##### Table of Contents



UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the quarterly period ended July 1, 2006
 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
  Delaware
    
    77-0210467(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification No.)
 1212 Terra Bella Avenue
Mountain View, California 94043-1824
 (650) 940-4700
 o þ
  o o þ
 o þ




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##### 



IRIDEX Corporation
 Table of Contents
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements(unaudited)Condensed Consolidated Balance Sheets as of July 1, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the three and six months ended July 1, 2006 and July 2, 2005
    
    
    4Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended July 1, 2006 and July 2, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2006 and July 2, 2005
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    25PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    27Item 1A. Risk Factors
    
    
    28Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    38Item 3. Defaults Upon Senior Securities
    
    
    38Item 4.
Submission of Matters to a Vote of Security Holders
    
    
    38Item 5. Other Information
    
    
    39Item 6. Exhibits
    
    
    39Signature
    
    
    40
  2




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##### Table of Contents



Part I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 IRIDEX Corporation
 
 Condensed Consolidated Balance Sheets
 (in thousands)
 (unaudited)
 July 1,
    
    
    December 31,2006
    
    
    2005AssetsCurrent assets:Cash and cash equivalents
    
    $
    3,738
    
    
    $
    12,655Available-for-sale securities
    
    
    18,540
    
    
    
    8,779Accounts receivable, net
    
    
    6,035
    
    
    
    6,589Inventories
    
    
    8,877
    
    
    
    8,594Prepaids and other current assets
    
    
    777
    
    
    
    885Current deferred income taxes
    
    
    1,415
    
    
    
    1,415Total current assets
    
    
    39,382
    
    
    
    38,917Property and equipment, net
    
    
    1,048
    
    
    
    1,114Deferred income taxes and other long term assets
    
    
    1,099
    
    
    
    1,073Total assets
    
    $
    41,529
    
    
    $
    41,104Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    1,356
    
    
    $
    1,094Accrued expenses
    
    
    3,304
    
    
    
    4,421Deferred revenue
    
    
    1,224
    
    
    
    1,072Total liabilities
    
    
    5,884
    
    
    
    6,587Contingencies
(Note 6)Stockholders equity:Common stock
    
    
    78
    
    
    
    76Additional paid-in capital
    
    
    28,275
    
    
    
    26,334Accumulated other comprehensive loss
    
    
    (5
    )
    
    
    (27
    )Treasury stock
    
    
    (430
    )
    
    
    (430
    )Retained earnings
    
    
    7,727
    
    
    
    8,564Total stockholders equity
    
    
    35,645
    
    
    
    34,517Total liabilities and stockholders equity
    
    $
    41,529
    
    
    $
    41,104
  3




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##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Operations
 (in thousands, except per share data)
 (unaudited)
 Three Months Ended
    
    
    Six Months EndedJuly 1,
    
    
    July 2,
    
    
    July 1,
    
    
    July 2,2006
    
    
    2005
    
    
    2006
    
    
    2005Sales
    
    $
    8,804
    
    
    $
    9,387
    
    
    $
    17,647
    
    
    $
    17,532Cost of sales
    
    
    4,145
    
    
    
    4,842
    
    
    
    8,726
    
    
    
    9,309Gross profit
    
    
    4,659
    
    
    
    4,545
    
    
    
    8,921
    
    
    
    8,223Operating expenses:Research and development
    
    
    1,328
    
    
    
    922
    
    
    
    2,449
    
    
    
    1,961Sales, general and administrative
    
    
    3,864
    
    
    
    3,065
    
    
    
    7,796
    
    
    
    5,862Total operating expenses
    
    
    5,192
    
    
    
    3,987
    
    
    
    10,245
    
    
    
    7,823Income (loss) from operations
    
    
    (533
    )
    
    
    558
    
    
    
    (1,324
    )
    
    
    400Interest and other income,
net
    
    
    177
    
    
    
    130
    
    
    
    356
    
    
    
    256Income (loss) before income taxes
    
    
    (356
    )
    
    
    688
    
    
    
    (968
    )
    
    
    656Benefit from (provision for) income taxes
    
    
    (178
    )
    
    
    (258
    )
    
    
    131
    
    
    
    (246
    )Net income (loss)
    
    $
    (534
    )
    
    $
    430
    
    
    $
    (837
    )
    
    $
    410Net income (loss) per common share  basic
    
    ($
    0.07
    )
    
