
    Infrared & Visible
    
    Slit Lamp Adapter &
Operating Microscope
Adapter,Focal Retinal
Photocoagulation
    
    Visible
    
    Slit Lamp AdapterProliferative
    
    Pan-Retinal Photocoagulation
Vitrectomy Procedure
    
    Infrared & Visible
    
    Slit Lamp Adapter, Operating
Microscope Adapter, Laser
Indirect Ophthalmoscope,
EndoProbe*GlaucomaPrimary Open-Angle
    
    Trabeculoplasty
    
    Infrared & Visible
    
    Slit Lamp AdapterAngle-closure
    
    Iridotomy
    
    Infrared & Visible
    
    Slit Lamp AdapterUncontrolled
    
    Transscleral
Cyclophotocoagulation
    
    Infrared
    
    G-Probe*Retinal
Tears and Detachments
    
    Retinopexy Retinal
Photocoagulation Vitrectomy Procedure
    
    Infrared & Visible
    
    Slit Lamp Adapter, Laser
Indirect Ophthalmoscope,
Operating Microscope
Adapter, EndoProbe*Transscleral Retinal
Photocoagulation
    
    Infrared
    
    DioPexy ProbeRetinopathy of Prematurity
    
    Retinal Photocoagulation
    
    Infrared
    
    Laser Indirect OphthalmoscopeOcular Tumors
    
    Retinal Photocoagulation
    
    Infrared
    
    Slit Lamp Adapter, Operating
Microscope Adapter, Laser
Indirect OphthalmoscopeMacular Holes
    
    Vitrectomy Procedure
    
    Visible
    
    EndoProbe*
 *
    
    Disposable single use products  Dermatology Treatments:Condition
    
    Procedure
    
    Console
    
    Delivery DevicesVascular Lesions
    
    Selective Photothermolysis
    
    Visible
    
    DioLite HandpiecePigmented Lesions
    
    Selective Photothermolysis
    
    Visible
    
    DioLite Handpiece
 -6-




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Research and Product Innovation
     -7-




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Age-Related Macular Degeneration (AMD)  Wet Form.
 Age-Related Macular
 Degeneration  Dry Form .
 -8-




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Glaucoma.
 Diabetic Retinopathy
 Ocular Tumors.
  Customers and Customer Support
    -9-




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Sales and Marketing
      -10-




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Operations
     Competition
  -11-




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Patents and Proprietary Rights
   Government Regulation
   -12-




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-13-




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-14-




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Reimbursement
  -15-




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Product Liability and Insurance
  Backlog
  Employees
  -16-




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Available Information
 www.iridex.com
 
 Item 2. Properties
   
 Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
  -17-




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PART II
 
 Item 5. Market for Registrants Common Equity and Related Stockholder Matters, and Issuer
Purchases of Equity Securities
 Market Information for Common Equity
  High
    
    LowFiscal 2006First
Quarter (through March 23, 2006)
    
    $
    11.49
    
    
    $
    7.98Fiscal 2005First Quarter
    
    $
    6.19
    
    
    $
    4.21Second Quarter
    
    
    6.53
    
    
    
    5.07Third Quarter
    
    
    8.80
    
    
    
    6.16Fourth Quarter
    
    
    8.93
    
    
    
    6.29Fiscal 2004First Quarter
    
    $
    9.17
    
    
    $
    5.09Second Quarter
    
    
    9.15
    
    
    
    6.08Third Quarter
    
    
    7.05
    
    
    
    5.82Fourth Quarter
    
    
    7.19
    
    
    
    3.80
 Fiscal 2005
  Dividend Policy
  -18-




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Securities Authorized for Issuance Under Equity Compensation Plans
  (a)
    
    
    (b)
    
    
    (c)Number of securitiesremaining available for futureNumber of securities to
    
    
    Weighted-average exercise
    
    
    issuance under equitybe issued upon exercise
    
    
    price of outstanding
    
    
    compensation plansof outstanding options,
    
    
    options, warrants and
    
    
    (excluding securitiesPlan category
    
    warrants and rights
    
    
    rights
    
    
    reflected in column (a))Equity compensation
plans approved by
security holders
    
    
    1,894,899(1)
    
    
    $
    5.50
    
    
    
    353,338(2)Equity compensation
plans not approved by security holders
    
    
    259,104(3)
    
    
    
    6.07
    
    
    
    0Total
    
    
    2,154,003
    
    
    $
    5.56
    
    
    
    353,338
 (1)
    
    Includes 1,382,935 options to purchase shares outstanding under the 1998 Stock Plan,
101,250 options to purchase shares outstanding under the 1995 Director Option Plan and
410,714, options to purchase shares outstanding under the Amended and Restated 1989
Incentive Stock Plan.
 (2)
    
    Includes 295,516 options available for future issuance under the 1998 Stock Plan and
57,822 shares issuable under the 2005 Employee Stock Purchase Plan.
 (3)
    
    Consists of two items. The first is a Stand-Alone Option granted to Barry G.
Caldwell on July 5, 2005, entitling Mr. Caldwell to purchase up to 234, 104 shares of the
Companys common stock at an exercise price of $6.07 per share, issued as a stand-alone
option, outside of the Companys existing stock plans and as a material inducement to Mr.
Caldwell accepting employment with the Company. The shares covered by the Stand-Alone
Option vest over a four (4) year period, with 1/4th of the total number of
shares subject to the Stand-Alone Option vesting on July 5, 2006 and 1/48th of
the total number of shares subject to the Stand-Alone Option vesting each full month
thereafter, provided that Mr. Caldwell continues to be a service provider to the Company
on each such date.The second item is a warrant, issued in conjunction with the employment of the Companys
Chief Executive Officer, in consideration of services performed under a recruiting
contract, to purchase 25,000 shares of the Companys common stock at an exercise price of
$6.07 per share. The warrant is exercisable at any time and expires on July 5, 2008.
 -19-




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Item 6. Selected Financial Data
   Fiscal Year
    
    
    Fiscal Year
    
    
    Fiscal Year
    
    
    Fiscal Year
    
    
    Fiscal Year2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Consolidated Statement of Operations Data:Sales
    
    $
    37,029
    
    
    $
    32,810
    
    
    $
    31,699
    
    
    $
    30,634
    
    
    $
    27,275Cost of sales
    
    
    18,854
    
    
    
    17,922
    
    
    
    17,628
    
    
    
    17,046
    
    
    
    14,205Gross profit
    
    
    18,175
    
    
    
    14,888
    
    
    
    14,071
    
    
    
    13,588
    
    
    
    13,070Operating expenses:Research and development
    
    
    4,195
    
    
    
    4,509
    
    
    
    4,032
    
    
    
    4,315
    
    
    
    4,808Selling, general and administrative
    
    
    12,171
    
    
    
    11,455
    
    
    
    10,087
    
    
    
    9,454
    
    
    
    10,251Total operating expenses
    
    
    16,366
    
    
    
    15,964
    
    
    
    14,119
    
    
    
    13,769
    
    
    
    15,059Income (loss) from operations
    
    
    1,809
    
    
    
