##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For
the quarterly period ended September 30, 2006
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the Transition period from to
 Commission File Number: 0-27598
 IRIDEX CORPORATION
  Delaware
    
    77-0210467(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification No.)
 1212 Terra Bella Avenue
Mountain View, California 94043-1824
 (650) 940-4700
 þ o
  o o þ
 o þ




---



##### 



IRIDEX Corporation
 Table of Contents
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements(unaudited)Condensed Consolidated Balance Sheets as of September 30, 2006
and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2006 and October 1, 2005
    
    
    4Condensed Consolidated Statements of Comprehensive Income (Loss) for the
three and Nine Months Ended September 30, 2006 and
October 1, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2006 and October 1, 2005
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    26PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    28Item 1A. Risk Factors
    
    
    29Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    40Item 3. Defaults Upon Senior Securities
    
    
    40Item 4.
Submission of Matters to a Vote of Security Holders
    
    
    41Item 5. Other Information
    
    
    41Item 6. Exhibits
    
    
    41Signature
    
    
    42
  2




---



##### Table of Contents



Part I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 IRIDEX Corporation
 
 Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
 September 30,
    
    
    December 31,2006
    
    
    2005AssetsCurrent assets:Cash and cash equivalents
    
    $
    4,439
    
    
    $
    12,655Available-for-sale securities
    
    
    17,651
    
    
    
    8,779Accounts receivable, net
    
    
    6,373
    
    
    
    6,589Inventories
    
    
    8,529
    
    
    
    8,594Prepaids and other current assets
    
    
    639
    
    
    
    885Current deferred income taxes
    
    
    1,415
    
    
    
    1,415Total current assets
    
    
    39,046
    
    
    
    38,917Property and equipment, net
    
    
    1,082
    
    
    
    1,114Deferred income taxes and other long term assets
    
    
    1,179
    
    
    
    1,073Total assets
    
    $
    41,307
    
    
    $
    41,104Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    1,093
    
    
    $
    1,094Accrued expenses
    
    
    3,700
    
    
    
    4,421Deferred revenue
    
    
    1,328
    
    
    
    1,072Total liabilities
    
    
    6,121
    
    
    
    6,587Contingencies
(Note 5)Stockholders equity:Common stock
    
    
    79
    
    
    
    76Additional paid-in capital
    
    
    28,955
    
    
    
    26,334Accumulated other comprehensive loss
    
    
    (2
    )
    
    
    (27
    )Treasury stock
    
    
    (430
    )
    
    
    (430
    )Retained earnings
    
    
    6,584
    
    
    
    8,564Total stockholders equity
    
    
    35,186
    
    
    
    34,517Total liabilities and stockholders equity
    
    $
    41,307
    
    
    $
    41,104
  3




---



##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    October 1,
    
    
    September 30,
    
    
    October 1,2006
    
    
    2005
    
    
    2006
    
    
    2005Sales
    
    $
    9,222
    
    
    $
    9,081
    
    
    $
    26,869
    
    
    $
    26,613Cost of sales
    
    
    4,350
    
    
    
    4,202
    
    
    
    13,076
    
    
    
    13,511Gross profit
    
    
    4,872
    
    
    
    4,879
    
    
    
    13,793
    
    
    
    13,102Operating expenses:Research and development
    
    
    1,506
    
    
    
    1,172
    
    
    
    3,955
    
    
    
    3,133Sales, general and administrative
    
    
    4,854
    
    
    
    2,990
    
    
    
    12,651
    
    
    
    8,852Total operating expenses
    
    
    6,360
    
    
    
    4,162
    
    
    
    16,606
    
    
    
    11,985Income (loss) from operations
    
    
    (1,488
    )
    
    
    717
    
    
    
    (2,813
    )
    
    
    1,117Interest and other income,
net
    
    
    184
    
    
    
    157
    
    
    
    540
    
    
    
    413Income (loss) before income taxes
    
    
    (1,304
    )
    
    
    874
    
    
    
    (2,273
    )
    
    
    1,530Benefit from (provision for) income taxes
    
    
    161
    
    
    
    5
    
    
    
    293
    
    
    
    (241
    )Net income (loss)
    
    $
    (1,143
    )
    
    $
    879
    
    
    $
    (1,980
    )
    
    $
    1,289Net income (loss) per common share  basic
    
    
    ($0.15
    )
    
    $
    0.12
    
    
    
    ($0.26
    )
    
    $
    0.17Net income (loss) per common share  diluted
    
    
    ($0.15
    )
    