    $
    0.06
    
    
    ($
    0.11
    )
    
    $
    0.06Net income (loss) per common share  diluted
    
    ($
    0.07
    )
    
    $
    0.05
    
    
    ($
    0.11
    )
    
    $
    0.05Shares used in per common share basic
calculations
    
    
    7,694
    
    
    
    7,362
    
    
    
    7,641
    
    
    
    7,339Shares used in per common share diluted
calculations
    
    
    7,694
    
    
    
    7,955
    
    
    
    7,641
    
    
    
    7,778
  Three Months Ended
    
    
    Six Months EndedJuly
1,2006
    
    

July
2,2005
    
    

July
1,2006
    
    

July
2,2005(In thousands)Cost of sales
    
    $
    31
    
    
    $
    
    
    
    $
    67
    
    
    $
    Research and development
    
    
    73
    
    
    
    
    
    
    
    121
    
    
    
    Selling, general and administrative
    
    
    374
    
    
    
    
    
    
    
    747
    
    
    
    
  4




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##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Comprehensive Income (Loss)
 (in thousands)
 (unaudited)
 Three Months Ended
    
    
    Six Months EndedJuly 1,
    
    
    July 2,
    
    
    July 1,
    
    
    July 2,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    (534
    )
    
    $
    430
    
    
    $
    (837
    )
    
    $
    410Other comprehensive income (loss):Change in unrealized gain (loss) on
available-for-sale
securities, net of
tax
    
    
    5
    
    
    
    12
    
    
    
    14
    
    
    
    (13
    )Comprehensive income (loss)
    
    $
    (529
    )
    
    $
    442
    
    
    $
    (823
    )
    
    $
    397
  5




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##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Cash Flows
 (in thousands)
 (unaudited)
 Six Months EndedJuly 1,
    
    
    July 2,2006
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (837
    )
    
    $
    410Adjustments
to reconcile net income to net cash provided by (used in) operating activities:
    
    
    
    
    
    
    Depreciation and amortization
    
    
    251
    
    
    
    223Stock-based compensation
    
    
    935
    
    
    
    Provision for (recoveries of) doubtful accounts
    
    
    68
    
    
    
    36Provision
for excess and obsolete inventories
    
    
    16
    
    
    
    134Changes in operating assets and liabilities:Accounts receivable
    
    
    486
    
    
    
    191Inventories
    
    
    (299
    )
    
    
    (173
    )Prepaids and other current assets
    
    
    108
    
    
    
    (160
    )Other long term assets
    
    
    (26
    )
    
    
    Accounts payable
    
    
    262
    
    
    
    (83
    )Accrued expenses
    
    
    (1,115
    )
    
    
    (501
    )Deferred revenue
    
    
    152
    
    
    
    469Net cash
provided by operating activities
    
    
    1
    
    
    
    546Cash flows from investing activities:Purchases of available-for-sale securities
    
    
    (18,519
    )
    
    
    (3,593
    )Proceeds from maturity of available-for-sale securities
    
    
    8,778
    
    
    
    3,016Acquisition of property and equipment
    
    
    (185
    )
    
    
    (176
    )Net cash used in investing activities
    
    
    (9,926
    )
    
    
    (753
    )Cash flows from financing activities:Issuance of common stock
    
    
    1,008
    
    
    
    308Net cash provided by financing activities
    
    
    1,008
    
    
    
    308Net increase (decrease) in cash and cash equivalents
    
    
    (8,917
    )
    
    
    101Cash and cash equivalents at beginning of period
    
    
    12,655
    
    
    
    10,381Cash and cash equivalents at end of period
    
    $
    3,738
    
    
    $
    10,482
  6




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##### Table of Contents



IRIDEX Corporation
 
 Notes to Unaudited Condensed Consolidated Financial Statements
 1. Basis of Presentation
   2. Restatement of Financial Results for the Quarter Ended April 1, 2006
  3. Changes to August 3, 2006 Press Release
  
    
    Increase (decrease) in revenue of $94,000 and ($73,000) for the three and six months ended July 1,
2006, respectively, due to identified errors in revenue recognition in the first quarter
of 2006.
    
    Increase (decrease) in cost of sales of $53,000 and ($30,000) and
operating expenses of $6,000
and $(4,000) for the three and six months ended July 1, 2006, respectively, due to
identified errors in revenue recognition in the first quarter of 2006.
    