    (1,076
    )
    
    
    (48
    )
    
    
    (181
    )
    
    
    (1,989
    )Interest and other income, net
    
    
    528
    
    
    
    319
    
    
    
    212
    
    
    
    122
    
    
    
    426Income (loss) before income taxes
    
    
    2,337
    
    
    
    (757
    )
    
    
    164
    
    
    
    (59
    )
    
    
    (1,563
    )Benefit from (provision for) income taxes
    
    
    (666
    )
    
    
    355
    
    
    
    207
    
    
    
    209
    
    
    
    962Income (loss) from continuing operations
    
    
    1,671
    
    
    
    (402
    )
    
    
    371
    
    
    
    150
    
    
    
    (601
    )Income (loss) from operations of
discontinued Laser Research segment (net
of applicable income tax benefit
(provision) of $0, $0, $0, $0 and $124
respectively)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (204
    )Loss on disposal of Laser Research segment
(net of applicable income tax benefit of
$0, $0, $0, $0 and $315 respectively)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (468
    )Net income (loss)
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371
    
    
    $
    150
    
    
    $
    (1,273
    )Basic net income (loss) per common share:Continuing operations
    
    $
    0.23
    
    
    $
    (0.06
    )
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    (0.09
    )Discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.10
    )Basic net income (loss) per common share
    
    $
    0.23
    
    
    $
    (0.06
    )
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    (0.19
    )Diluted net income (loss) per common share:Continuing operations
    
    $
    0.21
    
    
    $
    ( 0.06
    )
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    (0.09
    )Discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.10
    )Diluted net income (loss) per common share
    
    $
    0.21
    
    
    $
    (0.06
    )
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    (0.19
    )Shares used in net income (loss) per
common share basic calculations
    
    
    7,405
    
    
    
    7,200
    
    
    
    6,933
    
    
    
    6,870
    
    
    
    6,757Shares used in net income (loss) per
common share diluted calculations
    
    
    7,880
    
    
    
    7,200
    
    
    
    7,072
    
    
    
    6,928
    
    
    
    6,757
 -20-




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December 31,
    
    January 1,
    
    January 3,
    
    December 28,
    
    December 29,2005
    
    2005
    
    2004
    
    2002
    
    2001Consolidated Balance
Sheet Data:Cash, cash equivalents
and available-for-sale
securities
    
    $
    21,434
    
    
    $
    18,028
    
    
    $
    16,292
    
    
    $
    11,542
    
    
    $
    9,102Working capital
    
    
    32,330
    
    
    
    25,342
    
    
    
    28,462
    
    
    
    28,072
    
    
    
    26,374Total assets
    
    
    41,104
    
    
    
    39,093
    
    
    
    35,839
    
    
    
    34,272
    
    
    
    33,788Total stockholders equity
    
    
    34,517
    
    
    
    31,783
    
    
    
    30,834
    
    
    
    30,198
    
    
    
    29,833
 -21-




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
 $32.8 million, and $31.7 million respectively.
     Results of Operations
  -22-




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Year Ended
    
    Year Ended
    
    Year EndedDecember 31,
    
    January 1,
    
    January 3,2005
    
    2005
    
    2004Sales
    
    
    100
    %
    
    
    100
    %
    
    
    100.0
    %Cost of sales
    
    
    50.9
    
    
    
    54.6
    
    
    
    55.6Gross profit
    
    
    49.1
    
    
    
    45.4
    
    
    
    44.4Operating expenses:Research and development
    
    
    11.3
    
    
    
    13.7
    
    
    
    12.7Sales, general and administrative
    
    
    32.9
    
    
    
    35.0
    
    
    
    31.8Total operating expenses
    
    
    44.2
    
    
    
    48.7
    
    
    
    44.5Operating income (loss)
    
    
    4.9
    
    
    
    (3.3
    )
    
    
    (0.1
    )Other income, net
    
    
    1.4
    
    
    
    1.0
    
    
    
    0.7Income (loss) before income taxes
    
    
    6.3
    
    
    
    (2.3
    )
    
    
    0.6Benefit from (provision for) income taxes
    
    
    (1.8
    )
    
    
    1.1
    
    
    
    0.7Net income (loss)
    
    
    4.5
    %
    
    
    (1.2
    %)
    
    
    1.3
    %
  Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31, 2005
    
    
    January 1, 2005
    
    
    January 3, 2004Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentageof total
    
    
    
    
    
    
    of total
    
    
    
    
    
    
    of totalAmount
    
    
    sales
    
    
    Amount
    
    
    sales
    
    
    Amount
    
    
    salesDomestic
    
    $
    22,713
    
    
    
    61.4
    %
    
    $
    19,894
    
    
    
    60.6
    %
    
    $
    20,072
    
    
    
    63.3
    %International
    
    $
    14,316
    
    
    
    38.6
    %
    
    $
    12,916
    
    
    
    39.4
    %
    
    
    11,627
    
    
    
    36.7
    %Total
    
    $
    37,029
    
    
    
    100.0
    %
    
    $
    32,810
    
    
    
    100.0
    %
    
    $
    31,699
    
    
    
    100.0
    %Ophthalmology:Domestic
    
    $
    17,762
    
    
    
    48.0
    %
    
    $
    16,443
    
    
    
    50.1
    %
    
    $
    15,724
    
    
    
    49.6
    %International
    
    $
    12,901
    
    
    
    34.8
    %
    
    $
    11,310
    
    
    
    34.5
    %
    
    
    10,436
    
    
    
    32.9
    %Total
    
    $
    30,663
    
    
    
    82.8
    %
    
    $
    27,753
    
    
    
    84.6
    %
    
    $
    26,160
    
    
    
    82.5
    %Dermatology:Domestic
    
    $
    4,951
    
    
    
    13.4
    %
    
    $
    3,451
    
    
    
    10.5
    %
    
    $
    4,348
    
    
    
    13.7
    %International
    
    $
    1,415
    
    
    
    3.8
    %
    
    $
    1,606
    
    
    
    4.9
    %
    
    
    1,191
    
    
    
    3.8
    %Total
    
    $
    6,366
    
    
    
    17.2
    %
    
    $
    5,057
    
    
    
    15.4
    %
    
    $
    5,539
    
    
    
    17.5
    %
 Ophthalmology
and Dermatology Sales Overview
   -23-




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Ophthalmology Sales
     Dermatology Sales
  -24-




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Gross Profit.
   Research and Development.
 -25-




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Sales, General and Administrative.
 Interest and Other income, net.
 Income Taxes.
 Liquidity and Capital Resources
       -26-




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Critical Accounting Policies
  Revenue Recognition
  Warranty
  -27-




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Sales Returns Allowance and Allowance for Doubtful Accounts
  Inventories.
  Income Taxes
  Deferred Assets and Liabilities
  -28-




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Contractual Obligations
  Payments Due by Period2010 andTotal
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    thereafterContractual ObligationsOperating Leases
    
    $
    1,319
    
    
    $
    402
    
    
    $
    416
    
    
    $
    429
    
    
    $
    72
    
    
    $
    0Unconditional
Purchase
Obligations*
    
    $
    1,505
    
    
    $
    1,505
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0Total Contractual
Cash Obligations
    
