UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION





Washington,
      D.C. 20549





FORM 10-Q





x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934





For
      the
      quarterly period ended  October 1, 2005





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
            
            77-0210467(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                employeridentification
                No.)





**1212
      Terra Bella Avenue**


**Mountain
      View, California 94043-1824**


(Address
      of principal executive offices, including zip code)





**(650)
      940-4700**


(Registrant’s
      telephone number, including area code)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days. Yes x   No o





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Exchange Act). Yes o   No x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes oNo
x








APPLICABLE
      TO CORPORATE ISSUERS:





The
      number of shares of common stock, $.01 par value, issued and outstanding as
      of
      November 11, 2005 was 7,497,361.








**IRIDEX
          Corporation**
 **Table
          of Contents**
 
 Page**PART
                    I.**
                **FINANCIAL
                    INFORMATION****Item
                    1.**
                **Condensed
                    Consolidated Financial Statements**(unaudited)Condensed
                    Consolidated Balance Sheets as of October 1, 2005 and
                    January 1, 2005
                3Condensed
                    Consolidated Statements of Operations
                    for the three and nine months ended October 1, 2005 and October
                    2,
                    2004
                4Condensed
                    Consolidated Statements of Cash Flows for the
                    nine months ended October 1, 2005 and October 2, 2004
                5Condensed
                    Consolidated Statements of Comprehensive
                    Income for the three and nine months ended October 1, 2005 and
                    October 2,
                    2004
                6Notes
                    to Condensed Consolidated Financial
                    Statements
                7**Item
                    2.**
                **Management’s
                    Discussion and Analysis of Financial
                    Condition and Results of Operations**
                14**Item
                    3.**
                **Quantitative
                    and Qualitative Disclosures About Market
                    Risk**
                30**Item
                    4**.
                **Controls
                    and
                    Procedures**
                31**PART
                    II.**
                **OTHER
                    INFORMATION****Item
                    1.**
                **Legal
                    Proceedings**
                32**Item
                    2.**
                **Changes
                    in Securities and Use of
                    Proceeds**
                32**Item
                    3.**
                **Defaults
                    Upon Senior
                    Securities**
                32**Item
                    4.**
                **Submission
                    of Matters to Vote of Security
                    Holders**
                32**Item
                    5.**
                **Other
                    Information**
                32**Item
                    6.**
                **Exhibits
                    and Reports on Form
                    8-K**
                32**Signature**
                
                33**CERTIFICATIONS**
                35Exhibit
                    31.1
                Certification
                    of Chief Executive Officer pursuant to Securities Exchange Act
                    Rules
                    13a-14(a) and 15d-14(a)Exhibit
                    31.2
                Certification
                    of Chief Financial Officer pursuant to Securities Exchange Act
                    Rules
                    13a-14(a) and 15d-14(a)Exhibit
                    32.1
                Certification
                    of Chief Executive Officer and Chief Financial Officer pursuant
                    to 18
                    U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                    Sarbanes-Oxley Act of 2002
 2
 Table
                of Contents


**Part
                I.**
            **FINANCIAL
                INFORMATION**





Item
      1. Condensed Consolidated Financial Statements




**IRIDEX
      Corporation**


**Condensed
      Consolidated Balance Sheets**


**(in
      thousands)**


**(unaudited)**




**October
                1,**
              **2005**
            
            **January
                1,**
              **2005****Assets**Current
                assets:Cash
                and cash equivalents
            
            $
            11,055
            
            $
            10,381Available-for-sale
                securities
            
            
            9,017
            
            
            3,323Accounts
                receivable, net
            
            
            6,857
            
            
            7,404Inventories
            
            
            9,327
            
            
            8,922Prepaids
                and other current assets
            
            
            763
            
            
            814Current
                deferred income taxes
            
            
            1,808
            
            
            1,808Total
                current assets
            
            
            38,827
            
            
            32,652Long
                term portion available-for-sale securities
            
            
            -
            
            
            4,324Property
                and equipment, net
            
            
            845
            
            
            852Deferred
                income taxes
            
            
            1,265
            
            
            1,265Total
                assets
            
            $
            40,937
            
            $
            39,093**Liabilities
                and Stockholders’ Equity**Current
                liabilities:Accounts
                payable
            
            $
            1,188
            
            $
            1,233Accrued
                expenses
            
            
            4,693
            
            
            5,167Deferred
                revenue
            
            
            1,242
            
            
            910Total
                liabilities
            
            
            7,123
            
            
            7,310Contingencies
              (Note 4)Stockholders’
                equity:Common
                stock
            
            
            76
            
            
            74Additional
                paid-in capital
            
            
            26,030
            
            
            25,281Accumulated
                other comprehensive loss
            
            
            (44
            )
            
            (35
            )Treasury
                stock
            
            
            (430
            )
            
            (430
            )Retained
                earnings
            
            
            8,182
            
            
            6,893Total
                stockholders’ equity
            
            
            33,814
            
            
            31,783Total
                liabilities and stockholders’ equity
            
            $
            40,937
            
            $
            39,093




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.




3
 Table
            of Contents





**IRIDEX
      Corporation**


**Condensed
      Consolidated Statements of
      Operations**


**(in
      thousands, except per share data)**


**(unaudited)**





**Three
                Months Ended**
            
            **Nine
                Months Ended****October
                1,**
              **2005**
            
            **October
                2,**
              **2004**
            
            **October
                1,**
              **2005**
            
            **October
                2,**
              **2004**Sales
            
            $
            9,081
            
            $
            8,178
            
            $
            26,613
            
            $
            23,679Cost
                of sales
            
            
            4,202
            
            
            4,708
            
            
            13,511
            
            
            13,187Gross
                profit
            
            
            4,879
            
            
            3,470
            
            
            13,102
            
            
            10,492Operating
                expenses:Research
                and development
            
            
            1,172
            
            
            1,025
            
            
            3,133
            
            
            3,409Sales,
                general and administrative
            
            
            2,990
            
            
            3,855
            
            
            8,852
            
            
            8,452Total
                operating expenses
            
            
            4,162
            
            
            4,880
            
            
            11,985
            
            
            11,861Income
                (loss) from operations
            
            
            717
            
            
            (1,410
            )
            
            1,117
            
            
            (1,369
            )Interest
                and other income, net
            
            
            157
            
            
            83
            
            
            413
            
            
            212Income
                before income taxes
            
            
            874
            
            
            (1,327
            )
            
            1,530
            
            
            (1,157
            )(Provision
                for) benefit from income taxes
            
            
            5
            
            
            607
            
            
            (241
            )
            
            553Net
                income (loss)
            
            $
            879
            
            $
            (720
            )
            $
            1,289
            
            $
            (604
            )Net
                income (loss) per share - basic
            
            $
            0.12
            
            $
            (
                0.10
            )
            $
            0.17
            
            $
            (
                0.08
            )Net
                income (loss) per share - diluted
            
            $
            0.11
            
            $
            (
                0.10
            )
            $
            0.16
            
            $
            (
                0.08
            )Shares
                used in computing net income (loss) per share - basic
            
            
            7,441
            
            
            7,244
            
            
            7,373
            
            
            7,171Shares
                used in computing net income (loss) per share - diluted
            
            
            8,102
            
            
            7,244
            
            
            7,885
            
            
            7,171




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.




4
 Table
            of Contents




**IRIDEX
      Corporation**


**Condensed
      Consolidated Statements of Cash
      Flows**


**(in
      thousands)**


**(unaudited)**




**Nine
                Months Ended****October
                1,**
            
            **October
                2,****2005**
            
            **2004**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            1,289
            
            $
            (604
            )Adjustments
                to reconcile net income (loss) to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            320
            
            
            296Warrants
                issued for services
            
            
            87
            
            
            --Provision
                for doubtful accounts
            
            
            38
            
            
            287Provision
                for inventories
            
            
            167
            
            
            429Deferred
                income taxes.
            
            
            --
            
            
            (607
            )Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            509
            
            
            (255
            )Inventories
            
            
            (572
            )
            
            (113
            )Prepaids
                and other current assets
            
            
            51
            
            
            196Accounts
                payable
            
            
            (45
            )
            
            (79
            )Accrued
                expenses
            
            
            (469
            )
            
            1,233Deferred
                revenue
            
            
            332
            
            
            193Net
                cash provided by operating activities
            
            
            1,707
            
            
            976Cash
                flows from investing activities:Purchases
                of available-for-sale securities
            
            
            (5,592
            )
            
            (8,960
            )Proceeds
                from maturity of available-for-sale securities
            
            
            4,222
            
            
            5,181Acquisition
                of property and equipment
            
            
            (327
            )
            
            (218
            )Net
                cash used in investing activities
            
            
            (
                1,697
            )
            
            (3,997
            )Cash
                flows from financing activities:Issuance
                of common stock
            
            
            664
            
            
            1,092Net
                cash provided by financing activities
            
            
            664
            
            
            1,092Net
                increase (decrease) in cash and cash equivalents
            
            
            674
            
            
            (1,929
            )Cash
                and cash equivalents at beginning of period
            
            
            10,381
            
            
            10,541Cash
                and cash equivalents at end of period
            
            $
            11,055
            
            $
            8,612




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





5
 Table
            of Contents




**IRIDEX
      Corporation**


**Condensed
      Consolidated Statements of Comprehensive Income
      (loss)**


**(in
      thousands)**


**(unaudited)**





**Three
                Months Ended**
            
            **Nine
                Months Ended****October
                1,**
            
            **October
                2,**
            
            **October
                1,**
            
            **October
                2,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                income (loss)
            
            $
            879
            
            $
            (720
            )
            $
            1,289
            
            $
            (604
            )Other
                comprehensive income (loss):Change
                in unrealized loss on available-for-sale securities
            
            
            4
            
            
            9
            
            
            (9
            )
            
            (19
            )Comprehensive
                income (loss)
            
            $
            883
            
            $
            (711
            )
            $
            1,280
            
            $
            (623
            )




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





6
 Table
            of Contents




**IRIDEX
      Corporation**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**





**1.**
            **Basis
                of Presentation**





The
      accompanying unaudited condensed consolidated financial statements of IRIDEX
      Corporation (“the Company”) have been prepared in accordance with generally
      accepted accounting principles in the United States of America for interim
      financial information and pursuant to the instructions to Form 10-Q and Article
      10-01 of Regulation S-X. Accordingly, they do not include all of the information
      and footnotes required by accounting principles generally accepted in the United
      States of America for complete financial statements. In the opinion of
      management, all adjustments, consisting of normal recurring adjustments,
      considered necessary for a fair presentation have been included.