    Increase in operating expenses of $169,000 for the three and six months ended July 1,
2006 due to an increase in the estimated provision for bad debt expense based on updated
information available subsequent to the issuance of the press release.
    
    Decrease in the income tax benefit of $448,000 and $414,000 for the three and six
months ended July 1, 2006, respectively, based on the changes identified above, as well as
to a change in the estimated tax rate based on updated forecast results for 2006.
 4. Summary of Significant Accounting Policies
  Revenue
Recognition
  7




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##### Table of Contents



Deferred
Revenue
  Six Months EndedJuly 1, 2006
    
    
    July 2, 2005Balance, beginning of period
    
    $
    1,072
    
    
    $
    910Additions to deferred revenue
    
    
    822
    
    
    
    1,185Revenue recognized
    
    
    (670
    )
    
    
    (716
    )Balance, end of period
    
    $
    1,224
    
    
    $
    1,379
 Warranty
  Six Months EndedJuly 1, 2006
    
    
    July 2, 2005Balance, beginning of period
    
    $
    1,128
    
    
    $
    933Accruals for warranties issued during the period
    
    
    335
    
    
    
    679Settlements made in kind during the period
    
    
    (534
    )
    
    
    (474
    )Balance, end of period
    
    $
    929
    
    
    $
    1,138
 8




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##### Table of Contents



5. Inventories
  July 1,
    
    
    December 31,2006
    
    
    2005Raw materials and work in progress
    
    $
    4,854
    
    
    $
    5,191Finished goods
    
    
    4,023
    
    
    
    3,403Total inventories
    
    $
    8,877
    
    
    $
    8,594
 6. Contingencies
  IRIDEX Corporation v. Synergetics USA, Inc.,
  Synergetics, Inc. v. Peregrine Surgical, Ltd., Innovatech Surgical, Inc., and
IRIDEX Corporation,
 Synergetics, Inc. v. IRIDEX Corporation,
  9




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7. Computations of Net Income (Loss) Per Common Share
   8. Business Segments
   Three Months Ended July 1, 2006
    
    
    Three Months Ended July 2, 2005Ophthalmology
    
    
    Dermatology
    
    
    
    
    
    
    Ophthalmology
    
    
    DermatologyMedical
    
    
    Medical
    
    
    
    
    
    
    Medical
    
    
    MedicalDevices
    
    
    Devices
    
    
    Total
    
    
    Devices
    
    
    Devices
    
    
    TotalSales
    
    $
    7,681
    
    
    $
    1,123
    
    
    $
    8,804
    
    
    $
    7,687
    
    
    $
    1,700
    
    
    $
    9,387Direct cost of goods
sold
    
    
    2,213
    
    
    
    475
    
    
    
    2,688
    
    
    
    2,660
    
    
    
    932
    
    
    
    3,592Direct gross margin
    
    
    5,468
    
    
    
    648
    
    
    
    6,116
    
    
    
    5,027
    
    
    
    768
    
    
    
    5,795Total unallocated
costs
    
    
    
    
    
    
    
    
    
    
    (6,472
    )
    
    
    
    
    
    
    
    
    
    
    (5,107
    )Pre-tax income (loss)
    
    
    
    
    
    
    
    
    
    
    (356
    )
    
    
    
    
    
    
    
    
    
    
    688
 10




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##### Table of Contents



Six Months Ended July 1, 2006
    
    
    Six Months Ended July 2, 2005Ophthalmology
    
    
    Dermatology
    
    
    
    
    
    
    Ophthalmology
    
    
    DermatologyMedical
    
    
    Medical
    
    
    
    
    
    
    Medical
    
    
    MedicalDevices
    
    
    Devices
    
    
    Total
    
    
    Devices
    
    
    Devices
    
    
    TotalSales
    
    $
    15,221
    
    
    $
    2,426
    
    
    $
    17,647
    
    
    $
    13,880
    
    
    $
    3,652
    
    
    $
    17,532Direct cost of goods sold
    
    
    4,742
    
    
    
    1,158
    
    
    
    5,900
    
    
    
    4,759
    
    
    
    1,927
    
    
    
    6,686Direct gross margin
    
    
    10,479
    
    
    
    1,268
    
    
    
    11,747
    
    
    
    9,121
    
    
    
    1,725
    
    
    