    $
    2,824
    
    
    $
    1,907
    
    
    $
    416
    
    
    $
    429
    
    
    $
    72
    
    
    $
    0
 
  Recent Accounting Pronouncements
 Share-Based Payment  An Amendment of FASB Statements No. 123 and 95 (SFAS 123R).
 -29-




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Share-Based
Payment (SAB 107).
  Accounting Changes and Error Corrections -
replacement of APB Opinion No. 20 and FASB Statement No. 3 SFAS 154
 Factors That May Affect Future Results
  We Rely on Continued Market Acceptance of Our Existing Products and Any Decline in Sales of
Our Existing Products Would Adversely Affect Our Business and Results of Operations.
 §
    
    Acceptance of product performance, features, ease of use, scalability and
durability;§
    
    Acceptance of the companys new marketing programs;§
    
    Recommendations and opinions by ophthalmologists, dermatologists, other
clinicians, plastic surgeons and their associated opinion leaders, including study
outcomes;§
    
    Price of our products and prices of competing products and technologies;§
    
    Availability of competing products, technologies and alternative treatments; and§
    
    Level of reimbursement for treatments administered with our products.
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We Face Strong Competition in Our Markets and Expect the Level of Competition to Grow in the
Foreseeable Future.
 Our Future Success Depends on Our Ability to Develop and Successfully Introduce New Products
and New Applications
 -31-




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##### Table of Contents



If We Cannot Increase Our Sales Volumes, Reduce Our Costs or Introduce Higher Margin Products
to Offset Anticipated Reductions in the Average Unit Price of Our Products, Our Operating Results
May Suffer.
 We Depend on Sales of Our Ophthalmology Products for a Significant Portion of Our Operating
Results
 We Depend on International Sales for a Significant Portion of Our Operating Results
 §
    
    Impact of recessions in economies outside of the United States;§
    
    Performance of our international channel of distributors;§
    
    Foreign certification requirements, including continued ability to use the
CE mark in Europe;
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##### Table of Contents



§
    
    Reduced or limited protections of intellectual property rights in
jurisdictions outside the United States;§
    
    Longer accounts receivable collection periods;§
    
    Potentially adverse tax consequences; and§
    
    Multiple protectionist, adverse and changing foreign governmental laws and
regulations.
  We Rely on Our Direct Sales Force and Network of International Distributors to Sell Our
Products and any Failure to Maintain Our Direct Sales Force and Distributor Relationships Could
Harm Our Business.
  If
We Lose Key Personnel or Fail to Integrate Replacement Personnel Successfully, Our Ability
to Manage Our Business Could Be Impaired
 We Face Manufacturing Risks
 If We Fail to Accurately Forecast Demand For Our Product and Component Requirements For the
Manufacture of Our Product, We Could Incur Additional Costs or Experience Manufacturing Delays and
May Experience Lost Sales or Significant Inventory Carrying Costs.
 -33-




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##### Table of Contents



We Depend on Sole Source or Limited Source Suppliers.
 §
    
    Unavailability of, shortages or limitations on the ability to obtain supplies of
components in the quantities that we require;§
    
    Delays in delivery or failure of suppliers to deliver critical components on the
dates we require;§
    
    Failure of suppliers to manufacture components to our specifications, and
potentially reduced quality; and§
    
    Inability to obtain components at acceptable prices.
 .
 Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year
 
    
    General economic uncertainties and political concerns;
    
    The timing of the introduction and market acceptance of new products, product
enhancements and new applications;
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##### Table of Contents




    
    Changes in demand for our existing line of dermatology and ophthalmic products;
    
    The cost and availability of components and subassemblies, including the ability of our
sole or limited source suppliers to deliver components at the times and prices that we have
planned;
    
    Our ability to maintain sales volumes at a level sufficient to cover fixed manufacturing
and operating costs;
    
    Fluctuations in our product mix between dermatology and ophthalmic products and foreign
and domestic sales;
    
    The effect of regulatory approvals and changes in domestic and foreign regulatory
requirements;
    
    Introduction of new products, product enhancements and new applications by our
competitors, entry of new competitors into our markets, pricing pressures and other
competitive factors;
    
    Our long and highly variable sales cycle;
    
    Changes in the prices at which we can sell our products;
    
    Changes in customers or potential customers budgets as a result of, among other
things, reimbursement policies of government programs and private insurers for treatments
that use our products; and
    
    Increased product innovation costs.
   Our Stock Price Has Been and May Continue to be Volatile and an Investment in Our Common Stock
Could Suffer a Decline in Value.
 We Are Subject To Government Regulation Which May Cause Us to Delay or Withdraw the
Introduction of New Products or New Applications for Our Products.
   We Depend on Collaborative Relationships to Develop, Introduce and Market New Products,
Product Enhancements and New Applications
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We Face Risks Associated with our Collaborative and OEM Relationships.
 We are Dependent on the Successful Outcome of Clinical Trials of Our Products and New
Applications Using Our Products.
  prophylactic therapeutic Unilateral study arm Bilateral study arm
 -36-




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##### Table of Contents



Our products could be subject to recalls even after receiving FDA approval or clearance. A
recall would harm our reputation and adversely affect our operating results.
   We Rely on Patents and Proprietary Rights to Protect our Intellectual Property and Business
 -37-




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The Requirements of Complying with the Sarbanes-Oxley Act of 2002 Might Strain Our Resources,
Which May Adversely Affect Our Business and Financial Condition
 Our Operating Results May be Adversely Affected by Changes in Third Party Coverage and
Reimbursement Policies and any Uncertainty Regarding Healthcare Reform Measures.
 -38-




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If Product Liability Claims are Successfully Asserted Against Us, We may Incur Substantial
Liabilities That May Adversely Affect Our Business or Results of Operations.
 If We Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could Harm Our
Operating Results.
 If Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be Seriously
Harmed.
 -39-




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##### Table of Contents



We May Need Additional Capital, which May Not Be Available, and Our Ability to Grow May be
Limited as a Result.
 Failure to Remediate the Material Weaknesses in Our Disclosure Controls and Procedures in a
Timely Manner, or At All, Could Harm Our Operating Results or Cause Us to Fail to Meet Our
Regulatory or Reporting Obligations.
 
 
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 Quantitative Disclosures
  Interest Rate Risk
  Qualitative Disclosures
 Interest Rate Risk
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##### Table of Contents




    
    The available-for-sale securities will fall in value if market interest rates increase.
    