    $
    0.11
    
    
    
    ($0.26
    )
    
    $
    0.16Shares used in per common share basic
calculations
    
    
    7,758
    
    
    
    7,441
    
    
    
    7,680
    
    
    
    7,373Shares used in per common share diluted
calculations
    
    
    7,758
    
    
    
    8,102
    
    
    
    7,680
    
    
    
    7,885
 (A)
    
    Results for the three and nine months ended September 30, 2006 and October 1, 2005 include
stock-based compensation expense as follows:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    October 1,
    
    
    September 30,
    
    
    October 1,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Cost of sales
    
    $
    28
    
    
    $
    
    
    
    $
    95
    
    
    $
    Research and development
    
    
    67
    
    
    
    
    
    
    
    188
    
    
    
    Selling, general and
administrative
    
    
    331
    
    
    
    
    
    
    
    1,077
    
    
    
    
  4




---



##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    October 1,
    
    
    September 30,
    
    
    October 1,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    (1,143
    )
    
    $
    879
    
    
    $
    (1,980
    )
    
    $
    1,289Other comprehensive income (loss):Change in unrealized gain (loss) on
available-for-sale securities, net of tax
    
    
    2
    
    
    
    4
    
    
    
    16
    
    
    
    (9
    )Comprehensive income (loss)
    
    $
    (1,141
    )
    
    $
    883
    
    
    $
    (1,964
    )
    
    $
    1,280
  5




---



##### Table of Contents



IRIDEX Corporation
 
 Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 Nine Months EndedSeptember 30,
    
    
    October 1,2006
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (1,980
    )
    
    $
    1,289Adjustments to reconcile net income to net cash provided by (used in) operating activities:
    
    
    
    
    
    
    Depreciation and amortization
    
    
    390
    
    
    
    320Warrants issued for services
    
    
    
    
    
    
    87Stock-based compensation
    
    
    1,360
    
    
    
    Provision for doubtful accounts
    
    
    108
    
    
    
    38Provision for excess and obsolete inventories
    
    
    51
    
    
    
    167Changes in operating assets and liabilities:Accounts receivable
    
    
    108
    
    
    
    509Inventories
    
    
    14
    
    
    
    (572
    )Prepaids and other current assets
    
    
    246
    
    
    
    51Other long term assets
    
    
    (106
    )
    
    
    Accounts payable
    
    
    (1
    )
    
    
    (45
    )Accrued expenses
    
    
    (721
    )
    
    
    (469
    )Deferred revenue
    
    
    256
    
    
    
    332Net cash
provided by (used in) operating activities
    
    
    (275
    )
    
    
    1,707Cash flows from investing activities:Purchases of available-for-sale securities
    
    
    (17,651
    )
    
    
    (5,592
    )Proceeds from maturity of available-for-sale securities
    
    
    8,804
    
    
    
    4,222Acquisition of property and equipment
    
    
    (358
    )
    
    
    (327
    )Net cash used in investing activities
    
    
    (9,205
    )
    
    
    (1,697
    )Cash flows from financing activities:Issuance of common stock
    
    
    1,264
    
    
    
    664Net cash provided by financing activities
    
    
    1,264
    
    
    
    664Net increase (decrease) in cash and cash equivalents
    
    
    (8,216
    )
    
    
    674Cash and cash equivalents at beginning of period
    
    
    12,655
    
    
    
    10,381Cash and cash equivalents at end of period
    
    $
    4,439
    
    
    $
    11,055
  6




---



##### Table of Contents



IRIDEX Corporation
 
 Notes to Unaudited Condensed Consolidated Financial Statements
 1. Basis of Presentation
   2. Restatement of Financial Results for the Quarter Ended April 1, 2006
  3. Summary of Significant Accounting Policies
  Revenue Recognition
  Deferred
Revenue
  7




---



##### Table of Contents



Nine Months EndedSeptember 30, 2006
    
    
    October 1, 2005Balance, beginning of period
    
    $
    1,072
    
    
    $
    910Additions to deferred revenue
    
    
    1,256
    
    
    
    1,135Revenue recognized
    
    
    (1,000
    )
    
    
    (803
    )Balance, end of period
    
    $
    1,328
    
    
    $
    1,242
 Warranty
  Nine Months EndedSeptember 30, 2006
    
    
    October 1, 2005Balance, beginning of period
    
    $
    1,128
    
    
    $
    933Accruals for warranties issued during the period
    
    
    586
    
    
    