    10,846Total unallocated costs
    
    
    
    
    
    
    
    
    
    
    (12,715
    )
    
    
    
    
    
    
    
    
    
    
    (10,190
    )Pre-tax income (loss)
    
    
    
    
    
    
    
    
    
    
    (968
    )
    
    
    
    
    
    
    
    
    
    
    656
   9. Stockbased Compensation
 Employee Stock Purchase Plan
  Stock Option Plans
 Amended and Restated 1989 Incentive Stock P lan
  11




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##### Table of Contents



1998 Stock Plan
  1995 Director Option Plan
    Stand-Alone Options and Warrants
  12




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##### Table of Contents



Stock-Based Compensation
    Employee Stock Option
    
    Employee Stock
    
    Employee Stock Option
    
    Employee StockPlan
    
    Purchase Plan
    
    Plan
    
    Purchase PlanThree Months Ended
    
    Three Months Ended
    
    Six Months Ended
    
    Six Months EndedJuly 1,
    
    July 2,
    
    July 1,
    
    July 2,
    
    July 1,
    
    July 2,
    
    July 1,
    
    July 2,2006
    
    2005
    
    2006
    
    2005
    
    2006
    
    2005
    
    2006
    
    2005Average risk free
interest rate
    
    
    5.13
    %
    
    
    3.63
    %
    
    
    5.11
    %
    
    
    3.22
    %
    
    
    4.80
    %
    
    
    3.50
    %
    
    
    5.11
    %
    
    
    2.50
    %Expected life (in
years)
    
    
    3.8
    
    
    
    3
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    3.7
    
    
    
    3.0
    
    
    
    0.5
    
    
    
    0.5Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Average volatility
    
    
    50.0
    %
    
    
    85.0
    %
    
    
    35.0
    %
    
    
    85.0
    %
    
    
    50.0
    %
    
    
    85.0
    %
    
    
    47.0
    %
    
    
    85.0
    %
 13




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJuly 1, 2006
    
    
    July 1, 2006Cost of sales
    
    $
    31
    
    
    $
    67Research and development
    
    
    73
    
    
    
    121Sales, general and administrative
    
    
    374
    
    
    
    747$
    478
    
    
    $
    935
   Three Months Ended
    
    
    Six Months EndedJuly 2, 2005
    
    
    July 2, 2005Net income, as reported for prior periods
    
    $
    430
    
    
    $
    410Stock-based compensation expense related
to employee stock options and employee
stock purchases
    
    
    (190
    )
    
    
    (315
    )Pro forma net income
    
    $
    240
    
    
    $
    95Basic net income per share:As reported
    
    $
    0.06
    
    
    $
    0.06Pro forma
    
    $
    0.03
    
    
    $
    0.01Diluted net income per share:As reported
    
    $
    0.05
    
    
    $
    0.05Pro forma
    
    $
    0.03
    
    
    $
    0.01
 14




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##### Table of Contents



Weighted Average
    
    
    Aggregate IntrinsicShares
    
    
    Exercise Price
    
    
    ValueOutstanding at December 31, 2005
    
    
    2,154,003
    
    
    $
    5.50
    
    
    $
    14,518Options granted
    
    
    146,800
    
    
    
    8.80
    
    
    
    145Options exercised
    
    
    (194,913
    )
    
    
    4.55
    
    
    
    (1,021
    )Options forfeited/cancelled/expired
    
    
    (24,442
    )
    
    
    7.08
    
    
    
    (66
    )Outstanding at July 1, 2006
    
    
    2,081,448
    
    
    $
    5.80
    
    
    $
    13,576
    Three Months
    
    
    Six MonthsEnded July 1,
    
    
    Ended July 1,2006
    
    
    2006Stock-based compensation expense by award type:Employee stock options granted
    
    $
    471
    
    
    $
    918Employee stock purchase plan
    
    
    7
    
    
    
    17Total stock-based compensation
    
    
    478
    
    
    
    935Total effect on stock-based compensation at
the Companys marginal tax rate
    
    
    (88
    )
    
    
    (162
    )Effect on net income (loss)
    
    $
    390
    
    
    $
    773Effect on net income (loss) per share:Basic and diluted
    
    $
    (0.05
    )
    
    $
    (0.10
    )
 15




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##### Table of Contents



Weighted AverageGrant Dated FairNumber of Shares
    
    ValueNon-vested at December 31, 2005
    
    
    893,119
    
    
    $
    5.72Granted
    
    
    146,800
    
    
    
