IRIDEX Corp (IRIX) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Iridex first quarter 2006 financial results conference call. My name is Tanya, and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question-and-answer session towards the end of today's conference.

[Operator instructions]

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. [Jennifer Bugleman], with the EDC Group. Please proceed.

Thank you. Thank you all for joining us today for the Iridex first quarter financial results conference call. This is Jennifer Bugleman with the EDC Group. With me today is Barry Caldwell, the Company's President and CEO, and Larry Tannenbaum, the Chief Financial Officer of Iridex Corp. If you have not received a copy of today's earnings release, please contact Susan Bruce at 650-962-8848 extension 3052 to get a copy or you may view the earnings release through our web site at www.Iridex.com. This conference call is also being webcast on our web site. The press release has information about how to access the replay of this teleconference.

Before we begin I'd like to go over our Safe Harbor Statement. Please note that this conference call contains forward-looking statements within the meaning of section 27A of the Securities Act of 1933 as amended, and section 21E of the Securities Act of 1934 as amended, relating to the Company's growth prospects, sales, revenues, gross margins, operating efficiencies, and profitability as well as results of studies related to products and development in the businesses of users of our products. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. These statements are subject to risks and uncertainties and actual results could differ materially from those projected in the forward-looking statements. Some of these factors that could cause results to differ include the actual order and shipment rate for the Company's ophthalmology and dermatology product lines, the rate of introduction and market acceptance of the Company's products, the financial consequences of states not reimbursing for all of the Company's A&D procedures, the impact of any continuing weakness and uncertainties related to general economic conditions or weakness in overall demand in the Company's markets, especially with regard to the company's dermatology products, which are typically used for elective procedures that can be deferred and the Company's ability to continue to reduce its costs and improve its operating efficiencies and the timing of the release of and actual results of studies related to its products.

Risks and uncertainties to which the company are subject may include, but may not necessarily be limited to, the amount of orders that the company receives and ships, dependence on international sales, and the company's network of independent distributors, the risks associated with bringing new products to market, the results of clinical trials and competition in the market.

Please see a detailed discussion of these risks contained in quarterly reports on form 10-Q, and annual report form 10-K for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission. Forward-looking statements contained in this announcement are made as of this date and will not be updated, and the company may not undertake to update them. Now I'd like to turn the call over to Barry Caldwell.

Thank you for that introduction, Jennifer, and thanks to the rest of you for joining us on our quarterly call updating the progress of the Company. During the first quarter, we continued to make progress on our first leg of our growth strategy, and that is to grow the core business. We reached several new milestones that illustrate this progress, including first of all achieving more than $9 million in revenue. We started the year in record fashion, as this is the highest first quarter ever in the history of the company. This is also the fourth consecutive quarter in which revenue has exceeded 9 million and the fifth consecutive quarter in which we've experienced double-digit growth after four years of little to no growth.

First a look at ophthalmology. Our sales increased by 23% over first quarter of last year and represented 84% of our total revenues. I think the line dropped when we started to talk about ophthalmology, so let me start there in terms of our ophthalmic revenues for the first quarter. Our sales increased overall in ophthalmology by 23% over prior year and that represented -- for the first quarter, ophthalmology represented 84% of our total revenues. The growth was fueled by our strength of our disposable sales, which increased 31% over prior year. Our recurring revenues, which include both our disposables and the service revenues, as you may recall represented 36% of our sales in 2005 and 33% in 2004. We have publicly said our goal is to increase recurring revenue to a level of 40% plus of our total revenue. Well, during the first quarter we are happy to say that our increasing recurring revenues reached a level of 42% of total sales, which is certainly a significant milestone for us. This sales growth illustrates the success of our new sales and marketing programs that have gained traction more quickly than our internal expectations. In my mind, we are a couple of quarters ahead of where I thought we'd be.

Turning to ophthalmic laser console sales, you may recall that during the third and fourth quarters of 2005 we experienced some one time OEM sales in ophthalmology laser consoles, which was a help in enhancing our growth, both top-line and bottom line. During the first quarter we returned to our normal level of OEM business. Thus the very positive growth in ophthalmology revenues was driven by our own direct US and international distributor sales. We achieved ophthalmology laser console sales growth of 27% in the US, excluding any OEM sales, and 26% internationally. Particularly for the US, these are very encouraging numbers, which reflect that our strategy to increase the number of sales reps is paying dividends in the form of increased laser console sales.