    955Settlements made in kind during the period
    
    
    (868
    )
    
    
    (789
    )Balance, end of period
    
    $
    846
    
    
    $
    1,099
 4. Inventories
  September 30,
    
    
    December 31,2006
    
    
    2005Raw materials and work in progress
    
    $
    3,781
    
    
    $
    5,191Finished goods
    
    
    4,748
    
    
    
    3,403Total inventories
    
    $
    8,529
    
    
    $
    8,594
 8




---



##### Table of Contents



5. Contingencies
 IRIDEX Corporation v. Synergetics USA, Inc
  Synergetics, Inc. v.
Peregrine Surgical, Ltd., Innovatech Surgical, Inc., and IRIDEX Corporation
 Synergetics, Inc. v. IRIDEX Corporation
  9




---



##### Table of Contents



6. Computations of Net Income (Loss) Per Common Share
   7. Business Segments
   10




---



##### Table of Contents



Three Months Ended September 30, 2006
    
    
    Three Months Ended October 1, 2005Ophthalmology
    
    
    Dermatology
    
    
    
    
    
    
    Ophthalmology
    
    
    DermatologyMedical
    
    
    Medical
    
    
    
    
    
    
    Medical
    
    
    MedicalDevices
    
    
    Devices
    
    
    Total
    
    
    Devices
    
    
    Devices
    
    
    TotalSales
    
    $
    7,954
    
    
    $
    1,268
    
    
    $
    9,222
    
    
    $
    7,883
    
    
    $
    1,198
    
    
    $
    9,081Direct cost of
goods sold
    
    
    2,444
    
    
    
    560
    
    
    
    3,004
    
    
    
    2,461
    
    
    
    465
    
    
    
    2,926Direct gross margin
    
    
    5,510
    
    
    
    708
    
    
    
    6,218
    
    
    
    5,422
    
    
    
    733
    
    
    
    6,155Total unallocated
costs
    
    
    
    
    
    
    
    
    
    
    ( 7,522
    )
    
    
    
    
    
    
    
    
    
    
    (5,281
    )Pre-tax income
(loss)
    
    
    
    
    
    
    
    
    
    
    (1,304
    )
    
    
    
    
    
    
    
    
    
    
    874
 Nine Months Ended September 30, 2006
    
    
    Nine Months Ended October 1, 2005Ophthalmology
    
    
    Dermatology
    
    
    
    
    
    
    Ophthalmology
    
    
    DermatologyMedical
    
    
    Medical
    
    
    
    
    
    
    Medical
    
    
    MedicalDevices
    
    
    Devices
    
    
    Total
    
    
    Devices
    
    
    Devices
    
    
    TotalSales
    
    
    23,175
    
    
    $
    3,694
    
    
    $
    26,869
    
    
    $
    21,764
    
    
    $
    4,849
    
    
    $
    26,613Direct cost of goods sold
    
    
    7,186
    
    
    
    1,718
    
    
    
    8,904
    
    
    
    7,219
    
    
    
    2,393
    
    
    
    9,612Direct gross margin
    
    
    15,989
    
    
    
    1,976
    
    
    
    17,965
    
    
    
    14,545
    
    
    
    2,456
    
    
    
    17,001Total unallocated costs
    
    
    
    
    
    
    
    
    
    
    (20,238
    )
    
    
    
    
    
    
    
    
    
    
    (15,471
    )Pre-tax income (loss)
    
    
    
    
    
    
    
    
    
    
    (2,273
    )
    
    
    
    
    
    
    
    
    
    
    1,530
   8. Stock-based Compensation
 Employee Stock Purchase Plan
  11




---



##### Table of Contents



Stock Option Plans
 Amended and Restated 1989 Incentive Stock P lan
  1998 Stock Plan
  1995 Director Option Plan
    12




---



##### Table of Contents



Stand-Alone Options and Warrants
    Stock-Based Compensation
    13




---



##### Table of Contents



Employee Stock Option
    
    Employee Stock
    
    Employee Stock Option
    
    Employee StockPlan
    
    Purchase Plan
    
    Plan
    
    Purchase PlanThree Months Ended
    
    Three Months Ended
    
    Nine Months Ended
    
    Nine Months EndedSeptember
    
    October
    
    September
    
    October
    
    September
    
    October
    
    September
    
    October30, 2006
    
    1, 2005
    
    30, 2006
    
    1, 2005
    
    30, 2006
    
    1, 2005
    
    30, 2006
    
    1, 2005Average risk free
interest rate
    
    
    4.80
    %
    
    
    4.04
    %
    
    
    4.99
    %
    
    
    3.68
    %
    
    
    4.80
    %
    
    
    4.13
    %
    
    
    4.99
    %
    
    
    3.25
    %Expected life (in
years)
    