    8.80Vested
    
    
    (107,491
    )
    
    
    4.35Cancelled/forfeited
    
    
    (24,442
    )
    
    
    7.08Non-vested at July 1, 2006
    
    
    907,986
    
    
    
    6.38
   Options Outstanding
    
    
    Options Vested and ExercisableWeighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    WeightedNumber of
    
    
    Average
    
    
    Weighted
    
    
    Number of
    
    
    Weighted
    
    
    AverageShares
    
    
    Remaining
    
    
    Average
    
    
    Shares
    
    
    Average
    
    
    RemainingRange of
    
    Outstanding at
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisable at
    
    
    Exercise
    
    
    ContractualExercise Prices
    
    July 1, 2006
    
    
    Life (Years)
    
    
    Price
    
    
    July 1, 2006
    
    
    Price
    
    
    Life (Years)$2.94 - $3.50
    
    
    248,680
    
    
    
    6.69
    
    
    $
    3.36
    
    
    
    198,105
    
    
    $
    3.37
    
    
    
    6.64$3.52 - $4.00
    
    
    315,013
    
    
    
    3.43
    
    
    $
    3.86
    
    
    
    299,059
    
    
    $
    3.87
    
    
    
    3.25$4.01- $5.00
    
    
    214,177
    
    
    
    4.90
    
    
    $
    4.43
    
    
    
    182,469
    
    
    $
    4.41
    
    
    
    4.34$5.08 - $5.50
    
    
    221,713
    
    
    
    6.52
    
    
    $
    5.24
    
    
    
    91,603
    
    
    $
    5.27
    
    
    
    4.29$5.56 - $6.00
    
    
    113,000
    
    
    
    8.07
    
    
    $
    5.61
    
    
    
    52,587
    
    
    $
    5.61
    
    
    
    7.21$6.07 - $6.07
    
    
    325,000
    
    
    
    9.01
    
    
    $
    6.07
    
    
    
    25,000
    
    
    $
    6.07
    
    
    
    9.01$6.19 - $7.63
    
    
    212,315
    
    
    
    6.76
    
    
    $
    6.83
    
    
    
    107,981
    
    
    $
    7.00
    
    
    
    5.12$7.98 - $8.88
    
    
    262,750
    
    
    
    5.92
    
    
    $
    8.40
    
    
    
    95,908
    
    
    $
    8.72
    
    
    
    2.04$9.00 - $12.19
    
    
    161,300
    
    
    
    4.91
    
    
    $
    9.69
    
    
    
    113,250
    
    
    $
    9.49
    
    
    
    4.00$12.75 - $12.75
    
    
    7,500
    
    
    
    4.01
    
    
    $
    12.75
    
    
    
    7,500
    
    
    $
    12.75
    
    
    
    4.01$2.94 - $12.75
    
    
    2,081,448
    
    
    
    6.16
    
    
    $
    5.80
    
    
    
    1,173,462
    
    
    $
    5.39
  10. Subsequent Event
  11. Recent Accounting Pronouncements
    16




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##### Table of Contents



Item 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 This Quarterly Report
 on Form 10-Q contains trend analysis and other 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;
expectations for future sales growth, generally, including expectations of additional sales from
our new products and new applications of our existing products; the potential for production cost
decreases and higher gross margins; our ability to develop and introduce new products through
strategic alliances; favorable Center for Medicare and Medicaid coverage decisions regarding AMD
procedures that use our products; 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, including as a result of the factors set forth under Factors That
May Affect Future Operating Results and other risks detailed in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on April 3, 2006 and detailed from time to time
in our reports filed with the Securities and Exchange Commission. 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 Quarterly Report on Form 10-Q . We undertake no obligation to update such
 forward-looking
statements to reflect events or circumstances occurring after the date of this report.
 Restatement of Financial Results for the Quarter
 Ended April 1, 2006
  Changes to August 3, 2006 Press Release
  
    
    Increase (decrease) in revenue of $94,000 and ($73,000) for the three and six months ended July 1,
2006, respectively, due to identified errors in revenue recognition in the first quarter
of 2006.
    
    Increase (decrease) in cost of goods sold of $53,000 and ($30,000) and operating expenses of
$6,000 and $(4,000) for the three and six months ended July 1, 2006, respectively, due
to identified errors in revenue recognition in the first quarter of 2006.
    