The
      condensed consolidated financial statements should be read in conjunction with
      the audited financial statements and notes thereto, together with management’s
      discussion and analysis of financial condition and results of operations,
      contained in our Annual Report on Form 10-K for the fiscal year ended January
      1,
      2005, which was filed with the Securities and Exchange Commission on April
      1,
      2005. The results of operations for the three month period ended October 1,
      2005
      are not necessarily indicative of the results for the year ending December
      31,
      2005 or any future interim period.





**2.**
            **Summary
                of Significant Accounting
                Policies**





The
      Company’s significant accounting policies are disclosed in our Annual Report on
      Form 10-K for the year ended January 1, 2005 which was filed with the Securities
      and Exchange Commission on April  1,
      2005.
      The Company’s significant accounting policies have not materially changed as of
      October 1, 2005. ****





Deferred
      Revenue





Deferred
      revenue related to warranty contracts is recognized on a straight line basis
      over the period of the applicable contract. Cost is recognized as incurred.
      A
      reconciliation of changes in the Company’s deferred revenue balances for the
      nine months ended October 1, 2005 and October 2, 2004 follows (in
      thousands):




Nine
                  Months EndedOctober
                  1, 2005
              
              October
                  2, 2004Balance,
                  beginning of period
              
              $
              910
              
              $
              596Additions
                  to deferral
              
              
              1,135
              
              
              787Revenue
                  recognized
              
              
              (803
              )
              
              (594
              )Balance,
                  end of period
              
              $
              1,242
              
              $
              789
 7
 Table
              of Contents


Warranty





The
      Company accrues for an estimated warranty cost upon shipment of products in
      accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5,
“Accounting for Contingencies.” Actual warranty costs incurred have not
      materially differed from those accrued. The Company’s warranty policy is
      effective for shipped products which are considered defective or fail to meet
      the product specifications. Warranty costs are reflected in the statement of
      operations as a cost of sales. A reconciliation of the changes in the Company’s
      warranty liability for the nine months ended October 1, 2005 and October 2,
      2004
      follows (in thousands):





Nine
                Months EndedOctober
                1, 2005
            
            October
                2, 2004Balance,
                beginning of period
            
            $
            933
            
            $
            801Accruals
                for warranties issued during the period
            
            
            955
            
            
            441Settlements
                made in kind during the period
            
            
            (789
            )
            
            (393
            )Balance,
                end of period
            
            $
            1,099
            
            $
            849







Accounting
      for Stock-Based Compensation





The
      Company accounts for stock-based compensation arrangements in accordance with
      provisions of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting
      for Stock Issued to Employees” and complies with the disclosure provisions of
      SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No.
      148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an
      Amendment of FASB Statement No. 123.”





Under
      APB
      25, compensation expense for grants to employees is based on the difference,
      if
      any, on the date of the grant, between the fair value of the Company’s stock and
      the option’s exercise price. SFAS 123 defines a “fair value” based method of
      accounting for an employee stock option or similar equity investment. The pro
      forma disclosure of the difference between compensation expense included in
      net
      income and the related cost measured by the fair value method is presented
      below.





The
      following table provides a reconciliation of net income to pro forma net income
      (loss) as if the fair value method had been applied to all employee awards
      (in
      thousands, except per share data):




8
 Table
            of Contents




Three
                Months Ended
            
            Nine
                Months EndedOctober
                1, 2005
            
            October
                2, 2004
            
            October
                1, 2005
            
            October
                2, 2004Net
                income (loss), as reported
            
            $
            879
            
            $
            (720
            )
            $
            1,289
            
            $
            (604
            )Add:
                Total stock based compensation expense, net of tax, determined under
                fair
                value based method for all awards to employees
            
            
            (205
            )
            
            (152
            )
            
            (537
            )
            
            (418
            )Pro
                forma net income (loss)
            
            $
            674
            
            $
            (872
            )
            $
            752
            
            $
            (1,022
            )Basic
                net income (loss) per share:As
                reported
            
            $
            0.12
            
            
            ($
                0.10
            )
            $
            0.17
            
            
            ($
                0.08
            )Pro
                forma
            
            $
            0.09
            
            
            ($
                0.12
            )
            $
            0.10
            
            
            ($
                0.14
            )Diluted
                net income (loss) per share:As
                reported
            
            $
            0.11
            
            
            ($
                0.10
            )
            $
            0.16
            
            
            ($
                0.08
            )Pro
                forma
            
            $
            0.08
            
            
            ($
                0.12
            )
            $
            0.10
            
            
            ($
                0.14
            )





The
      determination of fair value of all options granted by the Company is computed
      based on the following assumptions:




Employee
                Stock Option Plan
            Employee
                Stock Option Plan
            Employee
                Stock Purchase Plan
            Employee
                Stock Purchase PlanThree
                Months Ended
            Nine
                Months Ended
            Three
                Months Ended
            Nine
                Months EndedOctober
                1, 2005
            October
                2, 2004
            October
                1, 2005
            October
                2, 2004
            October
                1, 2005
            October
                2, 2004
            October
                1, 2005
            October
                2, 2004Average
                risk free interest rate
            4.04%
            4.25%
            4.13%
            5.10%
            3.68%
            1.95%
            3.25%
            1.36%Expected
                life (in years)
            3
            2
            3
            2
            0.5
            0.5
            0.5
            0.5Dividend
                yield
            --
            --
            --
            --
            --
            --
            --
            --Average
                volatility
            84.0%
            87.0%
            84.0%
            87.0%
            83.0%
            87.0%
            84.0%
            87.0%




9
 Table
            of Contents




**3.**
            **Inventories**





Inventories
      are stated at the lower of cost or market. Cost is based on actual sales
      computed on a first in, first out basis. The components of inventories consist
      of the following (in thousands):




**October
                1,**
              **2005**
            
            **January
                1,**
              **2005**Raw
                materials and work in progress
            
            $
            5,609
            
            $
            5,460Finished
                goods
            
            
            3,718
            
            
            3,462Total
                inventories
            
            $
            9,327
            
            $
            8,922





**4.**
            **Contingencies**





From
      time
      to time, the Company may be engaged in certain administrative proceedings,
      incidental to its normal business activities. Management believes that
      liabilities resulting from such proceedings, or claims which are pending or
      known to be threatened, are adequately covered by liability insurance and will
      not have a material adverse effect on the Company’s financial position or
      results of operations.





**5.**
            **Computations
                of Net Income (Loss) Per Common Share**





Basic
      and
      diluted net income (loss) per share are computed by dividing net income (loss)
      for the period by the weighted average number of shares of common stock
      outstanding during the period. The calculation of diluted net income per share
      includes the dilutive effect of potentially dilutive common stock provided
      the
      inclusion of such potential common stock is not antidilutive. Potential common
      stock consists of incremental common shares issuable upon the exercise of stock
      options.





A
      reconciliation of the numerator and denominator of net income (loss) per common
      share and diluted net income (loss) per common share is as follows (in
      thousands, except per share amounts):




10
 Table
            of Contents




Three
                  Months Ended
              Nine
                  Months EndedOctober
                  1, 2005
              October
                  2, 2004
              October
                  1, 2005
              October
                  2, 2004(unaudited)
              (unaudited)
              (unaudited)
              (unaudited)Numerator—Net
                  income (loss) per common share and diluted net income per common
                  shareNet
                  income (loss)
              $
                  879
              ($
                  720)
              $
                  1,289
              ($
                  604)Denominator—Net
                  income per common share
                
                Weighted
                  average
                  common stock outstanding
              7,441
              7,244
              7,373
              7,171Basic
                  net income (loss) per common share
              $
                  0.12
              ($
                  0.10)
              $
                  0.17
              ($
                  0.08)Denominator—
                  Diluted net income (loss) per common shareWeighted
                  average
                  common stock outstanding
              7,441
              7,244
              7,373
              7,171Effect
                  of dilutive securities
                
                Weighted
                  average
                  common stock options
              661
              -
              512
              -Total
                  weighted average stock and options outstanding
              8,102
              7,244
              7,885
              7,171Diluted
                  net income (loss) per common share
              $
                  0.11
              ($
                  0.10)
              $
                  0.16
              ($
                  0.08)


During
      the three months ended October 1, 2005 options to purchase 306,196 shares of
      common stock at a weighted average exercise price of $9.17 per share were not
      included in the computations of diluted net income per common share because
      the
      exercise price of the related options exceeded the average market price of
      the
      common shares. During the nine months ended October 1, 2005 options to purchase
      488,832 shares at a weighted average exercise price of $8.32 were outstanding,
      but were not included in the computations of diluted net income per share
      because the exercise price of the related options exceeded the average market
      price of the common shares. During the three and nine months ended October
      2,
      2004, options to purchase 1,861,275 shares at a weighted average exercise price
      of $ 5.40 were outstanding, but were not included in the computations of diluted
      net loss per share because their effect was antidilutive. These options could
      dilute earnings per share in future periods.





11
 Table
          of Contents


**6.**
            **Business
                Segments**





We
      operate in two reportable segments: the ophthalmology medical device segment
      and
      the dermatology medical device segment. In both segments, we develop,
      manufacture and market medical devices. Our revenues arise from the sale of
      consoles, delivery devices, disposables and service and support
      activities.





Information
      on reportable segments for the three and nine months ended October 1, 2005
      and
      October 2,
      2004
      is as follows (in thousands):




Three
                Months Ended October 1, 2005
            
            Three
                Months Ended October 2, 2004Ophthalmology
                Medical Devices
            
            Dermatology
                Medical Devices
            
            Total
            
            Ophthalmology
                Medical Devices
            
            Dermatology
                Medical Devices
            
            TotalSales
            
            $
            7,883
            
            $
            1,198
            
            $
            9,081
            
            $
            7,193
            
            $
            985
            
            $
            8,178Direct
                Cost of Goods Sold
            
            
            2,461
            
            
            465
            
            
            2,926
            
            
            2,641
            
            
            717
            
            
            3,358Direct
                Gross Margin
            
            
            5,422
            
            
            733
            
            
            6,155
            
            
            4,552
            
            
            268
            
            
            4,820Total
                Unallocated Costs
            
            
            
            
            
            
            
            
            (5,281
            )
            
            
            
            
            
            
            
            (6,147
            )Pre-tax
                income (loss)
            
            
            
            
            
            
            
            $
            874
            
            
            
            
            
            
            
            $
            (1,327
            )




Nine
                Months Ended October 1, 2005
            
            Nine
                Months Ended October 2, 2004Ophthalmology
                Medical Devices
            
            Dermatology
                Medical Devices
            
            Total
            
            Ophthalmology
                Medical Devices
            
            Dermatology
                Medical Devices
            
            TotalSales
            
            $
            21,764
            
            $
            4,849
            
            $
            26,613
            
            $
            20,122
            
            $
            3,557
            
            $
            23,679Direct
                Cost of Goods Sold
            
            
            7,219
            
            
            2,393
            
            
            9,612
            
            
            7,096
            
            
            2,141
            
            
            9,237Direct
                Gross Margin
            
            
            14,545
            
            
            2,456
            
            
            17,001
            
            
            13,026
            
            
            1,416
            
            
            14,422Total
                Unallocated Costs
            
            
            
            
            
            
            
            
            (15,471
            )
            
            
            
            
            
            
            
            (15,599
            )Pre-tax
                income (loss)
            
            
            
            
            
            
            
            $
            1,530
            
            
            
            
            
            
            
            $
            (1,157
            )




12
 Table
            of Contents





Indirect
      costs of manufacturing, research and development, and selling, general and
      administrative costs are not allocated to the segments.