    The impact of interest rate movements on our ability to obtain adequate financing to
fund future operations.
   Currency Rate Risk
  
 Item 8. Financial Statements and Supplementary Data
  -41-




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
    
 -42-




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##### Table of Contents



IRIDEX Corporation
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except share and per share data)
 December31,
    
    
    January 1,2005
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    12,655
    
    
    $
    10,381Available-for-sale securities
    
    
    8,779
    
    
    
    3,323Accounts receivable, net of allowance for doubtful accounts of $559
in 2005 and $466 in 2004
    
    
    6,589
    
    
    
    7,404Inventories, net
    
    
    8,594
    
    
    
    8,922Prepaids and other current assets
    
    
    885
    
    
    
    814Short term deferred income taxes
    
    
    1,415
    
    
    
    1,808Total current assets
    
    
    38,917
    
    
    
    32,652Long term portion of available-for-sale securities
    
    
    
    
    
    
    4,324Property and equipment, net
    
    
    1,114
    
    
    
    852Deferred income taxes
    
    
    1,073
    
    
    
    1,265Total assets
    
    $
    41,104
    
    
    $
    39,093LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,094
    
    
    $
    1,233Accrued expenses
    
    
    4,421
    
    
    
    5,167Deferred revenue
    
    
    1,072
    
    
    
    910Total liabilities
    
    
    6,587
    
    
    
    7,310Commitments and contingencies (Note 5).Stockholders EquityConvertible Preferred Stock, $.01 par value:Authorized: 2,000,000 shares;Issued and outstanding: none
    
    
    
    
    
    
    Common Stock, $.01 par value:Authorized: 30,000,000 shares;Issued and outstanding: 7,520,358 shares in 2005 and 7,308,857
shares in 2004
    
    
    76
    
    
    
    74Additional paid-in capital
    
    
    26,334
    
    
    
    25,281Accumulated other comprehensive loss
    
    
    (27
    )
    
    
    (35
    )Treasury stock, at cost
    
    
    (430
    )
    
    
    (430
    )Retained earnings
    
    
    8,564
    
    
    
    6,893Total stockholders equity
    
    
    34,517
    
    
    
    31,783Total liabilities and stockholders equity
    
    $
    41,104
    
    
    $
    39,093
  -43-




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##### Table of Contents



IRIDEX Corporation
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share data)
 Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Sales
    
    $
    37,029
    
    
    $
    32,810
    
    
    $
    31,699Cost of sales
    
    
    18,854
    
    
    
    17,922
    
    
    
    17,628Gross profit
    
    
    18,175
    
    
    
    14,888
    
    
    
    14,071Operating expenses:Research and development
    
    
    4,195
    
    
    
    4,509
    
    
    
    4,032Sales, general and administrative
    
    
    12,171
    
    
    
    11,455
    
    
    
    10,087Total operating expenses
    
    
    16,366
    
    
    
    15,964
    
    
    
    14,119Income (loss) from operations
    
    
    1,809
    
    
    
    (1,076
    )
    
    
    (48
    )Interest and other income, net
    
    
    528
    
    
    
    319
    
    
    
    212Income (loss) before income taxes
    
    
    2,337
    
    
    
    (757
    )
    
    
    164Benefit from (provision for) income taxes
    
    
    (666
    )
    
    
    355
    
    
    
    207Net income (loss)
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371Basic net income (loss) per common share
    
    $
    0.23
    
    
    $
    (0.06
    )
    
    $
    0.05Diluted net income (loss) per common share
    
    $
    0.21
    
    
    $
    (0.06
    )
    
    $
    0.05Shares used in net income (loss) per
common share basic calculations
    
    
    7,405
    
    
    
    7,200
    
    
    
    6,933Shares used in net income (loss) per
common share diluted
calculations
    
    
    7,880
    
    
    
    7,200
    
    
    
    7,072
  -44-




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##### Table of Contents



IRIDEX Corporation
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 (in thousands, except share data)
 AccumulatedAdditional
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Paid-in
    
    
    Treasury
    
    
    Comprehensive
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Income (Loss)
    
    
    Earnings
    
    
    TotalBalances, December 28, 2002
    
    
    6,905,998
    
    
    $
    70
    
    
    $
    23,631
    
    
    $
    (430
    )
    
    $
    3
    
    
    $
    6,924
    
    
    $
    30,198Issuance of Common Stock
under Stock Option
Plan
    
    
    52,466
    
    
    
    
    
    
    
    179
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Issuance of Common Stock under
Employee Stock Purchase
Plan
    
    
    28,569
    
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75Tax Benefit of Employee Stock
Option Plan
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Change in unrealized gains on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    371
    
    
    
    371Balances, January 3, 2004
    
    
    6,987,033
    
    
    
    70
    
    
    
    23,900
    
    
    
    (430
    )
    
    
    (1
    )
    
    
    7,295
    
    
    
    30,834Issuance of Common Stock
under Stock Option Plan
    
    
    294,852
    
    
    
    4
    
    
    
    1,081
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,085Issuance of Common Stock
under Employee Stock
Purchase Plan
    
    
    26,972
    
    
    
    
    
    
    
    122
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122Tax Benefit of Employee Stock
Option Plan
    
    
    
    
    
    
    
    
    
    
    178
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    178Change in unrealized gains on
available-for-sale
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34
    )
    
    
    
    
    
    
    (34
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (402
    )
    
    
    (402
    )Balances, January 1, 2005
    
    
    7,308,857
    
    
    
    74
    
    
    
    25,281
    
    
    
    (430
    )
    
    
    (35
    )
    
    
    6,893
    
    
    
    31,783Issuance of Common Stock
under Stock Option Plan
    
    
    183,873
    
    
    
    2
    
    
    
    661
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    663Issuance of Common Stock
under Employee Stock
Purchase Plan
    
    
    27,628
    
    
    
    
    
    
    
    134
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    134Tax Benefit of Employee Stock
Option Plan
    
    
    
    
    
    
    
    
    
    
    171
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    171Change in unrealized gains on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    8Warrants issued for services
    
    
    
    
    
    
    
    
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    87Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,671
    
    
    
    1,671Balances, December 31, 2005
    
    
    7,520,358
    
    
    $
    76
    
    
    $
    26,334
    
    
    $
    (430
    )
    
    $
    (27
    )
    
    $
    8,564
    
    
    $
    34,517
  -45-




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##### Table of Contents



IRIDEX Corporation
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Cash flows from operating activities:Net income (loss)
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Depreciation and amortization
    
    
    435
    
    
    
    384
    
    
    
    703Issuance of warrant
    
    
    87
    
    
    
    
    
    
    
    Provision for doubtful accounts
    
    
    132
    
    
    
    376
    
    
    
    (142
    )Provision for inventories
    
    
    407
    
    
    
    694
    
    
    
    (63
    )Deferred income taxes
    
    
    585
    
    
    
    (579
    )
    
    
    (235
    )Changes in assets and liabilities:Accounts receivable
    
    
    683
    
    
    
    (1,232
    )
    
    
    1,631Inventories
    
    
    (436
    )
    
    
    (895
    )
    
    
    2,067Prepaids and other current assets
    
    
    (71
    )
    
    
    120
    
    
    
    (175
    )Accounts payable
    
    
    (139
    )
    
    
    204
    
    
    
    372Accrued expenses
    
    
    (746
    )
    
    
    1,787
    
    
    
    356Deferred revenue
    
    
    162
    
    
    
    314
    
    
    
    203Net cash provided by operating activities
    
    
    2,770
    
    
    
    771
    
    
    
    5,088Cash flows from investing activities:Purchases of available-for-sale securities
    