    
    3.8
    
    
    
    3.0
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    3.8
    
    
    
    3.0
    
    
    
    0.5
    
    
    
    0.5Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Average volatility
    
    
    65.0
    %
    
    
    84.0
    %
    
    
    42.0
    %
    
    
    83.0
    %
    
    
    65.0
    %
    
    
    84.0
    %
    
    
    42.0
    %
    
    
    84.0
    %
   Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2006Cost of sales
    
    $
    28
    
    
    $
    95Research and development
    
    
    67
    
    
    
    188Sales, general and administrative
    
    
    331
    
    
    
    1,077$
    426
    
    
    $
    1,360
   14




---



##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    October 1, 2005Net income, as reported for prior periods
    
    $
    879
    
    
    $
    1,289Stock-based compensation expense related
to employee stock options and employee
stock purchases
    
    
    (205
    )
    
    
    (537
    )Pro forma net income
    
    $
    674
    
    
    $
    752Basic net income per share:As reported
    
    $
    0.12
    
    
    $
    0.17Pro forma
    
    $
    0.09
    
    
    $
    0.10Diluted net income per share:As reported
    
    $
    0.11
    
    
    $
    0.16Pro forma
    
    $
    0.08
    
    
    $
    0.10
   Weighted Average
    
    
    Aggregate IntrinsicShares
    
    
    Exercise Price
    
    
    ValueOutstanding at December 31, 2005
    
    
    2,154,003
    
    
    $
    5.50
    
    
    $
    14,518Options granted
    
    
    297,650
    
    
    
    8.45
    
    
    
    88Options exercised
    
    
    (215,626
    )
    
    
    4.48
    
    
    
    (920
    )Options forfeited/cancelled/expired
    
    
    (28,014
    )
    
    
    6.73
    
    
    
    (56
    )Outstanding at September 30, 2006
    
    
    2,208,013
    
    
    $
    5.98
    
    
    $
    13,630
   15




---



##### Table of Contents



Three Months
    
    
    Nine MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2006
    
    
    2006Stock-based compensation expense by award type:Employee stock options granted
    
    $
    418
    
    
    $
    1,336Employee stock purchase plan
    
    
    8
    
    
    
    24Total stock-based compensation
    
    
    426
    
    
    
    1,360Total effect on stock-based compensation at
the Companys marginal tax rate
    
    
    (76
    )
    
    
    (238
    )Effect on net income (loss)
    
    $
    350
    
    
    $
    1,122Effect on net income (loss) per share:Basic and diluted
    
    $
    (0.04
    )
    
    $
    (0.14
    )
  Weighted AverageGrant Dated FairNumber of Shares
    
    ValueNon-vested at December 31, 2005
    
    
    893,119
    
    
    $
    5.72Granted
    
    
    297,650
    
    
    
    8.45Vested
    
    
    (249,102
    )
    
    
    5.17Cancelled/forfeited
    
    
    (28,014
    )
    
    
    6.73Non-vested at September 30, 2006
    
    
    913,653
    
    
    
    6.66
  16




---



##### Table of Contents



Options Outstanding
    
    
    Options Vested and ExercisableNumber of
    
    
    Weighted
    
    
    
    
    
    
    Number of
    
    
    
    
    
    
    WeightedShares
    
    
    Average
    
    
    Weighted
    
    
    Shares
    
    
    Weighted
    
    
    AverageOutstanding at
    
    
    Remaining
    
    
    Average
    
    
    Exercisable at
    
    
    Average
    
    
    RemainingRange of
    
    September 30,
    
    
    Contractual
    
    
    Exercise
    
    
    September 30,
    
    
    Exercise
    
    
    ContractualExercise Prices
    
    2006
    
    
    Life (Years)
    
    
    Price
    
    
    2006
    
    
    Price
    
    
    Life (Years)$2.94  $3.50
    
    
    242,617
    
    
    
    6.44
    
    
    $
    3.36
    
    
    
    210,622
    
    
    $
    3.37
    
    
    
    6.40$3.52  $4.00
    
    
    300,170
    
    
    
    3.20
    
    
    $
    3.86
    
    
    
    287,095
    
    
    $
    3.87
    
    
    
    3.04$4.01 $5.08
    
    
    309,999
    
    
    