    Increase in operating expenses of $169,000 for the three and six months ended July 1, 2006 due
to an increase in the estimated provision for bad debt expense based on updated
information available subsequent to the issuance of the press release.
    
    decrease in the income tax benefit of $448,000 and $414,000 for the three and six
months ended July 1, 2006, respectively, based on the changes identified above as well as
to a change in the estimated tax rate based on updated forecast results for 2006.
 Overview
  17




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##### Table of Contents



Results of Operations
  Three Months Ended
    
    Six Months EndedJuly 1,
    
    July 2,
    
    July 1,
    
    July 2,2006
    
    2005
    
    2006
    
    2005Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.1
    %
    
    
    51.6
    %
    
    
    49.4
    %
    
    
    53.1
    %Gross profit
    
    
    52.9
    %
    
    
    48.4
    %
    
    
    50.6
    %
    
    
    46.9
    %Operating expenses:Research and development
    
    
    15.1
    %
    
    
    9.8
    %
    
    
    13.9
    %
    
    
    11.2
    %Sales, general and administrative
    
    
    43.9
    %
    
    
    32.6
    %
    
    
    44.2
    %
    
    
    33.4
    %Total operating expenses
    
    
    59.0
    %
    
    
    42.4
    %
    
    
    58.1
    %
    
    
    44.6
    %Income (loss) from operations
    
    
    (6.1
    )%
    
    
    6.0
    %
    
    
    (7.5
    )%
    
    
    2.3
    %Interest and other income, net
    
    
    2.0
    %
    
    
    1.3
    %
    
    
    2.0
    %
    
    
    1.4
    %Income(loss) before income taxes
    
    
    (4.1
    )%
    
    
    7.3
    %
    
    
    (5.5
    )%
    
    
    3.7
    %Benefit from (provision for) income taxes
    
    
    (2.0
    )%
    
    
    (2.7
    )%
    
    
    0.8
    %
    
    
    (1.4
    %)Net income (loss)
    
    
    (6.1
    )%
    
    
    4.6
    %
    
    
    (4.7
    )%
    
    
    2.3
    %
 18




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentageof total
    
    
    
    
    
    
    of total
    
    
    
    
    
    
    of total
    
    
    
    
    
    
    of totalAmount
    
    
    sales
    
    
    Amount
    
    
    sales
    
    
    Amount
    
    
    sales
    
    
    Amount
    
    
    salesDomestic
    
    $
    5,296
    
    
    
    60.2
    %
    
    $
    5,725
    
    
    
    61.0
    %
    
    $
    10,426
    
    
    
    59.1
    %
    
    $
    10,650
    
    
    
    60.8
    %International
    
    
    3,508
    
    
    
    39.8
    %
    
    
    3,662
    
    
    
    39.0
    %
    
    
    7,221
    
    
    
    40.9
    %
    
    
    6,882
    
    
    
    39.2
    %Total
    
    
    8,804
    
    
    
    100.0
    %
    
    
    9,387
    
    
    
    100.0
    %
    
    
    17,647
    
    
    
    100.0
    %
    
    
    17,532
    
    
    
    100.0
    %Ophthalmology:Domestic
    
    
    4,544
    
    
    
    51.6
    %
    
    
    4,333
    
    
    
    46.2
    %
    
    
    8,637
    
    
    
    49.0
    %
    
    
    7,746
    
    
    
    44.2
    %International
    
    
    3,137
    
    
    
    35.6
    %
    
    
    3,354
    
    
    
    35.7
    %
    
    
    6,584
    
    
    
    37.3
    %
    
    
    6,134
    
    
    
    35.0
    %Total
    
    
    7,681
    
    
    
    87.2
    %
    
    
    7,687
    
    
    
    81.9
    %
    
    
    15,221
    
    
    
    86.3
    %
    
    
    13,880
    
    
    
    79.2
    %Dermatology:Domestic
    
    
    753
    
    
    
    8.6
    %
    
    
    1,392
    
    
    
    14.8
    %
    
    
    1,789
    
    
    
    10.1
    %
    
    
    2,904
    
    
    
    16.6
    %International
    
    
    370
    
    
    
    4.2
    %
    
    
    308
    
    
    
    3.3
    %
    
    
    637
    
    
    