**7.**
            **Warrant
                to Purchase Common Stock**




On
      July
      5, 2005, in consideration for services performed under a recruiting contract,
      the Company issued a warrant 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 in July 5, 2008. The fair value of the warrants of
 $87,000 was recorded as an expense for the nine month period ended October
      1, 2005. The fair value of the warrant was calculated using the Black-Scholes
      pricing model with the following assumptions: divided yield 0 percent,
      contractual life of 3 years, risk free rates of  4.04 percent and
      volatility of  83 percent. At October 1, 2005, all the warrant remains
      outstanding.




The
      Company’s assets and liabilities are not evaluated on a segment basis.
      Accordingly, no disclosure on segment assets and liabilities is
      provided.





**8.**
            **Subsequent
                Events**





In
      October 2005, the Company announced that it filed suit against Synergetics
      USA,
      Inc. for infringement of the IRIDEX Patent No. 5,085,492 entitled “Optical Fiber
      with Electrical Encoding” covering its laser probe technology. The suit seeks
      monetary damages as well as a permanent injunction against continued
      infringement by Synergetics for the sale of its Quick Disconnect laser probes
      and its Quick Disconnect Laser Probe Adapter.





**9.**
            **Recent
                Accounting Pronouncements**





In
      November 2004, the Financial Accounting Standards Board, or FASB issued SFAS
      No.
      151, Inventory Costs, an amendment of Accounting Research Bulletin, or ARB,
      No.
      43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of
      idle facility expense, freight, handling costs and wasted material. SFAS No.
      151
      is effective for inventory costs incurred during fiscal years beginning after
      June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a
      material effect on our financial position, results of operations or cash
      flows.





In
      December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which will
      replace SFAS No. 123 and supersede APB 25. SFAS No. 123R addresses the
      accounting for share-based payment transactions in which a company receives
      employee services in exchange for either equity instruments of the company
      or
      liabilities that are based on the fair value of the company's equity instruments
      or that may be settled by the issuance of such equity instruments. Under SFAS
      No. 123R, companies will no longer be able to account for share-based
      compensation transactions using the intrinsic method in accordance with APB
      25,
      but will be required to account for such transactions using a fair-value method
      and recognize the expense in the consolidated statement of earnings. SFAS No.
      123R is effective at the beginning of fiscal 2006. We have not yet determined
      which fair-value method and transitional provision we will follow and have
      not
      yet determined the impact on our financial statements of SFAS No.
      123R.





In
      March
      2005, the SEC issued Staff Accounting Bulletin No. 107, *“Share-Based
      Payment”*  *(“SAB
      107”).* SAB 107
      provides guidance on the initial implementation of SFAS 123R. In particular,
      the
      statement includes guidance related to share-based payment awards for
      non-employees, valuation methods and selecting underlying assumptions such
      as
      expected volatility and expected term. SAB 107 also gives guidance on the
      classification of compensation expense associated with such awards and
      accounting for the income tax effects of those awards upon the adoption of
      SFAS
      123R. We are currently assessing the guidance provided in SAB 107 in connection
      with the implementation of SFAS 123R.





In
      April
      2005, the SEC announced the adoption of a new rule that amends the effective
      date of SFAS 123R. The effective date of the new standard under these new rules
      for our financial statements is January 1, 2006. Adoption of this statement
      is
      expected to have a significant impact on our financial statements as we will
      be
      required to expense the fair value of our stock option grants and stock
      purchases under our employee stock purchase plan (“ESPP”) rather than disclose
      the impact on our net loss within our footnotes, as is our current practice.
      The
      full impact of SFAS 123R on our financial statements and related disclosures
      is
      still being evaluated by management but is expected to be material to our
      results of operations. Our actual share-based compensation expense in 2006
      will
      be dependent on a number of factors, including the amount of awards granted
      and
      the fair value of those awards at the time of grant.




13
 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 1, 2005 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 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.*





**Results
      of Operations**





The
      following table sets forth certain operating data as a percentage of sales
      for
      the periods indicated.





**Three
                Months Ended**
            
            **Nine
                Months Ended****October
                1,**
            
            **October
                2,**
            
            **October
                1,**
            
            **October
                2,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of sales
            
            
            46.3
            %
            
            57.6
            %
            
            50.8
            %
            
            55.7
            %Gross
                profit
            
            
            53.7
            %
            
            42.4
            %
            
            49.2
            %
            
            44.3
            %Operating
                expenses:Research
                and development
            
            
            12.9
            %
            
            12.5
            %
            
            11.8
            %
            
            14.4
            %Sales,
                general and administrative
            
            
            32.9
            %
            
            47.2
            %
            
            33.2
            %
            
            35.7
            %Total
                operating expenses
            
            
            45.8
            %
            
            59.7
            %
            
            45.0
            %
            
            50.1
            %Income
                (loss) from operations
            
            
            7.9
            %
            
            (17.2
            )%
            
            4.2
            %
            
            (5.8
            )%Interest
                and other income, net
            
            
            1.7
            %
            
            1.0
            %
            
            1.5
            %
            
            0.9
            %Income
                (loss) before income taxes
            
            
            9.6
            %
            
            (16.2
            )%
            
            5.7
            %
            
            (4.9
            )%(Provision
                for) benefit from income taxes
            
            
            0.0
            %
            
            7.4
            %
            
            (0.9
            %)
            
            2.3
            %Net
                income (loss)
            
            
            9.6
            %
            
            (8.8
            )%
            
            4.8
            %
            
            (2.6
            )%





The
      following table sets forth for the periods indicated the amount of sales for
      our
      operating segments and sales as a percentage of total sales.




14
 Table
            of Contents





Three
                Months Ended
            
            Nine
                Months EndedOctober
                1, 2005
            
            October
                2, 2004
            
            October
                1, 2005
            
            October
                2, 2004Amount
            
            Percentage
                of total sales
            
            Amount
            
            Percentage
                of total sales
            
            Amount
            
            Percentage
                of total sales
            
            Amount
            
            Percentage
                of total salesDomestic
            
            $
            5,787
            
            
            63.7
            %
            $
            5,161
            
            
            63.1
            %
            $
            16,438
            
            
            61.8
            %
            $
            14,162
            
            
            59.8
            %International
            
            
            3,294
            
            
            36.3
            %
            
            3,017
            
            
            36.9
            %
            
            10,175
            
            
            38.2
            %
            
            9,517
            
            
            40.2
            %Total
            
            
            9,081
            
            
            100.0
            %
            
            8,178
            
            
            100.0
            %
            
            26,613
            
            
            100.0
            %
            
            23,679
            
            
            100.0
            %Ophthalmology:Domestic
            
            
            4,733
            
            
            52.1
            %
            
            4,541
            
            
            55.5
            %
            
            12,481
            
            
            46.9
            %
            
            11,964
            
            
            50.5
            %International
            
            
            3,150
            
            
            34.7
            %
            
            2,652
            
            
            32.4
            %
            
            9,283
            
            
            34.9
            %
            
            8,157
            
            
            34.5
            %Total
            
            
            7,883
            
            
            86.8
            %
            
            7,193
            
            
            87.9
            %
            
            21,764
            
            
            81.8
            %
            
            20,121
            
            
            85.0
            %Dermatology:Domestic
            
            
            1,054
            
            
            11.6
            %
            
            620
            
            
            7.6
            %
            
            3,957
            
            
            14.9
            %
            
            2,198
            
            
            9.3
            %International
            
            
            144
            
            
            1.6
            %
            
            365
            
            
            4.5
            %
            
            892
            
            
            3.3
            %
            
            1,360
            
            
            5.7
            %Total
            
            $
            1,198
            
            
            13.2
            %
            $
            985
            
            
            12.1
            %
            $
            4,849
            
            
            18.2
            %
            $
            3,558
            
            
            15.0
            %





*Ophthalmology
      Sales*





Ophthalmology
      sales increased 9.6% to $7.9 million for the three months ended October 1,
      2005
      from $7.2 million for the three months ended October 2, 2004. For the nine
      months ended October 1, 2005, ophthalmology sales increased 8.2% to $21.8
      million from $20.1 million for the nine months ended October 2, 2004. For the
      three month period ended October 1, 2005, domestic ophthalmology sales increased
      4.2% to $4.7 million from $4.5 million for the three months ended October 2,
      2004 due to approximately $0.1 million in increased unit sales of laser
      consoles and a $0.1 million increase in unit sales of delivery devices. Domestic
      ophthalmology sales increased 4.3% for the nine months ended October 1, 2005
      to
      $12.5 million from $12.0 million for the nine months ended October 2, 2004
      due
      to a $0.7 million increase in unit sales of laser consoles (primarily to our
      OEM
      ophthalmology customers) and service revenue offset by a $0.2 million decrease
      in unit sales of delivery devices. International ophthalmology sales increased
      18.8% to $3.2 million for the three months ended October 1, 2005 from $2.7
      million for the three months ended October 2, 2004. The increase in
      international ophthalmology sales during this period was due to a $0.4 million
      increase in unit sales of laser consoles and a $0.1 million increase in unit
      sales of delivery devices. For the nine months ended October 1, 2005,
      international ophthalmology sales increased 13.8% to $9.3 million from $8.2
      million for the nine months ended October 2, 2004 due to a $0.8 million increase
      in unit sales of laser consoles and service and a $0.3 million increase in
      unit
      sales of delivery devices.