    
    (8,770
    )
    
    
    (7,681
    )
    
    
    (5,755
    )Proceeds from maturity of available-for-sale securities
    
    
    7,646
    
    
    
    5,751
    
    
    
    2,356Acquisition of property and equipment
    
    
    (340
    )
    
    
    (386
    )
    
    
    (603
    )Net cash used in investing activities
    
    
    (1,464
    )
    
    
    (2,316
    )
    
    
    (4,002
    )Cash flows from financing activities:Issuance of common stock under stock purchase and option
plans
    
    
    968
    
    
    
    1,385
    
    
    
    269Net cash provided by financing activities
    
    
    968
    
    
    
    1,385
    
    
    
    269Net increase (decrease) in cash and cash
equivalents
    
    
    2,274
    
    
    
    (160
    )
    
    
    1,355Cash and cash equivalents, beginning of year
    
    
    10,381
    
    
    
    10,541
    
    
    
    9,186Cash and cash equivalents, end of year
    
    $
    12,655
    
    
    $
    10,381
    
    
    $
    10,541Supplemental disclosure of cash flow information:Cash paid during the year for:Income taxes
    
    $
    209
    
    
    $
    25
    
    
    $
    138
  -46-




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IRIDEX Corporation
 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 (in thousands)
 Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Net income (loss)
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371Other comprehensive loss:Changes in unrealized losses on
available-for-sale securities, net
    
    
    6
    
    
    
    (34
    )
    
    
    (4
    )Comprehensive income (loss)
    
    $
    1,677
    
    
    $
    (436
    )
    
    $
    367
  -47-




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##### Table of Contents



IRIDEX Corporation
 
 Notes to Consolidated Financial Statements
 1.
    
    Business of the Company
 Description of Business
  2.
    
    Summary of Significant Accounting Policies
 Financial Statement Presentation
  Cash and Cash Equivalents
  Available-for-Sale Securities
  Sales Returns Allowance and Allowance for Doubtful Accounts
  -48-




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##### Table of Contents



Inventories
  Property and Equipment
  Revenue Recognition
  Deferred Revenue
  Balance, January 3, 2004
    
    $
    596Additions to deferral
    
    
    1,146Revenue recognized
    
    
    (832
    )Balance, January 1, 2005
    
    
    910Additions to deferral
    
    
    1,451Revenue recognized
    
    
    (1,289
    )Balance, December 31, 2005
    
    $
    1,072
 -49-




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##### Table of Contents



Warranty
  Balance, January 3, 2004
    
    $
    801Accruals for warranties issued during the year
    
    
    861Settlements made in kind during the year
    
    
    (729
    )Balance, January 1, 2005
    
    $
    933Accruals for warranties issued during the year
    
    
    1,163Settlements made in kind during the year
    
    
    (968
    )Balance, December 31, 2005
    
    $
    1,128
 Research
and Development
  Advertising
  Fair Value of Financial Instruments
  -50-




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##### Table of Contents



Income Taxes
  Accounting for Stock-Based Compensation
    Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Net income (loss), as reported
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371Add: Total stock based
compensation expense determined
under fair value based method for
all awards, net of tax
    
    
    (966
    )
    
    
    (560
    )
    
    
    (534
    )Pro forma net income (loss)
    
    $
    705
    
    
    $
    (962
    )
    
    $
    (163
    )Basic net income (loss) per share:As reported
    
    $
    0.23
    
    
    $
    (0.06
    )
    
    $
    0.05Pro forma
    
    $
    0.10
    
    
    $
    (0.13
    )
    
    $
    (0.02
    )Diluted net income (loss) per share:As reported
    
    $
    0.21
    
    
    $
    (0.06
    )
    
    $
    0.05Pro forma
    
    $
    0.09
    
    
    $
    (0.13
    )
    
    $
    (0.02
    )
 -51-




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##### Table of Contents



2005
    
    2004
    
    2003Group A
    
    Group B
    
    Group A
    
    Group B
    
    Group A
    
    Group BRisk-free Interest Rates
    
    
    4.40
    %
    
    
    4.40
    %
    
    
    3.50
    %
    
    
    3.50
    %
    
    
    3.30
    %
    
    
    3.30
    %Expected Life
    
    7 years
    
    5 years
    
    4 years
    
    4 years
    
    4 years
    
    4 yearsVolatility
    
    
    0.83
    
    
    
    0.77
    
    
    
    0.88
    
    
    
    0.88
    
    
    
    0.88
    
    
    
    0.88Dividend Yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
     2005
    
    2004
    
    2003Risk-free Interest Rates
    
    
    4.20
    %
    
    
    2.56
    %
    
    
    1.45
    %Expected Life
    
    0.5 year
    
    0.5 year
    
    0.5 yearVolatility
    
    
    0.46
    
    
    
    0.84
    
    
    
    0.86Dividend Yield
    
    
    
    
    
    
    
    
    
    
    
  Concentration of Credit Risk and Other Risks and Uncertainties
  -52-




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##### Table of Contents



Reliance on Certain Suppliers
  Use of Estimates
  Fiscal Year
  Net Income (loss) per Share
  Recent Accounting Pronouncements
 Share-Based Payment  An Amendment of FASB Statements No. 123 and 95 (SFAS 123R).
 -53-




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##### Table of Contents



Share-Based
Payment (SAB 107).
  Accounting Changes and Error Corrections -
replacement of APB Opinion No. 20 and FASB Statement No. 3 SFAS 154
 -54-




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##### Table of Contents



3.
    
    Balance Sheet Detail
 Available-for-sale securities (in thousands)
 Unrealized
    
    
    Estimated
    
    
    MaturityCost
    
    
    Gain (Loss)
    
    
    Fair Value
    
    
    DatesAs of December 31, 2005, available-for-sale securities consisted of the following:Corporate notes
    
    $
    5,442
    
    
    $
    (19
    )
    
    $
    5,423
    
    
    
    2/066/06Government agencies
    
    
    3,364
    
    
    
    (8
    )
    
    
    3,356
    
    
    
    1/063/06Total
    
    $
    8,806
    
    
    $
    (27
    )
    
    $
    8,779As of January 1, 2005, short term available-for-sale securities consisted of the following :Corporate notes
    
    $
    3,345
    
    
    $
    (22
    )
    
    $
    3,323
    
    
    
    5/05  8/05Total
    
    $
    3,345
    
    
    $
    (22
    )
    
    $
    3,323As of January 1, 2005, long term available-for-sale securities consisted of the following :Corporate notes
    
    $
    4,312
    
    
    $
    (12
    )
    
    $
    4,324
    
    
    
    2/06  5/06Total
    
    $
    4,312
    
    
    $
    (12
    )
    
    $
    4,324
  December 31,
    
    
    January 1,2005
    
    
    2005Inventories:Raw materials and work in process
    
    $
    5,191
    
    
    $
    5,460Finished goods
    
    
    3,403
    
    
    
    3,462Total inventories
    
    $
    8,594
    
    
    $
    8,922Property and Equipment:Equipment
    
    $
    4,937
    
    
    $
    4,264Leasehold improvements
    
    
    1,921
    
    
    