    5.88
    
    
    $
    4.64
    
    
    
    220,459
    
    
    $
    4.53
    
    
    
    4.89$5.13  $5.69
    
    
    228,627
    
    
    
    6.01
    
    
    $
    5.47
    
    
    
    121,342
    
    
    $
    5.48
    
    
    
    4.47$6.00  $6.00
    
    
    7,437
    
    
    
    8.67
    
    
    $
    6.00
    
    
    
    770
    
    
    $
    6.00
    
    
    
    8.67$6.07  $6.07
    
    
    325,000
    
    
    
    8.76
    
    
    $
    6.07
    
    
    
    112,502
    
    
    $
    6.07
    
    
    
    8.16$6.19  $7.84
    
    
    317,063
    
    
    
    6.65
    
    
    $
    7.16
    
    
    
    117,083
    
    
    $
    6.97
    
    
    
    5.12$7.98  $8.75
    
    
    248,300
    
    
    
    7.08
    
    
    $
    8.35
    
    
    
    39,267
    
    
    $
    8.47
    
    
    
    3.81$8.88  $12.19
    
    
    221,300
    
    
    
    3.64
    
    
    $
    9.47
    
    
    
    177,720
    
    
    $
    9.28
    
    
    
    2.87$12.75  $12.75
    
    
    7,500
    
    
    
    3.76
    
    
    $
    12.75
    
    
    
    7,500
    
    
    $
    12.75
    
    
    
    3.76$2.94  $12.75
    
    
    2,208,013
    
    
    
    6.01
    
    
    $
    5.98
    
    
    
    1,294,360
    
    
    $
    5.45
  9. Subsequent Event
  10 Recent Accounting Pronouncements
    17




---



##### 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 age-related macular degeneration (AMD)
procedures that use our products; results of clinical studies and risks associated with bringing
new products to market; general economic conditions; and levels of international sales. In some
cases, forward-looking statements can be identified by terminology, such as may, will,
should, expects, plans, anticipates, believes, estimates, predicts, intends,
potential, continue, or the negative of such terms or other comparable terminology. These
statements involve known and unknown risks, uncertainties and other factors which may cause our
actual results, performance or achievements to differ materially from those expressed or implied by
such forward-looking statements, including as a result of the factors set forth under Factors That
May Affect Future Operating Results and other risks detailed in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on April 3, 2006 and detailed from time to time
in our reports filed with the Securities and Exchange Commission. The reader is cautioned not to
place undue reliance on these forward-looking statements, which reflect managements analysis only
as of the date of this Quarterly Report on Form 10-Q . We undertake no obligation to update such forward-looking
statements to reflect events or circumstances occurring after the date of this report.
 Restatement of Financial Results for the Quarter Ended April 1, 2006
  Overview
   18




---



##### Table of Contents



Results of Operations
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    October 1,
    
    
    September 30,
    
    
    October 1,2006
    
    
    2005
    
    
    2006
    
    
    2005Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.2
    %
    
    
    46.3
    %
    
    
    48.7
    %
    
    
    50.8
    %Gross profit
    
    
    52.8
    %
    
    
    53.7
    %
    
    
    51.3
    %
    
    
    49.2
    %Operating expenses:Research and development
    
    
    16.3
    %
    
    
    12.9
    %
    
    
    14.7
    %
    
    
    11.8
    %Sales, general and administrative
    
    
    52.7
    %
    
    
    32.9
    %
    
    
    47.1
    %
    
    
    33.2
    %Total operating expenses
    
    
    69.0
    %
    
    
    45.8
    %
    
    
    61.8
    %
    
    
    45.0
    %Income (loss) from operations
    
    
    (16.1
    )%
    
    
    7.9
    %
    
    
    (10.5
    )%
    
    
    4.2
    %Interest and other income, net
    
    
    2.0
    %
    
    
    1.7
    %
    
    
    2.0
    %
    
    
    1.5
    %Income (loss) before income taxes
    
    
    (14.1
    )%
    
    
    9.6
    %
    
    
    (8.5
    )%
    
    
    5.7
    %Benefit from (provision for) income taxes
    
    
    1.7
    %
    
    
    0.0
    %
    
    
    1.1
    %
    
    
    (0.9
    %)Net income (loss)
    
    
    (12.4
    )%
    
    
    9.6
    %
    
    
    (7.4
    )%
    
    
    4.8
    %
  Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    October 1, 2005
    
    
    September 30, 2006
    
    
    October 1, 2005Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentageof total
    