15
 Table
            of Contents




*Dermatology
      Sales*





Primarily
      based on strong domestic sales of our dual-wave length VariLite laser,
      introduced in late 2004, dermatology sales increased 21.6% to $1.2 million
      for
      the three months ended October 1, 2005 from $1.0 million for the three months
      ended October 2, 2004. For the nine months ended October 1, 2005 dermatology
      sales increased 36.3% to $4.8 million from $3.6 million for the nine months
      ended October 2, 2004. Domestic dermatology sales increased 70.0% to $1.1
      million for the three month period ended October 1, 2005 from $0.6 million
      for
      the comparable prior year three month period due primarily to a $0.4 million
      increase in unit sales of laser consoles. For the nine months ended October
      1,
      2005 domestic dermatology sales increased 80.0% to $4.0 million from $2.2
      million due to a $1.8 million increase in unit sales of laser consoles and
      domestic dermatology service revenue. International dermatology sales for both
      the three and nine month periods ended October 1, 2005 decreased primarily
      as a
      result of the level of sales in 2004 associated with our hair removal laser
      on
      which we offered decreased average selling prices based on our decision to
      discontinue the product. Specifically, international dermatology sales decreased
      60.5% to $0.1 million for the three months ended October 1, 2005 from $0.4
      million for the three months ended October 2, 2004 primarily due to a $0.2
      million decrease in unit sales of our hair removal laser consoles and a $0.1
      million decrease in service revenue. For the nine months ended October 1, 2005,
      international dermatology sales decreased 34.4% to $0.9 million from $1.4
      million due to a $0.9 million decrease in unit sales of our discontinued hair
      removal laser offset by an increase of $0.4 million in unit sales of other
      laser
      consoles. Dermatology procedures are typically elective procedures that are
      deferred by patients in difficult economic times. See “-Factors that May Affect
      Future Results - Our Business Has Been Adversely Impacted by the Worldwide
      Economic Slowdown and Related Uncertainties.”





*Gross
      Profit* .
      Our
      gross profit increased by $1.4 million to $4.9 million for the three month
      periods ended October 1, 2005 compared to $3.5 million for the three months
      ended October 2, 2004. Gross profit as a percentage of sales for the three
      months ended October 1, 2005 increased to 53.7% from 42.4% for the comparable
      prior year three month period. The
      improvement in our gross margin was fueled in particular by atypically high
      gross margins on certain non-recurring domestic OEM ophthalmology
      products. The total 11.2% increase in gross profit as a percentage
      of sales during this period included an increase of 8.0% relating to lower
      product costs including product mix (such
      as
      the mix impact of the OEM ophthalmology products), inventory
      reserves and warranty charges as well as an increase of 3.7% due to lower
      manufacturing overhead spending offset by a 0.5% decrease due to reduced average
      selling prices. For the nine months ended October 1, 2005, gross profit
      increased by $2.6 million to $13.1million from $10.5 million for the nine months
      ended October 2, 2004. Gross profit as a percentage of sales for the nine months
      ended October 1, 2005 increased to 49.2% from 44.3%. The total 4.9% increase
      in
      gross profit as a percentage of sales related to an increase of 2.9% associated
      with decreased manufacturing spending as a percent of sales, an increase of
      2.8%
      due to lower product costs including product mix and the change in inventory
      reserves and warranty charges offset by an increase of 0.8% for lower average
      selling prices. While we believe in the next few years that we can achieve
      the type of operating efficiencies necessary to consistently reach the level
      of
      gross margin reported as of October 1, 2005, we expect margins for the next
      year or so to be below the atypically high level achieved for the third quarter
      of fiscal year 2005.  Although increasing competition has continued to
      result in a downward trend in average selling prices for some products, we
      intend to continue our efforts to reduce the cost of components and
      manufacturing and thereby mitigate the impact of price reductions on our gross
      profit. In addition, as we evaluate gross margins on each of our product lines,
      we may choose to place greater focus on product lines with better margins.
      See
“-Factors That May Affect Future Results - If We Cannot Increase Our Sales
      Volumes, Reduce Our Costs or Introduce Higher Margin Products to Offset
      Anticipated Reductions in the Average Unit Selling Price of our Products, Our
      Operating Results May Suffer.” We expect our gross profit margins to continue to
      fluctuate due to changes in the relative proportions of domestic and
      international sales, mix of sales of existing products, pricing, product costs
      and a variety of other factors. See “-Factors That May Affect Future Results -
      Our Operating Results May Fluctuate from Quarter to Quarter and Year to
      Year.”




*Research
      and Development* .
      Our
      research and development expenses increased by 14.3% to $1.2 million for the
      three months ended October 1, 2005 from $1.0 million for the three months ended
      October 2, 2004. Research and development expenses increased as a percentage
      of
      sales to 12.9% for the three months ended October 1, 2005 from 12.5% for the
      comparable prior year three-month period. The increase in research and
      development expense in absolute dollars and as a percentage of sales for the
      three month period ended October 1, 2005 was due primarily to increased spending
      on engineering projects and associated consulting costs of $0.2 million. For
      the
      nine months ended October 1, 2005 research and development expenses decreased
      8.1% to $3.1 million from $3.4 million for the nine months ended October 2,
      2004. As a percentage of sales, research and development expense decreased
      to
      11.8% for the nine months ended October 1, 2005 from 14.4% for the nine months
      ended October 2, 2004. The decrease in research and development expense in
      absolute dollars and as a percentage of sales for the nine month period ended
      October 1, 2005 was due primarily to $0.3 million in decreased spending on
      engineering projects associated with the release of the VariLite and IQ810
      products in 2004.





16
 Table
            of Contents





*Sales,
      General and Administrative* .
      Our
      sales, general and administrative expenses decreased by 22.4% to $3.0 million
      for the three months ended October 1, 2005 from $3.9 million for the three
      months ended October 2, 2004. As a percentage of sales, sales, general and
      administrative expenses decreased to 32.9% for the three months ended October
      1,
      2005 from 47.2% for the comparable prior year three-month period. The decrease
      in sales, general and administrative expense in absolute dollars and as a
      percentage of sales for the three month period ended October 1, 2005 as compared
      to the three month period ended October 2, 2004 was due primarily to a one
      time
      charge of $1.2 million for sales tax as well as a $0.3 million increase in
      the
      allowance for doubtful accounts in the third quarter of fiscal 2004 offset
      by
      $0.6 million in increased selling, general and administrative spending in the
      third quarter of fiscal 2005. The $0.6 million increase in selling, general
      and
      administrative expense related mainly to $0.3 million in increased selling
      expenses associated primarily with increased headcount and expenses associated
      with increased revenue, the accrual of bonus for 2005 as well as $0.1 million
      in
      increased general and administrative costs. For the nine months ended October
      1,
      2005 sales, general and administrative expense increased 4.7% to $8.9 million
      from $8.5 million for the nine months ended October 2, 2004. As a percentage
      of
      sales, sales, general and administrative expense decreased to 33.2% for the
      nine
      months ended October 1, 2005 from 35.7% for the nine months ended October 2,
      2004. The increase in sales, general and administrative expense in absolute
      dollars was due to net increases in spending for sales of $0.3 million and
      marketing of $0.3 million offset by a net decrease in general and administrative
      spending of $0.2 million. The increase in selling expense included $0.6 million
      in increased spending primarily for increased headcount and expenses associated
      with increased revenue offset by a $0.3 million increase in the third quarter
      of
      fiscal 2004 to the allowance for doubtful accounts. The $0.3 million increase
      in
      marketing expense was associated with increased spending on marketing programs.
      The net decrease in general and administrative expense of $0.2 million included
      a decrease of $1.2 million representing a one-time charge for sales tax offset
      by increased general and administrative spending of $1.0 million due to
      increased recruiting and headcount costs mainly for our new CEO, increased
      consulting fees associated with preparation for Sarbanes-Oxley 404 compliance,
      increased legal and other administrative spending. The decrease in sales,
      general and administrative expense as a percentage of sales for the nine months
      ended October 1, 2005 was based mainly on the increase in selling, general
      and
      administrative expense relative to the level of increased revenue during that
      period.




*Interest
      and Other Income, net.* For the
      three months ended October 1, 2005 we had net other income of $157,000 as
      compared with net other income of $ 83,000 for the three months ended October
      2,
      2004. For the nine months ended October 1, 2005, net other income was $413,000
      as compared with $212,000 for the nine months ended October 2, 2004. The change
      in net other income for both the three and nine month periods was due primarily
      to increased interest rates and to increased cash, cash equivalents and
      available for sale securities.





*Income
      Taxes* .
      The
      effective income tax rates for both the three and nine month periods ending
      October 1, 2005 and October 2, 2004 were lower than the Federal and State
      combined statutory rate of 40% because of certain tax benefits associated with
      tax credits for research and development activities and due to the adjustment
      of
      certain tax reserves following the expiration of Federal and State statutes
      of
      limitations.





17
 Table
            of Contents




**Liquidity
      and Capital Resources**





At
      October 1, 2005, our primary sources of liquidity included cash and cash
      equivalents and available-for-sale securities in the aggregate amount of $20.1
      million. In addition, we have available $4 million under our unsecured line
      of
      credit which bears interest at the bank’s prime rate and expires in October
      2006. As of October 1, 2005, no borrowings were outstanding under this credit
      facility. We expect to renew the line of credit in October 2006, assuming that
      the terms continue to be acceptable.





During
      the nine months ended October 1, 2005, operating activities provided $1.7
      million of cash. The primary sources of cash from operating activities included
      net income of $1.3 million, a decrease in net accounts receivable of $0.5
      million, an increase in deferred revenue of $0.3 million, depreciation of $0.3
      million, the valuation of warrants for $0.1 million and a decrease in prepaid
      expenses of $0.1 million offset by uses of cash which included a $0.5 million
      decrease in accrued expenses and an increase in net inventory of $0.4 million.
      The decrease in accounts receivable resulted primarily from continued focus
      on
      collection efforts. The increase in deferred revenue related primarily to
      increased extended service contracts and to advanced payment on revenue. The
      decrease in accrued expenses was due mainly to payment of state sales taxes.
      The
      increase in net inventory was associated with new product
      introductions.





Investing
      activities used $1.7 million in cash and cash equivalents during the nine months
      ended October 1, 2005, primarily due to net purchases of available for sale
      securities of $1.4 million and by purchases of fixed assets of $0.3 million.





Net
      cash
      provided by financing activities during the nine months ended October 1, 2005
      was $0.7 million which consisted of the issuance of common stock under employee
      option plans and the employee stock purchase plan.