    3.6
    %
    
    
    748
    
    
    
    4.2
    %Total
    
    $
    1,123
    
    
    
    12.8
    %
    
    $
    1,700
    
    
    
    18.1
    %
    
    $
    2,426
    
    
    
    13.7
    %
    
    $
    3,652
    
    
    
    20.8
    %Total recurring
revenue
    
    $
    3,932
    
    
    
    44.7
    %
    
    $
    3,333
    
    
    
    35.5
    %
    
    $
    7,712
    
    
    
    43.7
    %
    
    $
    6,429
    
    
    
    36.7
    %Total non-recurring
revenue
    
    $
    4,872
    
    
    
    55.3
    %
    
    $
    6,054
    
    
    
    64.5
    %
    
    $
    9,935
    
    
    
    56.3
    %
    
    $
    11,103
    
    
    
    63.3
    %
 Ophthalmology and Dermatology Sales Overview
   19




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Ophthalmology Sales
    Dermatology Sales
   20




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Gross Margin
 Three Months Ended
    
    Six Months EndedJuly 1,
    
    July 2,
    
    July 1,
    
    July 2,2006
    
    2005
    
    2006
    
    2005Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.1
    %
    
    
    51.6
    %
    
    
    49.4
    %
    
    
    53.1
    %Gross profit
    
    
    52.9
    %
    
    
    48.4
    %
    
    
    50.6
    %
    
    
    46.9
    %
   Research and Development
 Three Months Ended
    
    Six Months EndedJuly 1,
    
    July 2,
    
    July 1,
    
    July 2,2006
    
    2005
    
    2006
    
    2005Research and
development
expense as a
percentage of
total revenue
    
    
    15.1
    %
    
    
    9.8
    %
    
    
    13.9
    %
    
    
    11.2
    %
 21




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##### Table of Contents



Selling, General and Administrative
 Three Months Ended
    
    Six Months EndedJuly 1,
    
    July 2,
    
    July 1,
    
    July 2,2006
    
    2005
    
    2006
    
    2005Selling,
general and
administrative
expense as a
percentage of
total revenue
    
    
    43.9
    %
    
    
    32.6
    %
    
    
    44.2
    %
    
    
    33.4
    %
   22




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##### Table of Contents



Interest and Other
 Income, net.
 Income Taxes.
 Liquidity and Capital Resources
       23




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##### Table of Contents



Accounting Policies
    Recent Accounting Pronouncements
    
 Item 3. Quantitative and Qualitative Disclosure about Market Risk
 Quantitative Disclosures
  Interest Rate Risk
  Qualitative Disclosures
 Interest Rate Risk
 §
    
    the fall in value of available-for-sale securities if market interest rates
increase; and§
    
    the impact of interest rate movements on our ability to obtain adequate financing
to fund future operations.
   24




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##### Table of Contents



Currency
Rate Risk.
 
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures
 a) Evaluation of disclosure controls and procedures.
         25




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##### Table of Contents



Plan for remediation of material weaknesses
   
    
    implementation of additional controls over the preparation and review of key
spreadsheets;
    
    implementation of automated general ledger reports to replace existing key spreadsheets
where possible;
    
    correction of a system generated custom report to include additional information
necessary to prepare accurate financial information;
    
    implementation of additional review procedures; and
    
    enhancement of the current capabilities of the finance function.
  
    
    reassignment of responsibilities for oversight of the sales function and
responsibilities for internal control over sales transactions;
    
    provision of additional training on a recurring basis for all domestic sales personnel
on revenue recognition policies and procedures;
    
    establishment of annual formal training for our customer service group on revenue
recognition policies and procedures;
    
    establishment of a checklist for use by our customer service group in processing
revenue transactions to verify proper recognition and establishment of a policy by which
this checklist is signed off by the preparer and at least one
reviewer;
    
    establishment of internal audit procedures over all domestic laser sale transactions;
and
    
    formalization over our sales returns process to include more thorough documentation,
review and approval for all returns.
   (b) Changes in internal control over financial reporting
  26




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 IRIDEX Corporation v. Synergetics USA, Inc.,
  Synergetics, Inc. v. Peregrine Surgical, Ltd., Innovatech
Surgical, Inc., and IRIDEX Corporation,
 Synergetics, Inc. v. IRIDEX Corporation,
  27