    
    
    
    
    
    of total
    
    
    
    
    
    
    of total
    
    
    
    
    
    
    of totalAmount
    
    
    sales
    
    
    Amount
    
    
    sales
    
    
    Amount
    
    
    sales
    
    
    Amount
    
    
    salesDomestic
    
    $
    5,699
    
    
    
    61.8
    %
    
    $
    5,787
    
    
    
    63.7
    %
    
    $
    16,126
    
    
    
    60.0
    %
    
    $
    16,438
    
    
    
    61.8
    %International
    
    
    3,523
    
    
    
    38.2
    %
    
    
    3,294
    
    
    
    36.30
    %
    
    
    10,743
    
    
    
    40.0
    %
    
    
    10,175
    
    
    
    38.2
    %Total
    
    
    9,222
    
    
    
    100.0
    %
    
    
    9,081
    
    
    
    100.0
    %
    
    
    26,869
    
    
    
    100.0
    %
    
    
    26,613
    
    
    
    100.0
    %Ophthalmology:Domestic
    
    
    4,803
    
    
    
    52.1
    %
    
    
    4,733
    
    
    
    52.1
    %
    
    
    13,441
    
    
    
    50.0
    %
    
    
    12,481
    
    
    
    46.9
    %International
    
    
    3,151
    
    
    
    34.2
    %
    
    
    3,150
    
    
    
    34.7
    %
    
    
    9,734
    
    
    
    36.2
    %
    
    
    9,283
    
    
    
    34.9
    %Total
    
    
    7,954
    
    
    
    86.3
    %
    
    
    7,883
    
    
    
    86.8
    %
    
    
    23,175
    
    
    
    86.2
    %
    
    
    21,764
    
    
    
    81.8
    %Dermatology:Domestic
    
    
    896
    
    
    
    9.7
    %
    
    
    1,054
    
    
    
    11.6
    %
    
    
    2,685
    
    
    
    10.0
    %
    
    
    3,957
    
    
    
    14,9
    %International
    
    
    372
    
    
    
    4.0
    %
    
    
    144
    
    
    
    1.6
    %
    
    
    1,009
    
    
    
    3.8
    %
    
    
    892
    
    
    
    3.3
    %Total
    
    $
    1,268
    
    
    
    13.7
    %
    
    $
    1,198
    
    
    
    13.2
    %
    
    $
    3,694
    
    
    
    13.8
    %
    
    $
    4,849
    
    
    
    18.2
    %Total recurring
revenue
    
    $
    3,732
    
    
    
    40.5
    %
    
    $
    3,223
    
    
    
    35.5
    %
    
    $
    11,443
    
    
    
    42.6
    %
    
    $
    9,653
    
    
    
    36.3
    %Total non-recurring
revenue
    
    $
    5,490
    
    
    
    59.5
    %
    
    $
    5,858
    
    
    
    64.5
    %
    
    $
    15,426
    
    
    
    57.4
    %
    
    $
    16,960
    
    
    
    63.7
    %
 19




---



##### Table of Contents



Ophthalmology and Dermatology Sales Overview
    Ophthalmology Sales
  20




---



##### Table of Contents



Dermatology Sales
    Gross Margin
 Three Months Ended
    
    Nine Months EndedSeptember 30
    
    October 1,
    
    September 30
    
    October 1,2006
    
    2005
    
    2006
    
    2005Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.2
    %
    
    
    46.3
    %
    
    
    48.7
    %
    
    
    50.8
    %Gross profit
    
    
    52.8
    %
    
    
    53.7
    %
    
    
    51.3
    %
    
    
    49.2
    %
   21




---



##### Table of Contents



Research and Development
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    October 1,
    
    September 30,
    
    October 1,2006
    
    2005
    
    2006
    
    2005Research and
development
expense as a
percentage of
total revenue
    
    
    16.3
    %
    
    
    12.9
    %
    
    
    14.7
    %
    
    
    11.8
    %
    22




---



##### Table of Contents



elling, General and Administrative
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    October 1,
    
    September 30,
    
    October 1,2006
    
    2005
    
    2006
    
    2005Selling,
general and
administrative
expense as a
percentage of
total revenue
    
    
    52.7
    %
    
    
    32.9
    %
    
    
    47.1
    %
    
    
    33.3
    %
   Interest
and Other Income, net.
 Income Taxes.
 23




---



##### Table of Contents



Liquidity and Capital Resources
       24




---



##### Table of Contents



Accounting Policies
    Recent Accounting Pronouncements
    
 Item 3. Quantitative and Qualitative Disclosure about Market Risk
 Quantitative Disclosures
  Interest Rate Risk
  Qualitative Disclosures
 Interest Rate Risk
 
    
    the fall in value of available-for-sale securities if market interest rates
increase; and
    
    the impact of interest rate movements on our ability to obtain adequate financing
to fund future operations.
   25