We
      believe that, based on current estimates, our cash, cash equivalents and
      available-for-sale securities together with cash generated from operations
      and
      our credit facility will be sufficient to meet our anticipated cash requirements
      for at least the next 12 months. Our liquidity could be negatively affected
      by a
      decline in demand for our products, the need to invest in new product
      development or reductions in spending by our customers as a result of the
      continuing economic downturn or other factors. There can be no assurance that
      additional debt or equity financing will be available when required or, if
      available, can be secured on terms satisfactory to us. See “-Factors That May
      Affect Future Results - We May Need Additional Capital, which May Not Be
      Available, and Our Ability to Grow May Be Limited as a Result.”





In
      December 1998, we instituted a stock repurchase program whereby up to 150,000
      shares of our common stock may be repurchased in the open market. To date,
      we
      have purchased 103,000 shares of our common stock under this program. We have
      utilized all of the reacquired shares for reissuance in connection with employee
      stock programs. No shares were repurchased during the three months ended October
      1, 2005. There are no plans to repurchase additional shares as the stock
      repurchase program has been discontinued in 2005.





**Critical
      Accounting Policies**





The
      Company’s significant accounting policies are disclosed in our Annual Report on
      Form 10-K for the year ended January 1, 2005 which was filed with the Securities
      and Exchange Commission on April 1, 2005.





**Recent
      Accounting Pronouncements**





In
      November 2004, the Financial Accounting Standards Board, or FASB issued SFAS
      No.
      151, Inventory Costs, an amendment of Accounting Research Bulletin, or ARB,
      No.
      43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of
      idle facility expense, freight, handling costs and wasted material. SFAS No.
      151
      is effective for inventory costs incurred during fiscal years beginning after
      June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a
      material effect on our financial position, results of operations or cash
      flows.





18
 Table
            of Contents





In
      December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which will
      replace SFAS No. 123 and supersede APB 25. SFAS No. 123R addresses the
      accounting for share-based payment transactions in which a company receives
      employee services in exchange for either equity instruments of the company
      or
      liabilities that are based on the fair value of the company’s equity instruments
      or that may be settled by the issuance of such equity instruments. Under SFAS
      No. 123R, companies will no longer be able to account for share-based
      compensation transactions using the intrinsic method in accordance with APB
      25,
      but will be required to account for such transactions using a fair-value method
      and recognize the expense in the consolidated statement of earnings. SFAS No.
      123R is effective at the beginning of fiscal 2006. We have not yet determined
      which fair-value method and transitional provision we will follow and have
      not
      yet determined the impact on our financial statements of SFAS No.
      123R.





In
      March
      2005, the SEC issued Staff Accounting Bulletin No. 107, *“Share-Based
      Payment”*  *(“SAB
      107”).* SAB 107
      provides guidance on the initial implementation of SFAS 123R. In particular,
      the
      statement includes guidance related to share-based payment awards for
      non-employees, valuation methods and selecting underlying assumptions such
      as
      expected volatility and expected term. SAB 107 also gives guidance on the
      classification of compensation expense associated with such awards and
      accounting for the income tax effects of those awards upon the adoption of
      SFAS
      123R. We are currently assessing the guidance provided in SAB 107 in connection
      with the implementation of SFAS 123R.





In
      April
      2005, the SEC announced the adoption of a new rule that amends the effective
      date of SFAS 123R. The effective date of the new standard under these new rules
      for our financial statements is January 1, 2006. Adoption of this statement
      is
      expected to have a significant impact on our financial statements as we will
      be
      required to expense the fair value of our stock option grants and stock
      purchases under our employee stock purchase plan (“ESPP”) rather than disclose
      the impact on our net loss within our footnotes, as is our current practice.
      The
      full impact of SFAS 123R on our financial statements and related disclosures
      is
      still being evaluated by management but is expected to be material to our
      results of operations. Our actual share-based compensation expense in 2006
      will
      be dependent on a number of factors, including the amount of awards granted
      and
      the fair value of those awards at the time of grant.




**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.* We
      currently market visible and infrared light semiconductor-based photocoagulator
      medical laser systems to the ophthalmic and dermatology market. We believe
      that
      continued and increased sales, if any, of these medical laser systems is
      dependent upon a number of factors including the following:




§
            Product
                performance, features, ease of use, scalability and
                durability;








§
            Recommendations
                by and opinions of 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;




19
 Table
            of Contents





§
            Availability
                of competing products, technologies and alternative
                treatments;








§
            Willingness
                of ophthalmologists and dermatologists to convert to semiconductor-based
                or infrared laser systems from alternative technologies;
                and







§
            Level
                of reimbursement for treatments administered with our
                products.








In
      addition, we derive a meaningful portion of our revenues from the sale of
      delivery devices. Our ability to increase revenues from the sale of delivery
      devices will depend primarily upon the features, ease of use and prices of
      our
      products, including the relationship to prices of competing delivery devices.
      The level of service revenues will depend on our quality of care, responsiveness
      and the willingness of our customers to request our services rather than
      purchase competing products or services. Any significant decline in market
      acceptance of our products or our revenues derived from the sales of laser
      consoles, delivery devices or services would have a material adverse effect
      on
      our business, results of operations and financial condition.





*We
      Face Strong Competition in Our Markets and Expect the Level of Competition
      to
      Grow in the Foreseeable Future.* Competition
      in the market for devices used for ophthalmic and dermatology treatment
      procedures is intense and is expected to increase. Our competitive position
      depends on a number of factors including product performance, characteristics
      and functionality, ease of use, scalability, durability and cost. Our principal
      competitors in ophthalmology are Carl Zeiss, Inc., Alcon, Nidek, Inc., Lumenis
      Ltd. and Synergetics. All of these companies currently offer a competitive
      semiconductor-based laser system to be used in the ophthalmology
      market. Also within ophthalmology pharmaceutical alternative treatments for
      AMD
      such as Visudyne (Novartis), Macugen (Eyetech) and Genentech (Lucentis) compete
      rigorously with traditional laser procedures. Our principal competitors in
      dermatology are Laserscope, Palomar Technologies, Candela Corporation, Lumenis
      Ltd and Syneron. Some competitors have substantially greater financial,
      engineering, product development, manufacturing, marketing and technical
      resources than we do. Some companies also have greater name recognition than
      we
      do and long-standing customer relationships. In addition to other companies
      that
      manufacture photocoagulators, we compete with pharmaceuticals, other
      technologies and other surgical techniques. Some medical companies, academic
      and
      research institutions, or others, may develop new technologies or therapies
      that
      are more effective in treating conditions targeted by us or are less expensive
      than our current or future products. Any such developments could have a material
      adverse effect on our business, financial condition and results of
      operations.





*Our
      Future Success Depends on Our Ability to Develop and Successfully Introduce
      New
      Products and New Applications* .
      Our
      future success is dependent upon, among other factors, our ability to develop,
      obtain regulatory approval or clearance of, manufacture and market new products.
      In the first nine months of 2005, we released six endo ocular
      probes, three stepped EndoProbe, and one straight EndoProbe. In October
      2004, we introduced two new laser products, the IQ810 in ophthalmology and
      the
      VariLite in dermatology. In May 2004, we introduced a new type of illuminating
      EndoProbe. In June 2003 we began shipment of two new products; a 50 micron
      slit
      lamp adaptor and a 25 gauge single-use EndoProbe. In October 2002, we announced
      the introduction of a number of new products, specifically the OcuLight Symphony
      multi-wavelength laser delivery system, an expanded EndoProbe product line
      and a
      5 mm Large Spot Slit Lamp Adapter. We also announced the Millennium Endolase
      module in 2002, which we manufacture to be included in Bausch & Lomb’s
      Millennium Microsurgical System. Successful commercialization of these and
      other
      new products and new applications will require that we effectively transfer
      production processes from research and development to manufacturing and
      effectively coordinate with our suppliers. In addition, we must successfully
      sell and achieve market acceptance of new products and applications and enhanced
      versions of existing products. The extent of, and rate at which, market
      acceptance and penetration are achieved by future products is a function of
      many
      variables, which include, among other things, price, safety, efficacy,
      reliability, marketing and sales efforts, the development of new applications
      for these products, the availability of third-party reimbursement of procedures
      using our new products, the existence of competing products and general economic
      conditions affecting purchasing patterns. Our ability to market and sell new
      products may also be subject to government regulation, including approval or
      clearance by the United States Food and Drug Administration, or FDA, and foreign
      government agencies. Any failure in our ability to successfully develop and
      introduce new products or enhanced versions of existing products and achieve
      market acceptance of new products and new applications could have a material
      adverse effect on our operating results and would cause our net revenues to
      decline.





20
 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
      have
      experienced declines in the average unit price of our products and expect to
      continue to suffer from declines in the future. The average unit price of our
      products may decrease in the future in response to changes in product mix,
      competitive pricing pressures, new product introductions by our competitors
      or
      other factors. If we are unable to offset the anticipated decrease in our
      average selling prices by increasing our sales volumes or through new product
      introductions, our net revenues will decline. In addition, to maintain our
      gross
      margins, we must continue to reduce the manufacturing cost of our products.
      If
      we cannot maintain our gross margins, our business could be seriously harmed,
      particularly if the average selling price of our products decreases
      significantly without a corresponding increase in sales.





*We
      Depend on Sales of Our Ophthalmology Products for a Significant Portion of
      Our
      Operating Results* .
      We
      derive, and expect to continue to derive, a large portion of our revenue and
      profits from sales of our ophthalmology products. For the three months ended
      October 1, 2005 our ophthalmology sales were $7.9 million or 86.8% of total
      sales. For the nine months ended October 1, 2005, our ophthalmology sales were
      $21.8 million or 81.8% of total sales. We anticipate that sales of our
      ophthalmology products will continue to account for a significant portion of
      our
      revenues in the foreseeable future as we continue to introduce new ophthalmology
      products, such as the new stepped and endo ocular probes introduced in the
      second quarter of 2005.