    1,903Less: accumulated depreciation and amortization
    
    
    (5,744
    )
    
    
    (5,315
    )Property and equipment, net
    
    $
    1,114
    
    
    $
    852
  Accrued Expenses:Accrued payroll, vacation and related expenses
    
    $
    1,671
    
    
    $
    1,100Accrued warranty
    
    
    1,129
    
    
    
    933Income taxes payable
    
    
    552
    
    
    
    783Sales and use tax payable
    
    
    220
    
    
    
    1,277Other accrued expenses
    
    
    849
    
    
    
    1,074Total accrued expenses
    
    $
    4,421
    
    
    $
    5,167
 4. Bank Borrowings
  -55-




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##### Table of Contents



5. Commitments and Contingencies
 Lease Agreements
  in thousands)
 Fiscal Year
    
    Operating Lease Payments2006
    
    $
    4022007
    
    
    4162008
    
    
    4292009
    
    
    72$
    1,319
 License Agreements
  Contingencies
  -56-




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##### Table of Contents



6. Stockholders Equity
 Convertible Preferred Stock
  Treasury Stock
  Stock Option Plans
 Amended and Restated 1989 Incentive Stock Plan
  1998 Stock Plan
  -57-




---



##### Table of Contents



1995 Director Option Plan
    Stand-Alone Option
  -58-




---



##### Table of Contents



2005 Employee Stock Purchase Plan
   Outstanding OptionsShares
    
    
    
    
    
    
    
    
    WeightedAvailable
    
    
    Number
    
    
    Aggregate
    
    
    Averagefor Grant
    
    
    of Shares
    
    
    Price
    
    
    Exercise PriceBalances, December 28, 2002
    
    
    399,747
    
    
    
    1,700,863
    
    
    
    8,687
    
    
    5.11Additional shares reserved
    
    
    270,000
    
    
    
    
    
    
    
    
    
    
    Options granted
    
    
    (395,000
    )
    
    
    395,000
    
    
    
    1,516
    
    
    3.84Options exercised
    
    
    
    
    
    
    (52,466
    )
    
    
    (179
    )
    
    3.40Options cancelled
    
    
    (649
    )Options terminated
    
    
    39,114
    
    
    
    (39,114
    )
    
    
    (189
    )
    
    4.83Balances, January 3, 2004
    
    
    313,212
    
    
    
    2,004,283
    
    
    
    9,835
    
    
    4.91Additional shares reserved
    
    
    270,000
    
    
    
    
    
    
    
    
    
    
    Options granted
    
    
    (214,750
    )
    
    
    214,750
    
    
    
    1,379
    
    
    6.42Options exercised
    
    
    
    
    
    
    (294,852
    )
    
    
    (1,085
    )
    
    3.68Options cancelled
    
    
    (15,000
    )Options terminated
    
    
    100,789
    
    
    
    (100,789
    )
    
    
    (701
    )
    
    6.95Balances, January 1, 2005
    
    
    454,251
    
    
    
    1,823,392
    
    
    
    9,428
    
    
    5.18Additional shares reserved
    
    
    434,104
    
    
    
    
    
    
    
    
    
    
    Options granted
    
    
    (622,050
    )
    
    
    622,050
    
    
    
    3,791
    
    
    6.09Warrants issued
    
    
    (25,000
    )
    
    
    25,000Options exercised
    
    
    
    
    
    
    (183,873
    )
    
    
    (663
    )
    
    3.60Options cancelled
    
    
    (78,355
    )Options terminated
    
    
    132,566
    
    
    
    (132,566
    )
    
    
    (866
    )
    
    6.53Balances, December 31, 2005
    
    
    295,516
    
    
    
    2,154,003
    
    
    $
    11,845
    
    
    $5.50
 -59-




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##### Table of Contents



Options Outstanding
    
    
    Options ExercisableWeighted AverageNumber
    
    
    Remaining
    
    
    Weighted Average
    
    
    Number
    
    
    Weighted AverageOutstanding
    
    
    Contractual Life
    
    
    Exercise
    
    
    Exercisable
    
    
    ExerciseRange of Exercise Prices
    
    at 12/31/05
    
    
    (Years)
    
    
    Price
    
    
    at 12/31/05
    
    
    Price$2.94- $3.50
    
    
    271,482
    
    
    
    7.17
    
    
    $
    3.36
    
    
    
    176,327
    
    
    $
    3.38$3.52 - $3.98
    
    
    162,558
    
    
    
    6.13
    
    
    
    3.67
    
    
    
    138,433
    
    
    
    3.68$4.00 - $4.00
    
    
    284,289
    
    
    
    1.80
    
    
    
    4.00
    
    
    
    284,289
    
    
    
    4.00$4.01 - $5.00
    
    
    222,710
    
    
    
    5.50
    
    
    
    4.42
    
    
    
    177,420
    
    
    
    4.41$5.08 - $5.50
    
    
    228,334
    
    
    
    7.01
    
    
    
    5.24
    
    
    
    84,272
    
    
    
    5.29$5.56 - $6.00
    
    
    119,838
    
    
    
    8.62
    
    
    
    5.64
    
    
    
    38,828
    
    
    
    5.62$6.07 - $6.07
    
    
    300,000
    
    
    
    9.51
    
    
    
    6.07
    
    
    
    0
    
    
    
    0.00$6.19 - $7.25
    
    
    228,154
    
    
    
    7.85
    
    
    
    6.66
    
    
    
    102,821
    
    
    
    6.72$7.38 - $9.00
    
    
    247,950
    
    
    
    5.03
    
    
    
    8.49
    
    
    
    175,431
    
    
    
    8.62$9.06 - $14.88
    
    
    88,688
    
    
    
    4.47
    
    
    
    10.22
    
    
    
    83,063
    
    
    
    10.30$2.94  -  $14.88
    
    
    2,154,003
    
    
    
    6.31
    
    
    $
    5.50
    
    
    
    1,260,884
    
    
    
    5.35
  7. Employee Benefit Plan
  8. Income Taxes
  Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Current:Federal
    
    $
    59
    
    
    $
    212
    
    
    $
    19State
    
    
    31
    
    
    
    14
    
    
    
    990
    
    
    
    226
    
    
    
    28Deferred:Federal
    
    
    451
    
    
    
    (519
    )
    
    
    (148
    )State
    
    
    125
    
    
    
    (62
    )
    
    
    (87
    )576
    
    
    
    (581
    )
    
    
    (235
    )Income tax provision (benefit)
    
    $
    666
    
    
    $
    (355
    )
    
    $
    (207
    )
 -60-




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##### Table of Contents



Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Income tax provision at statutory rate
    
    
    34
    %
    
    
    34
    %
    
    
    34
    %State income taxes, net of federal benefit
    
    
    6
    %
    
    
    8
    %
    
    
    6
    %Tax exempt interest
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Nondeductible permanent differences
    
    
    1
    %
    
    
    (5
    %)
    
    
    19
    %Research and development credits
    
    
    (13
    %)
    