---



##### Table of Contents



Currency
Rate Risk
 
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures
 a) Evaluation of disclosure controls and procedures.
         26




---



##### Table of Contents



Plan for remediation of material weaknesses
   
    
    implementation of additional controls over the preparation and review of key
spreadsheets;
    
    implementation of automated general ledger reports to replace existing key spreadsheets
where possible;
    
    correction of a system generated custom report to include additional information
necessary to prepare accurate financial information;
    
    implementation of additional review procedures; and
    
    enhancement of the current capabilities of the finance function.Related to our revenue recognition practices:
    
    reassignment of responsibilities for oversight of the sales function and
responsibilities for internal control over sales transactions;
    
    provision of additional training on a recurring basis for all domestic sales personnel
on revenue recognition policies and procedures;
    
    establishment of annual formal training for our customer service group on revenue
recognition policies and procedures;
    
    establishment of a checklist for use by our customer service group in processing
revenue transactions to verify proper recognition and establishment of a policy by which
this checklist is signed off by the preparer and at least one reviewer;
    
    establishment of internal audit procedures over all domestic laser sale transactions;
and
    
    formalization over our sales returns process to include more thorough documentation,
review and approval for all returns.
   (b) Changes in internal control over financial reporting
  27




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 IRIDEX Corporation v. Synergetics USA, Inc
  Synergetics, Inc. v.
Peregrine Surgical, Ltd., Innovatech Surgical, Inc., and IRIDEX Corporation
 Synergetics, Inc. v.
IRIDEX Corporation
  28




---



##### Table of Contents



Item 1A. Risk Factors
 Factors That May Affect Future Results
  We Rely on Continued Market Acceptance of Our Existing Products and Any Decline in Sales of
Our Existing Products Would Adversely Affect Our Business and Results of Operations.
 
    
    acceptance of product performance, features, ease of use, scalability and durability;
    
    acceptance of the companys new marketing programs;
    
    recommendations and opinions by ophthalmologists, dermatologists, other
clinicians, plastic surgeons and their associated opinion leaders, including study
outcomes;
    
    price of our products and prices of competing products and technologies;
    
    availability of competing products, technologies and alternative treatments; and
    
    level of reimbursement for treatments administered with our products.
  29




---



##### Table of Contents



Our Future Success Depends on Our Ability to Develop and Successfully Introduce New Products
and New Applications
 We Face Strong Competition in Our Markets and Expect the Level of Competition to Grow in the
Foreseeable Future.
 If We Cannot Increase Our Sales Volumes, Reduce Our Costs or Introduce Higher Margin Products
to Offset Anticipated Reductions in the Average Unit Price of Our Products, Our Operating Results
May Suffer.
 We Depend on Sales of Our Ophthalmology Products for a Significant Portion of Our Operating
Results
 30




---



##### Table of Contents



We Depend on International Sales for a Significant Portion of Our Operating Results
 
    
    impact of recessions in economies outside of the United States;
    
    performance of our international channel of distributors;
    
    foreign certification requirements, including continued ability to use the
CE mark in Europe;
    
    reduced or limited protections of intellectual property rights in
jurisdictions outside the United States;
    
    longer accounts receivable collection periods;
    
    potentially adverse tax consequences; and
    
    multiple protectionist, adverse and changing foreign governmental laws and
regulations.
  We Rely on Our Direct Sales Force and Network of International Distributors to Sell Our
Products and any Failure to Maintain Our Direct Sales Force and Distributor Relationships Could
Harm Our Business.
  31




---



##### Table of Contents



Failure to Remediate the Material Weaknesses in Our Disclosure Controls and Procedures in a
Timely Manner, or At All, Could Harm Our Operating Results or Cause Us to Fail to Meet Our
Regulatory or Reporting Obligations.
   If We Lose Key Personnel or Fail to Integrate Replacement Personnel Successfully, Our Ability
to Manage Our Business Could Be Impaired
 If We Fail to Accurately Forecast Demand For Our Product and Component Requirements For the
Manufacture of Our Product, We Could Incur Additional Costs or Experience Manufacturing Delays and
May Experience Lost Sales or Significant Inventory Carrying Costs.
 We Depend on Sole Source or Limited Source Suppliers.
 32