*We
      Depend on International Sales for a Significant Portion of Our Operating
      Results* .
      We
      derive, and expect to continue to derive, a large portion of our revenue from
      international sales. For the three months ended October 1, 2005, our
      international sales were $3.3 million or 36.3% of total sales. For the nine
      months ended October 1, 2005, our international sales were $10.2 million or
      38.2% of total sales. We anticipate that international sales will continue
      to
      account for a significant portion of our revenues in the foreseeable future.
      None of our international revenues and costs has been denominated in foreign
      currencies. As a result, an increase in the value of the U.S. dollar relative
      to
      foreign currencies makes our products more expensive and thus less competitive
      in foreign markets. The factors stated above could have a material adverse
      effect on our business, financial condition or results of operations. Our
      international operations and sales are subject to a number of other risks
      including:








§
            Longer
                accounts receivable collection
                periods;








§
            Impact
                of recessions in economies outside of the United
                States;








§
            Foreign
                certification requirements, including continued ability to use the
“CE”
                mark in Europe;








§
            Reduced
                or limited protections of intellectual property rights in jurisdictions
                outside the United States;




21
 Table
            of Contents





§
            Potentially
                adverse tax consequences; and








§
            Multiple
                protectionist, adverse and changing foreign governmental laws and
                regulations.








Any
      one
      or more of these factors stated above could have a material adverse effect
      on
      our business, financial condition or results of operations. For additional
      discussion about our foreign currency risks, see Item 3, “Quantitative and
      Qualitative Disclosures about Market Risk.”





*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.* Our
      ability to sell our products and generate revenue depends upon our direct sales
      force within the United States and relationships with independent distributors
      outside the United States. As of October 1, 2005 our direct sales force
      consisted of 14 employees with 4 additional open positions and we maintained
      relationships with 73 independent distributors internationally who sell our
      products into 107 countries. We generally grant our distributors exclusive
      territories for the sale of our products in specified countries. The amount
      and
      timing of resources dedicated by our distributors to the sales of our products
      is not within our control. Our international sales are entirely dependent on
      the
      efforts of these third parties. If any distributor breaches or fails to generate
      sales of our products, we may be forced to replace the distributor and our
      ability to sell our products into that exclusive sales territory would be
      adversely affected.





We
      do not
      have any long-term employment contracts with the members of our direct sales
      force. We may be unable to replace our direct sales force personnel with
      individuals of equivalent technical expertise and qualifications, which may
      limit our revenues and our ability to maintain market share. The loss of the
      services of these key personnel would harm our business. Similarly, our
      distributorship agreements are generally terminable at will by either party
      and
      distributors may terminate their relationships with us, which would affect
      our
      international sales and results of operations.





*We
      are Dependent on the Successful Outcome of Clinical Trials of Our Products
      and
      New Applications Using Our Products.* Our
      success will depend in part on the successful outcome of clinical trials of
      our
      products and new applications using our products. Clinical trials are long,
      expensive and uncertain processes. We have supported several clinical trials,
      including, for example, the TTT4CNV clinical trial. The TTT4CNV clinical trial
      is a physician initiated multi-center, prospective, double-masked,
      placebo-controlled, randomized trial conducted at 22 centers in the United
      States. This is a clinical trial performed within the FDA cleared indications
      of
      the OcuLight SLx and is being conducted to determine whether TTT laser treatment
      using our OcuLight SLx infrared laser system and Large Spot Slit Lamp Adapter
      can reduce the risk of vision loss for patients with wet age-related macular
      degeneration (“wet AMD”) compared to a randomized control, which should reflect
      the natural history of the disease. In June 2003, we announced the publication
      of two additional clinical studies, which also support the effectiveness of
      TTT
      for the treatment of wet AMD. Both studies were prospective, non-randomized,
      non-masked case series that were performed using our OcuLight SLx laser and
      Large Spot Size Slit Lamp Adapter. In October 2004, we announced that the
      preliminary visual outcome data in the intent-to-treat evaluation showed that
      TTT, as applied in the TTT4CNV trial, showed favorable trends but overall did
      not demonstrate a significant beneficial effect relative to sham treatments
      and
      announced that further subgroup analysis would be conducted. Since that time,
      results of subgroup analysis has demonstrated a statistically significant
      benefit in a subgroup of patients with baseline visual acuity of 20/100 or
      worse. Within the TTT4CNV Clinical trial, about 41% of the patients enrolled
      had
      baseline vision of 20/100 or worse. Specifically, at 12 months following
      treatment 23% of TTT treated eyes improved vision by one or more lines and
      14%
      of TTT treated eyes improved vision by three or more lines compared with none
      of
      the eyes in the placebo treated control group. Furthermore, at 18 months, there
      was a 2 line benefit in preserving vision in this subgroup when compared to
      placebo treated eyes. Specifically, TTT treated eyes on average lost 2 lines
      of
      visual acuity while placebo treated eyes lost 4 lines. Any impact on laser
      sales
      related to these trial results may take a number of years. If the future results
      of any clinical trial regarding our products fails to demonstrate improved
      outcomes of treatment using our products, our ability to generate revenues
      from
      new products or new applications using our products would be adversely
      affected.





22
 Table
            of Contents





*We
      Face Manufacturing Risks* .
      The
      manufacture of our infrared and visible light photocoagulators and the related
      delivery devices is a highly complex and precise process. We assemble critical
      subassemblies and all of our final products at our facility in Mountain View,
      California. We may experience manufacturing difficulties, quality control issues
      or assembly constraints, particularly with regard to new products that we may
      introduce. We may not be able to manufacture sufficient quantities of our
      products, which may require that we qualify other manufacturers for our
      products. Furthermore, we may experience delays, disruptions, capacity
      constraints or quality control problems in our manufacturing operations and,
      as
      a result, product shipments to our customers could be delayed, which would
      negatively impact our net revenues.





*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
      use
      quarterly and annual forecasts based primarily on our anticipated product orders
      to plan our manufacturing efforts and determine our requirements for components
      and materials. It is very important that we accurately predict both the demand
      for our product and the lead times required to obtain the necessary components
      and materials. Lead times for components vary significantly and depend on
      numerous factors, including the specific supplier, the size of the order,
      contract terms and current market demand for such components. If we overestimate
      the demand for our product, we may have excess inventory, which would increase
      our costs. Over the past several quarters, we have placed a high priority on
      our
      asset management efforts to, among other things, reduce overall inventory levels
      and increase our cash position. If we underestimate demand for our product
      and,
      consequently, our component and materials requirements, we may have inadequate
      inventory, which could interrupt our manufacturing, delay delivery of our
      product to our customers and result in the loss of customer sales. Any of these
      occurrences would negatively impact our business and operating
      results.





*We
      Depend on Sole Source or Limited Source Suppliers.* We
      rely
      on third parties to manufacture substantially all of the components used in
      our
      products, including optics, laser diodes and crystals. We have some long term
      or
      volume purchase agreements with our suppliers and currently purchase components
      on a purchase order basis. Some of our suppliers and manufacturers are sole
      or
      limited sources. In addition, some of these suppliers are relatively small
      private companies that may discontinue their operations at any time. There
      are
      risks associated with the use of independent manufacturers, including the
      following:








§
            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.





23
 Table
            of Contents





Our
      business and operating results may suffer from the lack of alternative sources
      of supply for critical ** sole
      and
      limited source components *.* The
      process of qualifying suppliers is complex, requires extensive testing with
      our
      products, and may be lengthy, particularly as new products are introduced.
      New
      suppliers would have to be educated in our production processes. In addition,
      the use of alternate components may require design alterations to our products
      and additional product testing under FDA and relevant foreign regulatory agency
      guidelines, which may delay sales and increase product costs. Any failures
      by
      our vendors to adequately supply limited and sole source components may impair
      our ability to offer our existing products, delay the submission of new products
      for regulatory approval and market introduction, materially harm our business
      and financial condition and cause our stock price to decline. Establishing
      our
      own capabilities to manufacture these components would be expensive and could
      significantly decrease our profit margins. We do not currently intend to
      manufacture any of these components. Our business, results of operations and
      financial condition would be adversely affected if we are unable to continue
      to
      obtain components in the quantity and quality desired and at the prices we
      have
      budgeted.





*Our
      Operating Results May Fluctuate from Quarter to Quarter and Year to
      Year* .
      Our
      sales and operating results may vary significantly from quarter to quarter
      and
      from year to year in the future. Our operating results are affected by a number
      of factors, many of which are beyond our control. Factors contributing to these
      fluctuations include the following:




·
            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;





24
 Table
            of Contents




·
            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 development costs.




·
            Legal
                costs associated with litigation, in particular the law suit filed
                against
                Synergetics USA, Inc. for infringement of IRIDEX Patent No.
                5,085,492.







In
      addition to these factors, our quarterly results have been, and are expected
      to
      continue to be, affected by seasonal factors.




Our
      expense levels are based, in part, on expected future sales. If sales levels
      in
      a particular quarter do not meet expectations, we may be unable to adjust
      operating expenses quickly enough to compensate for the shortfall of sales,
      and
      our results of operations may be adversely affected. In addition, we have
      historically made a significant portion of each quarter’s product shipments near
      the end of the quarter. If that pattern continues, any delays in shipment of
      products could have a material adverse effect on results of operations for
      such
      quarter. Due to these and other factors, we believe that quarter to quarter
      and
      year to year comparisons of our past operating results may not be meaningful.
      You should not rely on our results for any quarter or year as an indication
      of
      our future performance. Our operating results in future quarters and years
      may
      be below expectations, which would likely cause the price of our common stock
      to
      fall.





*We
      Depend on Collaborative Relationships to Develop, Introduce and Market New
      Products, Product Enhancements and New Applications* .
      We
      depend on both clinical and commercial collaborative relationships to develop,
      introduce and market new products, product enhancements and new applications.
      We
      have entered into collaborative relationships with academic medical centers
      and
      physicians in connection with the research and development and clinical testing
      of our products. Commercially, we currently collaborate with Bausch & Lomb
      to design and manufacture a solid-state green wavelength (532 nm) laser
      photocoagulator module, called the Millennium Endolase module. The Millennium
      Endolase module is designed to be a component of Bausch & Lomb’s ophthalmic
      surgical suite product offering and is not expected to be sold as a stand-alone
      product. Sales of the Millennium Endolase module are dependent upon the actual
      order rate from and shipment rate to Bausch & Lomb, which depends on the
      efforts of our partner and is beyond our control. We cannot assure you that
      our
      relationship with Bausch & Lomb will result in further sales of our
      Millennium Endolase module. We also collaborated with Miravant Medical
      Technologies, a maker of photodynamic drugs, on a device that emits a laser
      beam
      to activate a photodynamic drug developed by Miravant for the treatment of
      wet
      AMD. In January 2002, Miravant announced that the top line results of their
      Phase III clinical trial indicated that PHOTREX, the photodynamic
      drug developed, did not meet the primary efficacy endpoint in the study
      population. As we could not be assured that PHOTREX would be timely or
      successfully pursued through clinical trials by Miravant, we charged to expense
      in the fourth quarter of 2001, $0.3 million of inventory related to the OcuLight
      664, the laser used by Miravant in the Phase III clinical trials. Miravant
      has
      since received an approvable letter from the FDA for PHOTREX with conditions
      for
      final marketing approval which includes a request for an additional confirmatory
      clinical trial. Miravant has recently started those clinical trials requested
      by
      the FDA. Our OcuLight 664 activation laser has been exclusively used in this
      application and is included in the FDA trials. We are the exclusive provider
      of
      the OcuLight 664 activation laser used in this application. Successful
      commercialization of this product will depend, among other things, on the
      results of the confirmatory clinical trial, acceptance of this product and
      Miravant’s ability to successfully market and sell this therapy. The failure of
      any current or future clinical or commercial collaboration relationships could
      have a material adverse effect on our ability to introduce new products or
      applications and therefore could have a material adverse effect on our business,
      results of operations and financial condition.