    
    12
    %
    
    
    (164
    %)Other
    
    
    0
    %
    
    
    (2
    %)
    
    
    (22
    %)Effective tax rate
    
    
    28
    %
    
    
    47
    %
    
    
    (127
    %)
  December 31,
    
    
    January 1,2005
    
    
    2005Fixed assets
    
    $
    558
    
    
    $
    640Accrued liabilities
    
    
    595
    
    
    
    1,039Allowance for excess and obsolete inventories
    
    
    599
    
    
    
    514Research credit
    
    
    514
    
    
    
    626State tax
    
    
    1
    
    
    
    1Allowance for doubtful accounts
    
    
    215
    
    
    
    184Other
    
    
    6
    
    
    
    69Net deferred tax asset
    
    $
    2,488
    
    
    $
    3,073
  9. Major Customers and Business Segments
    Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004United States
    
    $
    22,713
    
    
    $
    19,894
    
    
    $
    20,072Europe
    
    $
    7,138
    
    
    
    6,498
    
    
    
    5,297Rest of Americas
    
    $
    1,703
    
    
    
    631
    
    
    
    1,000Asia/Pacific Rim
    
    $
    5,475
    
    
    
    5,787
    
    
    
    5,330$
    37,029
    
    
    $
    32,810
    
    
    $
    31,699
   -61-




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##### Table of Contents



Year Ended December 31, 2005Ophthalmology
    
    
    DermatologyMedical Devices
    
    

Medical Devices
    
    
    TotalSales
    
    $
    30,663
    
    
    $
    6,366
    
    
    $
    37,029Direct cost of goods sold
    
    $
    10,374
    
    
    $
    3,138
    
    
    $
    13,512Direct gross margin
    
    $
    20,289
    
    
    $
    3,228
    
    
    $
    23,517Total unallocated indirect costs
    
    
    
    
    
    
    
    
    
    $
    21,708Income from operations
    
    
    
    
    
    
    
    
    
    $
    1,809
 Year Ended January 1, 2005Ophthalmology
    
    
    DermatologyMedical Devices
    
    
    Medical Devices
    
    
    TotalSales
    
    $
    27,753
    
    
    $
    5,057
    
    
    $
    32,810Direct cost of goods sold
    
    $
    9,876
    
    
    $
    2,898
    
    
    $
    12,774Direct gross margin
    
    $
    17,877
    
    
    $
    2,159
    
    
    $
    20,036Total unallocated indirect costs
    
    
    
    
    
    
    
    
    
    $
    21,112Loss from operations
    
    
    
    
    
    
    
    
    
    $
    (1,076
    )
 Year Ended January 3, 2004Ophthalmology
    
    
    DermatologyMedical Devices
    
    
    Medical Devices
    
    
    TotalSales
    
    $
    26,160
    
    
    $
    5,539
    
    
    $
    31,699Direct cost of goods sold
    
    $
    9,217
    
    
    $
    2,782
    
    
    $
    11,999Direct gross margin
    
    $
    16,943
    
    
    $
    2,757
    
    
    $
    19,700Total unallocated indirect costs
    
    
    
    
    
    
    
    
    
    $
    19,748Loss from operations
    
    
    
    
    
    
    
    
    
    $
    (48
    )
 -62-




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##### Table of Contents



10. Computation of Net Income Per Common Share and Per Diluted Common Share
  Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2005
    
    
    2004Net income (loss)
    
    $
    1,671
    
    
    $
    (402
    )
    
    $
    371Denominator  Net income (loss) per common shareWeighted average common stock outstanding
    
    
    7,405
    
    
    
    7,200
    
    
    
    6,933Effect of dilutive securitiesWeighted average common stock options
    
    
    475
    
    
    
    
    
    
    
    139Total weighted average stock and options outstanding
    
    
    7,880
    
    
    
    7,200
    
    
    
    7,072Net income (loss) per common share
    
    $
    0.23
    
    
    $
    (0.06
    )
    
    $
    0.05Diluted net income (loss) per common share
    
    $
    0.21
    
    
    $
    (0.06
    )
    
    $
    0.05
  11. Selected Quarterly Financial Data, (Unaudited)
 QuarterFirst
    
    Second
    
    Third
    
    Fourth(In thousands, except per share amounts)Year Ended December 31, 2005Sales
    
    $
    8,145
    
    
    $
    9,387
    
    
    $
    9,081
    
    
    $
    10,416Gross profit
    
    $
    3,678
    
    
    $
    4,545
    
    
    $
    4,879
    
    
    $
    5,073Net income (loss)
    
    $
    (20
    )
    
    $
    430
    
    
    $
    879
    
    
    $
    381Net income (loss) per common share
    
    $
    (0.00
    )
    
    $
    0.06
    
    
    $
    0.12
    
    
    $
    0.05Diluted net income (loss) per common share
    
    $
    (0.00
    )
    
    $
    0.05
    
    
    $
    0.11
    
    
    $
    0.05Year Ended January 1, 2005Sales
    
    $
    7,392
    
    
    $
    8,109
    
    
    $
    8,178
    
    
    $
    9,131Gross profit
    
    $
    3,215
    
    
    $
    3,807
    
    
    $
    3,470
    
    
    $
    4,396Net income (loss)
    
    $
    (17
    )
    
    $
    133
    
    
    $
    (720
    )
    
    $
    202Net income (loss) per common share
    
    $
    (0.00
    )
    
    $
    (0.02
    )
    
    $
    (0.10
    )
    
    $
    0.03Diluted net income (loss) per common share
    
    $
    (0.00
    )
    
    $
    (0.02
    )
    
    $
    (0.10
    )
    
    $
    0.03
 -63-




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##### Table of Contents



Item 9. Changes in And Disagreements with Accountants On Accounting and Financial Disclosure
  
 Item 9A. Controls and Procedures
 Evaluation of disclosure controls and procedures .
 a) Evaluation of disclosure controls and procedures.
    b) Changes in internal control over financial reporting.
 
    
    Implement additional controls over the preparation and review of key spreadsheets
    
    Implement automated general ledger reports to replace existing key spreadsheets where
possible,
    
    Correct a system generated custom report to include additional information necessary to
prepare accurate financial information
    
    Implement additional review procedures
    
    Enhance the current capabilities of the finance function.
   Item 9B. Other Information
  -64-




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##### Table of Contents



PART III
  
 Item 10. Directors and Executive Officers of the Registrant
  
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  
 Item 13. Certain Relationships and Related Transactions
  
 Item 14. Principal Accountant Fees and Services.
  -65-




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##### Table of Contents



PART IV
 
 Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
 Page inForm 10-KReport(a)
    
    The following documents are filed
in Part II of this Annual Report on Form 10-K:1. Financial StatementsReport
of Independent Registered Public Accounting Firm
    
    42Consolidated Balance
Sheets as of December 31, 2005 and January 1, 2005
    
    43Consolidated
Statements of Operations for the years ended December  31, 2005,  January 1, 2005 and January 3, 2004
    
    44Consolidated
Statements of Stockholders Equity for the years ended December 31, 2005, January 1, 2005 and January 3, 2004
    