---



##### Table of Contents




    
    unavailability of, shortages or limitations on the ability to obtain supplies of
components in the quantities that we require;
    
    delays in delivery or failure of suppliers to deliver critical components on the
dates we require;
    
    failure of suppliers to manufacture components to our specifications, and
potentially reduced quality; and
    
    inability to obtain components at acceptable prices.
 .
 We Face Risks Associated with our Collaborative and OEM Relationships.
 We Face Manufacturing Risks
 33




---



##### Table of Contents



We Depend on Collaborative Relationships to Develop, Introduce and Market New Products,
Product Enhancements and New Applications
 Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year
 
    
    general economic uncertainties and political concerns;
    
    the timing of the introduction and market acceptance of new products, product
enhancements and new applications;
    
    changes in demand for our existing line of dermatology and ophthalmic products;
    
    the cost and availability of components and subassemblies, including the ability of our
sole or limited source suppliers to deliver components at the times and prices that we have
planned;
    
    our ability to maintain sales volumes at a level sufficient to cover fixed manufacturing
and operating costs;
    
    fluctuations in our product mix between dermatology and ophthalmic products and foreign
and domestic sales;
    
    the effect of regulatory approvals and changes in domestic and foreign regulatory
requirements;
    
    introduction of new products, product enhancements and new applications by our
competitors, entry of new competitors into our markets, pricing pressures and other
competitive factors;
    
    our long and highly variable sales cycle;
    
    changes in the prices at which we can sell our products;
    
    changes in customers or potential customers budgets as a result of, among other
things, reimbursement policies of government programs and private insurers for treatments
that use our products; and
    
    increased product innovation costs.
 34




---



##### Table of Contents



We entered into
 a definitive asset purchase agreement with American Medical Systems, Inc. and
Laserscope, a wholly owned subsidiary of American Medical Systems, Inc. on November 30, 2006 and we
may experience unexpected difficulties closing this transaction or integrating the aesthetics
business which we agreed to purchase in this transaction.
  
    
    we may experience unexpected losses of employees or customers we expected
to gain in connection with this transaction;
    
    we may not achieve expected levels of revenue growth;
    
    we may not be able to coordinate our current product
development efforts with those of the aesthetics business of Laserscope in a way which permits us to
bring future new products to the market in a timely and cost-effective manner; and
    
    we may discover that liabilities that we assumed are greater than
anticipated.
  35




---



##### Table of Contents



Our Stock Price Has Been and May Continue to be Volatile and an Investment in Our Common
Stock Could Suffer a Decline in Value.
 We Are Subject To Government Regulation Which May Cause Us to Delay or Withdraw the
Introduction of New Products or New Applications for Our Products.
   36




---



##### Table of Contents



We Rely on Patents and Proprietary Rights to Protect our Intellectual Property and Business
    37




---



##### Table of Contents



The Requirements of Complying with the Sarbanes-Oxley Act of 2002 Might Strain Our Resources,
Which May Adversely Affect Our Business and Financial Condition
 Our products could be subject to recalls even after receiving FDA approval or clearance. A
recall would harm our reputation and adversely affect our operating results.
  38




---



##### Table of Contents



If We Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could Harm Our
Operating Results.
 If Product Liability Claims are Successfully Asserted Against Us, We may Incur Substantial
Liabilities That May Adversely Affect Our Business or Results of Operations.
 Our Operating Results May be Adversely Affected by Changes in Third Party Coverage and
Reimbursement Policies and any Uncertainty Regarding Healthcare Reform Measures.
 39




---



##### Table of Contents



The Successful Outcome of Clinical Trials and the Development of New Applications Using
Certain of Our Products will Accelerate Future Revenue Growth Rates.
 We May Need Additional
 Capital, which May Not Be Available, and Our Ability to Grow May be
Limited as a Result.
 If Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be Seriously
Harmed.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 40




---



##### Table of Contents



Item 4.
Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 Trademark Acknowledgments
  41




---



##### Table of Contents



SIGNATURE
  IRIDEX Corporation(Registrant)Date:
December 22, 2006
    
    
    
    By:
    
    /s/ Larry TannenbaumLarry TannenbaumChief Financial Officer and Vice President, Administration(Principal Financial, Principal Accounting Officer andAuthorized Signatory)
 42




---



##### Table of Contents



Exhibit Index
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 43