25
 Table
            of Contents





*We
      Face Risks Associated with our Collaborative Relationships.* Our
      collaborators may not pursue further development and commercialization of
      products resulting from collaborations with us or may not devote sufficient
      resources to the marketing and sale of such products. Our reliance on others
      for
      clinical development, manufacturing and distribution of our products may result
      in unforeseen problems. Further, our collaborative partners may develop or
      pursue alternative technologies either on their own or in collaboration with
      others. If a collaborator elects to terminate its agreement with us, our ability
      to develop, introduce, market and sell the product may be significantly impaired
      and we may be forced to discontinue altogether the product resulting from the
      collaboration. We may not be able to negotiate alternative collaboration
      agreements on acceptable terms, if at all. The failure of any current or future
      collaboration efforts could have a material adverse effect on our ability to
      introduce new products or applications and therefore could have a material
      adverse effect on our business, results of operations and financial
      condition.





*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.* The
      medical devices that we market and manufacture are subject to extensive
      regulation by the FDA and by foreign and state governments. Under the Federal
      Food, Drug and Cosmetic Act and the related regulations, the FDA regulates
      the
      design, development, clinical testing, manufacture, labeling, sale, distribution
      and promotion of medical devices. Before a new device can be introduced into
      the
      market, the product must undergo rigorous testing and an extensive regulatory
      review process implemented by the FDA under federal law. Unless otherwise
      exempt, a device manufacturer must obtain market clearance through either the
      510(k) premarket notification process or the lengthier premarket approval
      application (PMA) process. Depending upon the type, complexity and novelty
      of
      the device and the nature of the disease or disorder to be treated, the FDA
      process can take several years, require extensive clinical testing and result
      in
      significant expenditures. Even if regulatory approval is obtained, later
      discovery of previously unknown safety issues may result in restrictions on
      the
      product, including withdrawal of the product from the market. Other countries
      also have extensive regulations regarding clinical trials and testing prior
      to
      new product introductions. Our failure to obtain government approvals or any
      delays in receipt of such approvals would have a material adverse effect on
      our
      business, results of operations and financial condition.





The
      FDA
      imposes additional regulations on manufacturers of approved medical devices.
      We
      are required to comply with the applicable Quality System regulations (QSRs)
      and
      our manufacturing facilities are subject to ongoing periodic inspections by
      the
      FDA and corresponding state agencies, including unannounced inspections, and
      must be licensed as part of the product approval process before being utilized
      for commercial manufacturing. Noncompliance with the applicable requirements
      can
      result in, among other things, fines, injunctions, civil penalties, recall
      or
      seizure of products, total or partial suspension of production, withdrawal
      of
      marketing approvals, and criminal prosecution. The FDA also has the authority
      to
      request repair, replacement or refund of the cost of any device we manufacture
      or distribute. Any of these actions by the FDA would materially and adversely
      affect our ability to continue operating our business and the results of our
      operations.





In
      addition, we are also subject to varying product standards, packaging
      requirements, labeling requirements, tariff regulations, duties and tax
      requirements. As a result of our sales in Europe, we are required to have all
      products “CE” marked, an international symbol affixed to all products
      demonstrating compliance with the European Medical Device Directive and all
      applicable standards. While currently all of our released products are CE
      marked, continued certification is based on the successful review of our quality
      system by our European Registrar during their annual audit. Any loss of
      certification would have a material adverse effect on our business, results
      of
      operations and financial condition.





26
 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.* The
      FDA
      and similar governmental authorities in other countries in which we market
      and
      sell our products have the authority to require the recall of our products
      in
      the event of material deficiencies or defects in design or manufacture. A
      government mandated recall, or a voluntary recall by us, could occur as a result
      of component failures, manufacturing errors or design defects, including defects
      in labeling. A recall could divert management’s attention, cause us to incur
      significant expenses, harm our reputation with customers and negatively affect
      our future sales.





If
      we
      modify one of our FDA approved or cleared devices, we may need to seek new
      approvals or clearances which, if not granted, would prevent us from selling
      our
      modified products.





Any
      modifications to an FDA-approved or cleared device that would significantly
      affect its safety or effectiveness or that would constitute a major change
      in
      its intended use would require a new 510(k) clearance or possibly a PMA
      approval. We may not be able to obtain additional 510(k) clearances or PMA
      approvals for new products or for modifications to, or additional intended
      uses
      or indications for, our existing products in a timely fashion, or at all. Delays
      in obtaining future clearances would adversely affect our ability to introduce
      new or enhanced products in a timely manner, which in turn would harm our
      revenue and future profitability. We have made modifications to our devices
      and
      the labeling of our devices in the past and may make additional modifications
      in
      the future that we believe do not or will not require additional clearances
      or
      approvals. If the FDA disagrees and requires new clearances or approvals for
      the
      modifications, we may be required to recall and stop marketing the modified
      devices, which could harm our operating results and require us to redesign
      or
      relabel our products.





*We
      Rely on Patents and Proprietary Rights to Protect our Intellectual Property
      and
      Business* .
      Our
      success and ability to compete is dependent in part upon our proprietary
      information. We rely on a combination of patents, trade secrets, copyright
      and
      trademark laws, nondisclosure and other contractual agreements and technical
      measures to protect our intellectual property rights. We file patent
      applications to protect technology, inventions and improvements that are
      significant to the development of our business. We have been issued fifteen
      United States patents and five foreign patents on the technologies related
      to
      our products and processes. We have approximately six pending patent
      applications in the United States and five foreign pending patent applications
      that have been filed. Our patent applications may not be approved. Any patents
      granted now or in the future may offer only limited protection against potential
      infringement and development by our competitors of competing products. Moreover,
      our competitors, many of which have substantial resources and have made
      substantial investments in competing technologies, may seek to apply for and
      obtain patents that will prevent, limit or interfere with our ability to make,
      use or sell our products either in the United States or in international
      markets. In October 2005, the Company announced that it filed suit against
      Synergetics USA, Inc. for infringement of the IRIDEX Patent No. 5,085,492
      entitled “Optical Fiber with Electrical Encoding” covering its laser probe
      technology. The suit seeks monetary damages as well as a permanent injunction
      against continued infringement by Snergetics for the sale of its Quick
      Disconnect laser probes and its Quick Disconnect Laser Probe
      Adapter.




In
      addition to patents, we rely on trade secrets and proprietary know-how which
      we
      seek to protect, in part, through proprietary information agreements with
      employees, consultants and other parties. Our proprietary information agreements
      with our employees and consultants contain industry standard provisions
      requiring such individuals to assign to us without additional consideration
      any
      inventions conceived or reduced to practice by them while employed or retained
      by us, subject to customary exceptions. Proprietary information agreements
      with
      employees, consultants and others may be breached, and we may not have adequate
      remedies for any breach. Also, our trade secrets may become known to or
      independently developed by competitors.





27
 Table
            of Contents





The
      laser
      and medical device industry is characterized by frequent litigation regarding
      patent and other intellectual property rights. Companies in the medical device
      industry have employed intellectual property litigation to gain a competitive
      advantage. Numerous patents are held by others, including academic institutions
      and our competitors. Until recently patent applications were maintained in
      secrecy in the United States until the patents issued. Patent applications
      filed
      in the United States after November 2000 generally will be published eighteen
      months after the filing date. However, since patent applications continue to
      be
      maintained in secrecy for at least some period of time, both within the United
      States and with regards to international patent applications, we cannot assure
      you that our technology does not infringe any patents or patent applications
      held by third parties. We have, from time to time, been notified of, or have
      otherwise been made aware of, claims that we may be infringing upon patents
      or
      other proprietary intellectual property owned by others. If it appears necessary
      or desirable, we may seek licenses under such patents or proprietary
      intellectual property. Although patent holders commonly offer such licenses,
      licenses under such patents or intellectual property may not be offered or
      the
      terms of any offered licenses may not be reasonable.





Any
      claims, with or without merit, and regardless of whether we are successful
      on
      the merits, would be time-consuming, result in costly litigation and diversion
      of technical and management personnel, cause shipment delays or require us
      to
      develop noninfringing technology or to enter into royalty or licensing
      agreements. An adverse determination in a judicial or administrative proceeding
      and failure to obtain necessary licenses or develop alternate technologies
      could
      prevent us from manufacturing and selling our products, which would have a
      material adverse effect on our business, results of operations 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* .
      Our
      ophthalmology products are typically purchased by doctors, clinics, hospitals
      and other users, which bill various third-party payers, such as governmental
      programs and private insurance plans, for the health care services provided
      to
      their patients. Third-party payers are increasingly scrutinizing and challenging
      the coverage of new products and the level of reimbursement for covered
      products. Doctors, clinics, hospitals and other users of our products may not
      obtain adequate reimbursement for use of our products from third-party payers.
      While we believe that the laser procedures using our products have generally
      been reimbursed, payers may deny coverage and reimbursement for our products
      if
      they determine that the device was not reasonable and necessary for the purpose
      used, was investigational or was not cost-effective. In addition, third party
      payers may not initiate coverage of new procedures using our products for a
      significant period. In September 2000, the Center for Medicare and Medicaid
      Services, or CMS, advised that claims for reimbursement for certain age related
      macular degeneration, or AMD, procedures which use our OcuLight SLx laser
      system, could be submitted for reimbursement, with coverage and payment to
      be
      determined by the local medical carriers at their discretion. To date five
      carriers representing 17 states have written reimbursement coverage policies
      on
      Transpupillary Thermotherapy, or TTT. The states reimbursing for TTT are Alaska,
      Arizona, California, Colorado, Hawaii, Iowa, Idaho, Mississippi, North Carolina,
      North Dakota, Nevada, Oregon, Pennsylvania, South Dakota, Tennessee, Washington
      and Wyoming. Domestic sales of the infrared laser systems may continue to be
      limited until more local medical carriers reimburse for performing such AMD
      procedures or until CMS advises that claims for these procedures may be
      submitted directly to CMS at the national level.