---



##### Table of Contents



Item 1A. Risk Factors
 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.
  Our Future Success Depends on Our Ability to Develop and Successfully Introduce New Products
and New Applications
 28




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We Face Strong Competition in Our Markets and Expect the Level of Competition to Grow in the
Foreseeable Future.
 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;
 29




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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.
  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.
   30




---



##### Table of Contents



If We Lose Key Personnel or Fail to Integrate Replacement Personnel Successfully, Our Ability
to Manage Our Business Could Be Impaired
 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.
 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.
 .
 31




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##### Table of Contents



We Face Risks Associated with our Collaborative and OEM Relationships.
 We Face Manufacturing Risks
 We Depend on Collaborative Relationships to Develop, Introduce and Market New Products,
Product Enhancements and New Applications
 32




---



##### Table of Contents



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;
    
    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.
   We entered into a definitive asset purchase agreement with American Medical Systems, Inc.
and Laserscope, a California corporation and a wholly owned subsidiary of American Medical Systems,
Inc. on November 30, 2006 and we may experience unexpected difficulties closing this transaction or
integrating the aesthetics business which we agreed to purchase in this transaction.
  
    
    we may experience unexpected losses of employees or customers we expected
to gain in connection with this transaction;
    
    we may not achieve expected levels of revenue growth;
    
    we may not be able to coordinate our current product and process
development efforts with those of the aesthetics business in a way which permits us to
bring future new products to the market in a timely and cost-effective manner; and
    
    we may discover that liabilities that we assumed are greater than
anticipated.
  Our Stock Price Has Been and May Continue to be Volatile and an Investment in Our Common Stock
Could Suffer a Decline in Value.
 33




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##### Table of Contents



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 Rely on Patents and Proprietary Rights to Protect our Intellectual Property and Business
 34




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35




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##### Table of Contents



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 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.
   If We Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could Harm Our
Operating Results.
 36




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##### Table of Contents



If Product Liability Claims are Successfully Asserted Against Us, We may Incur Substantial
Liabilities That May Adversely Affect Our Business or Results of Operations.
 Our Operating Results May be Adversely Affected by Changes in Third Party Coverage and
Reimbursement Policies and any Uncertainty Regarding Healthcare Reform Measures.
  37




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##### Table of Contents



The Successful Outcome of Clinical Trials and the Development of New Applications Using
Certain of Our Products will Accelerate Future Revenue Growth Rates.
 We May Need Additional Capital, which May Not Be Available, and Our Ability to Grow May be
Limited as a Result.
 If Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be Seriously
Harmed.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4.
Submission of Matters to a Vote of Security Holders
  1.
    
    To elect seven (7) directors to serve for the ensuing year or until their
successors are duly elected and qualified.
 Name
    
    Votes For
    
    Votes WithheldTheodore Boutacoff
    
    
    7,021,925
    
    
    
    29,824Barry G. Caldwell
    
    
    6,316,977
    
    
    
    734,772James L. Donovan
    
    
    6,959,325
    
    
    
    92,424Donald L. Hammond
    
    
    6,944,804
    
    
    
    106,945Garrett A. Garrettson
    
    
    6,945,004
    
    
    
    106,745Robert K. Anderson
    
    
    6,929,004
    
    
    
    122,745Sanford Fitch
    
    
    6,975,175
    
    
    
    76,574
 38




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##### Table of Contents



2.
    
    To approve the amendment and restatement of the Companys 1998 Stock Plan.
 Votes for:
    
    
    3,956,818Votes against:
    
    
    231,149Votes abstaining:
    
    
    37,921No-Vote:
    
    
    2,825,861
 3.
    
    To ratify the appointment of PricewaterhouseCoopers LLP as the independent
registered public accounting firm of the Company for the fiscal year ending December
30, 2006.
 Votes for:
    
    
    7,033,596Votes against:
    
    
    12,260Votes abstaining:
    
    
    5,893
 
 Item 5. Other Information
  
 Item 6. Exhibits
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.31.2
    
    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.
 Trademark Acknowledgments
  39




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##### Table of Contents



SIGNATURE
  IRIDEX Corporation
(Registrant)Date: December 22, 2006
    By:
    /s/   Larry TannenbaumLarry TannenbaumChief Financial Officer and Vice President, Administration
(Principal Financial, Principal Accounting Officer and
Authorized Signatory) 40




---



##### Table of Contents



Exhibit Index
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    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.