    45Consolidated
Statements of Cash Flows for the years ended December 31, 2005, January 1, 2005 and January 3, 2004
    
    46Consolidated
Statements of Comprehensive Income (Loss) for the years ended December 31, 2005,
January 1, 2005 and January 3, 2004
    
    47Notes to Consolidated Financial Statements
    
    482. Financial Statement ScheduleThe following financial statement
schedule of IRIDEX Corporation for the years ended December 31, 2005,
January 1, 2005 and January 3, 2004 is filed as part of this Annual
 Report and should be read in conjunction with the Consolidated
  Financial Statements of IRIDEX Corporation.Schedule II  Valuation and Qualifying Accounts
    
    68
   Exhibits
    
    Exhibit Title3.1(1)
    
    Amended and Restated Certificate of
Incorporation of Registrant.3.2(2)
    
    Amended and Restated Bylaws of Registrant.10.1(1)
    
    Form of Indemnification Agreement with directors and officers.10.2(1)
    
    2005 Employee Stock Purchase Plan.10.3(5)
    
    Employment Agreement with
Barry G. Caldwell dated July 5, 2005.10.4(6)
    
    Executive Transition Agreement
entered into by and between the Company and Theodore A.
Boutacoff dated April 28, 2005.10.5(6)
    
    Amended and Restated Severance and
Change of Control Agreement entered into by and between the Company
and Larry Tannenbaum on April 29, 2005.10.6(4)
    
    Lease Agreement dated December 6, 1996 by and between Zappettini
Investment Co. and the Registrant, as amended.10.7(3)
    
    1998 Stock Option Plan, as amended.21.1(1)
    
    Subsidiaries of Registrant.23.1
    
    Consent of Independent Registered
Public Accounting Firm.24.1
    
    Power of Attorney (See page 69).31.1
    
    Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
 -66-




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##### Table of Contents



Exhibits
    
    Exhibit Title31.2
    
    Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Incorporated by reference to the Exhibits filed with the Registration Statement on Form SB-2 (No. 333-00320-LA) which was declared
effective on February 15, 1996.(2)
    
    Incorporated by reference to the Exhibits in Registrants Report on Form 10-Q for the quarter ended October 3, 1998.(3)
    
    Incorporated by reference to the Exhibits in Registrants Proxy Statement for the Companys 1998 Annual Meeting of Stockholders which
was filed April 30, 1998.(4)
    
    Incorporated by reference to the Exhibits in Registrants Report on Form 10-Q for the quarter ended September 27, 2003. Trademark Acknowledgments
  -67-




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##### Table of Contents



Schedule II
 IRIDEX CORPORATION AND SUBSIDIARIES
 VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
 Balance at
    
    Charged to
    
    
    
    
    
    BalanceBeginning of
    
    Costs and
    
    
    
    
    
    at End ofDescription
    
    The Period
    
    Expenses
    
    Deductions
    
    The PeriodBalance for
the year ended January 3, 2004:Allowance for doubtful accounts receivable
    
    $
    262
    
    
    $
    
    
    
    $
    (142
    )
    
    $
    120Provision for inventory
    
    $
    1,106
    
    
    $
    
    
    
    $
    (63
    )
    
    $
    1,043Balance for
the year ended January 1, 2005:Allowance for doubtful accounts receivable
    
    $
    120
    
    
    $
    376
    
    
    $
    (30
    )
    
    $
    466Provision for inventory
    
    $
    1,043
    
    
    $
    694
    
    
    $
    
    
    
    $
    1,737Balance for
the year ended December 31, 2005:Allowance for doubtful accounts receivable
    
    $
    466
    
    
    $
    132
    
    
    $
    (39
    )
    
    $
    559Provision for inventory
    
    $
    1,737
    
    
    $
    407
    
    
    $
    (89
    )
    
    $
    2,055
 -68-




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##### Table of Contents



SIGNATURES
  IRIDEX CORPORATIONBy:

/s/ Barry G. CaldwellBarry G. CaldwellPresident, Chief Executive Officer,
and Director   /s/ Barry G. Caldwell
    
    President, Chief Executive Officer,
and Director
    
    March 31, 2006(Barry G. Caldwell)
    
    (Principal Executive Officer)/s/ Larry Tannenbaum
    
    Chief Financial Officer
and Vice President, Administration
    
    March 31, 2006(Larry Tannenbaum)
    
    (Principal Financial and
Accounting Officer)/s/ James L. Donovan
    
    Vice President, Corporate
Business
    
    March 31, 2006(James L. Donovan)
    
    Development and Director/s/ Robert K. Anderson
    
    Director
    
    March 31, 2006(Robert K. Anderson)/s/ Donald L. Hammond
    
    Director
    
    March 31, 2006(Donald L. Hammond)/s/ Sanford Fitch
    
    Director
    
    March 31, 2006(Sanford Fitch)/s/ Garrett A. Garrettson
    
    Director
    
    March 31, 2006(Garett A. Garrettson)/s/ Theodore A. Boutacoff
    
    Chairman of the Board
    
    March 31, 2006(Theodore A. Boutacoff)
 -69-




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##### Table of Contents



Exhibit Index
 Exhibits
    
    Exhibit Title3.1(1)
    
    Amended and Restated Certificate of Incorporation of Registrant.3.2(2)
    
    Amended and Restated Bylaws of Registrant.10.1(1)
    
    Form of Indemnification Agreement with directors and officers.10.2(1)
    
    2005 Employee Stock Purchase Plan.10.3(5)
    
    Employment Agreement with
Barry G. Caldwell dated July 5, 2005.10.4(6)
    
    Executive Transition Agreement
entered into by and between the Company and Theodore A.
Boutacoff dated April 28, 2005.10.5(6)
    
    Amended and Restated Severance and
Change of Control Agreement entered into by and between the Company
and Larry Tannenbaum on April 29, 2005.10.6(4)
    
    Lease Agreement dated December 6,
1996 by and between Zappettini Investment Co. and the Registrant, as amended.10.7(3)
    
    1998 Stock Option Plan, as amended.21.1(1)
    
    Subsidiaries of Registrant.23.1
    
    Consent of Independent Registered
Public Accounting Firm.24.1
    
    Power of Attorney (See page 69).31.1
    
    Certification of Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive
Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Incorporated by reference to the Exhibits filed with the Registration
Statement on Form SB-2 (No. 333-00320-LA) which was declared effective on February
15, 1996.(2)
    
    Incorporated by reference to the Exhibits in Registrants Report on
Form 10-Q for the quarter ended October 3, 1998.(3)
    
    Incorporated by reference to the Exhibits in Registrants Proxy
Statement for the Companys 2005 Annual Meeting of Stockholders which was filed
April 29, 2005.(4)
    
    Incorporated by reference to the Exhibits in Registrants Report on
Form 10-Q for the quarter ended September 27, 2003.(5)
    
    Incorporated by reference to the Exhibits filed with the
Registrants Report on Form 8-K dated July 5, 2005.(6)
    
    Incorporated by reference to the Exhibits filed with the
Registrants Report on Form 8-K dated April 28, 2005.