Changes
      in government legislation or regulation or in private third-party payers’
policies toward reimbursement for procedures employing our products may prohibit
      adequate reimbursement. There have been a number of legislative and regulatory
      proposals to change the healthcare system, reduce the costs of healthcare and
      change medical reimbursement policies. Doctors, clinics, hospitals and other
      users of our products may decline to purchase our products to the extent there
      is uncertainty regarding reimbursement of medical procedures using our products
      and any healthcare reform measures. Further proposed legislation, regulation
      and
      policy changes affecting third party reimbursement are likely. We are unable
      to
      predict what legislation or regulation, if any, relating to the health care
      industry or third-party coverage and reimbursement may be enacted in the future,
      or what effect such legislation or regulation may have on us. However, denial
      of
      coverage and reimbursement of our products would have a material adverse effect
      on our business, results of operations and financial condition.





28
 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.* We may
      be subject to product liability claims from time to time. Our products are
      highly complex and some are used to treat extremely delicate eye tissue and
      skin
      conditions on and near a patient’s face. Although we currently maintain and
      intend to continue the Company’s product liability insurance, adequate insurance
      may not be available on acceptable terms, if at all, and may not provide
      adequate coverage against potential liabilities. Product liability insurance
      is
      expensive. We might not be able to obtain product liability insurance in the
      future on acceptable terms or in sufficient amounts to protect us, if at all.
      A
      successful claim brought against us in excess of our insurance coverage could
      have a material adverse effect on our business, results of operations and
      financial condition.





*If
      We
      Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could
      Harm Our Operating Results.* We
      have
      experienced, and may continue to experience growth in our business. We have
      made
      and expect to continue to make significant investments to enable our future
      growth through, among other things, new product development and clinical trials
      for new applications and products. We must also be prepared to expand our work
      force and to train, motivate and manage additional employees as the need for
      additional personnel arises. Our personnel, systems, procedures and controls
      may
      not be adequate to support our future operations. Any failure to effectively
      manage future growth could have a material adverse effect on our business,
      results of operations and financial condition.





*If
      Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be
      Seriously Harmed.* Our
      facilities could be subject to catastrophic loss such as fire, flood or
      earthquake. All of our research and development activities, manufacturing,
      our
      corporate headquarters and other critical business operations are located near
      major earthquake faults in Mountain View, California. Any such loss at any
      of
      our facilities could disrupt our operations, delay production, shipments and
      revenue and result in large expense to repair and replace our
      facilities.





*We
      May Need Additional Capital, which May Not Be Available, and Our Ability to
      Grow
      May be Limited as a Result.* We
      believe that our existing cash balances, available-for-sale securities, credit
      facilities and cash flow expected to be generated from future operations will
      be
      sufficient to meet our capital requirements at least through the next 12 months.
      However, we may be required, or could elect, to seek additional funding prior
      to
      that time. The development and marketing of new products and associated support
      personnel requires a significant commitment of resources. If cash from available
      sources is insufficient, we may need additional capital, which may not be
      available on favorable terms, if at all. If we cannot raise funds on acceptable
      terms, we may not be able to develop or enhance our products, take advantage
      of
      future opportunities, fund potential acquisitions or respond to competitive
      pressures or unanticipated requirements. Any inability to raise additional
      capital when we require it would seriously harm our business.





*Our
      Stock Price Has Been and May Continue to be Volatile and an Investment in Our
      Common Stock Could Suffer a Decline in Value.* The
      trading price of our common stock has been subject to wide fluctuations in
      response to a variety of factors, some of which are beyond our control,
      including quarterly variations in our operating results, announcements by us
      or
      our competitors of new products or of significant clinical achievements, changes
      in market valuations of other similar companies in our industry and general
      market conditions. We receive only limited attention by securities analysts
      and
      may experience an imbalance between supply and demand for our common stock
      resulting from low trading volumes. In addition, the stock market has
      experienced extreme volatility in the last few years that has often been
      unrelated to the performance of particular companies. These broad market
      fluctuations could have a significant impact on the market price of our common
      stock regardless of our performance.





29
 Table
            of Contents





*Changes
      in Accounting Rules for Stock-Based Compensation Will Adversely Affect Our
      Operating Results, Our Stock Price and Our Competitiveness in the Employee
      Marketplace* .
      We have
      a history of using employee stock options and other stock-based compensation
      to
      hire, motivate and retain our workforce. In December 2004, the Financial
      Accounting Standards Board issued Statement of Financial Accounting Standards
      No. 123R, “Share-Based Payment,” which will require us, commencing for the
      fiscal year ending December 31, 2005, to measure compensation costs for all
      stock-based compensation (including stock options and our employee stock
      purchase plan) at fair value and to recognize these costs as expenses in our
      statement of operations. The recognition of these expenses in our statements
      of
      operations will result in lower earnings per share, which could negatively
      impact our future stock price. In addition, if we reduced or altered our use
      of
      stock-based compensation to minimize the recognition of these expenses, our
      ability to recruit, motivate and retain employees may be impaired, which could
      put us at a competitive disadvantage in the employee marketplace.





*Compliance
      with Internal Controls Evaluations and Attestation Requirements* .
      Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we will be required,
      beginning in fiscal 2007, to perform an evaluation of our internal controls
      over
      financial reporting and have our auditor publicly attest to such evaluation.
      We
      have prepared an internal plan of action for compliance, which includes a
      timeline and scheduled activities, although as of the date of this filing we
      have not yet prepared the evaluation. Compliance with these requirements is
      expected to be expensive and time-consuming. If we fail to timely complete
      this
      evaluation, or if our registered independent public accounting firm cannot
      timely attest to our evaluation, we could be subject to regulatory scrutiny
      and
      a loss of public confidence in our internal controls. In addition, any failure
      to implement required new or improved controls, or difficulties encountered
      in
      their implementation, could harm our operating results or cause us to fail
      to
      meet our reporting obligations.








**Item
                3.**
            **Quantitative
                and Qualitative Disclosure about Market
                Risk**





**Quantitative
      Disclosures**





We
      are
      exposed to market risks inherent in our operations, primarily related to
      interest rate risk and currency risk. These risks arise from transactions and
      operations entered into in the normal course of business. We do not use
      derivatives to alter the interest characteristics of our marketable securities
      or our debt instruments. We have no holdings of derivative or commodity
      instruments.





*Interest
      Rate Risk* .
      We are
      subject to interest rate risks on cash and cash equivalents, available-for-sale
      marketable securities and any future financing requirements. Interest rate
      risks
      related to marketable securities are managed by managing maturities in our
      marketable securities portfolio. We have no long-term debt as of October 1,
      2005.





The
      fair
      value of our investment portfolio or related income would not be significantly
      impacted by changes in interest rates since the marketable securities maturities
      do not exceed a term of 12 - 14 months.





**Qualitative
      Disclosures**





*Interest
      Rate Risk* .
      Our
      primary interest rate risk exposures relate to:





§
            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.





30
 Table
          of Contents




We
      have
      the ability to hold at least a portion of the fixed income investments until
      maturity and therefore would not expect the operating results or cash flows
      to
      be affected to any significant degree by a sudden change in market interest
      rates on its short- and long-term marketable securities portfolio.





Management
      evaluates our financial position on an ongoing basis.





*Currency
      Rate Risk.*





As
      all of
      our sales transactions are denominated in U.S. currency, we do not hedge any
      balance sheet exposures against future movements in foreign exchange rates.
      The
      exposure related to currency rate movements would not have a material impact
      on
      future net income or cash flows.








**Item
                4.**
            **Controls
                and Procedures**





**(a)**
            **Evaluation
                of Disclosure Controls and
                Procedures**





Our
      management, with the participation of our Chief Executive Officer and our Chief
      Financial Officer, evaluated the effectiveness of our disclosure controls and
      procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of
      1934,
      as of the end of the period covered by this Quarterly Report on Form 10-Q.
      Based
      on that evaluation, our Chief Executive Officer and our Chief Financial Officer
      concluded that our disclosure controls and procedures are effective to ensure
      that information we are required to disclose in reports that we file or submit
      under the Securities Exchange Act of 1934 is recorded, processed, summarized
      and
      reported within the time periods specified in the Securities and Exchange
      Commission rules and forms.





**(b)**
            **Changes
                in Internal Controls**





There
      was
      no change in our internal control over financial reporting that occurred during
      the period covered by this Quarterly Report on Form 10-Q that has materially
      affected, or is reasonably likely to materially affect, our internal control
      over financial reporting.




31
 Table
            of Contents




**PART
                II.**
            **OTHER
                INFORMATION**





**Item
                1.**
            **Legal
                Proceedings**


In
      October 2005, the Company announced that it filed suit against Synergetics
      USA,
      Inc. for infringement of the IRIDEX Patent No. 5,085,492 entitled “Optical Fiber
      with Electrical Encoding” covering its laser probe technology. The suit seeks
      monetary damages as well as a permanent injunction against continued
      infringement by Snergetics for the sale of its Quick Disconnect laser probes
      and
      its Quick Disconnect Laser Probe Adapter. ****





**Item
                2.**
            **Changes
                in Securities and Use of
                Proceeds**


None.





**Item
                3.**
            **Defaults
                Upon Senior Securities**


None.





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


None.





**Item
                5.**
            **Other
                Information**


None.





**Item
                6.**
            **Exhibits
                and Reports on Form 8-K**


(a)
            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 and 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**





IRIDEX,
      the IRIDEX logo, IRIS Medical, OcuLight, SmartKey, EndoProbe and Apex are our
      registered trademarks. IRIDERM, G-Probe, DioPexy, DioVet, TruFocus, TrueCW,
      UltraView, DioLite 532, Long Pulse, MicroPulse, ScanLite, ColdTip (Handpiece),
      VariSpot (Handpiece), TruView and EasyFit product names are our trademarks.
      All
      other trademarks or trade names appearing in the Form 10-Q are the property
      of
      their respective owners.




32
 Table
            of Contents




**SIGNATURE**




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




IRIDEX
      Corporation


(Registrant)





Date:
                November 15, 2005
            By:
            /s/
                Larry TannenbaumLarry
              TannenbaumChief
              Financial Officer and Vice President, Administration(Principal
              Financial, Principal Accounting Officer and Authorized
              Signatory)





33
 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 and Chief Financial Officer pursuant to
                18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.




34