In dermatology, the revenues represented a decrease over prior year. Obviously this is not good, but we believe we understand the reason and have taken steps to address the decline. Some of those factors are the AAD meeting or the American Academy of Dermatology meeting was held later in the quarter this year than it was last year, and obviously we had less time this year to close leads from that meeting. So that did impact this first quarter of '06. But more importantly, the productivity numbers of our US sales team has not improved, and we've talked about this before, and we are taking the appropriate actions to remedy this. Our dermatology sales should have been double what they were during the first quarter in my mind. We believe that our actions will allow us to achieve results that are similarly positive to those we've achieved in ophthalmology.

Overall, we had a strong quarter in revenues. We've built up positive trends which were established in '05 and have gotten off to a record start in 2006. With that as an introduction I'd like to now turn the call over to Larry for further details about the financial results for the quarter, after which I will add some additional operational comments before we proceed to questions and answers. Larry?

Thanks, Barry, and good afternoon everyone. We are pleased to report that revenues for the first quarter ended April 1, 2006 grew 11% to 9 million from the 8.1 million reported in the first quarter 2005. During the first quarter of 2006, we saw strong revenue growth both domestically and internationally. During the first quarter of 2006 domestic sales increased 7.5% to 5.3 million from 4.9 million reported in the first quarter of 2005. This was driven by a 27% increase in direct laser and disposable ophthalmology sales, excluding the OEM sales.

International sales were 3.7 million in the first quarter of 2006, representing a 15% increase from the 3.2 million posted in the year ago period. This was fueled by a 20% increase in laser and disposable ophthalmology sales. Since international sales are dominated in US dollars, foreign-currency fluctuations had no material impact on sales growth.

We were especially pleased with ophthalmology sales growth in the first quarter as both recurring revenue and laser systems experienced strong growth. Ophthalmology sales grew 22.5% to 7.6 million for the first quarter of 2006 compared with 6.2 million recorded in the corresponding quarter of 2005. Recurring revenue from disposable product sales and services increased 22%. Recurring revenue accounted for 40% of total revenues, which is a four percentage point increase from the 38% of total revenues in the first quarter of 2005, the highest percent of sales that recurring revenue has ever represented.

Dermatology sales approximately 27% to 1.4 million in the first quarter of 2006 from 1.95 million in the comparable period in 2005. While disappointing, we have implemented some changes to the sales organization that should allow us to return to a growth trajectory.

Gross margins expanded by three percentage points to 48.2% in the first quarter of 2006 from 45.2% in the year ago period, driven by the higher sales of disposable probes. Excluding the effect of 123R, gross margins were 48.6% for the first quarter of 2006 since a pro forma gross margins were 48.6 for the first quarter of 2006 or an improvement of 3.4 percentage points over the first quarter of 2005.

Our sales, general, and administrative expenses increased 3.9 million in Q1 2006 from 2.8 million in Q1 2005. The increase in sales, general, and administration expense was due primarily to four things. First, we had a 0.4 or even one consider a $0.5 million charge for 123R expense. We saw increasing spending based on our new sales and marketing programs and hiring of individuals and 3 million -- there was a $0.3 million increase in sales spending associated with increased revenue and the addition of those new sales reps. And then there was also an increase of 200,000 in marketing spending due mainly to increased headcount as well as increased spending on marketing programs.

And finally, there was a $200,000 increase in general administrative spending associated with headcount increases as well as legal fees.

On January 1 2006 the Company adopted the statement of financial accounting standards for its statement 123R or FAS 123R, which I've been referring to as 123R, which requires the Company to recognize share based payment transaction as a compensation expense in its financial statements. Including the effect of 123R, quarterly GAAP net loss was 264,000 and dilutive loss per share was $.03. The Company recorded a pretax charge related to 123R of $457,000. Management believes that excluding the effect of 123R provides a better comparison with prior results.

Excluding the effect of 123R, the company recorded a pro forma net loss of only $49,000 in the first quarter of 2006 compared with a loss of $20,000 in the year ago period. Excluding the effect of 123R, the rounded net loss per share was $0.01 in the first quarter of 2006 compared with a net loss per share of zero in the corresponding quarter of 2005. Obviously if you compare these two numbers they are very close to breakeven for the company.

Based on the Company's expected earnings for the year 2006, we used an effective tax rate of approximately 50%. More than 20% of this tax rate or approximately 11 percentage points relates specifically to the 123R book expense that we recorded. In Q1 2006 the company reported a net tax benefit of 274,000. If the R&D tax credit gets reenacted, we believe that the tax rate for the year should be around 35%. However, based on the timing of certain items, the tax rate will be cyclical each quarter as it was last year.

The balance sheet remains strong. Cash and cash equivalents and available for sale of securities as of April 1, 2006 were 21.4 million or roughly flat with those at December 31, 2005.

Inventories were 8.7 million compared with 8.6 at the end of last year, as inventory turns improved to 2.2 turns in the first quarter of 2006 compared to 1.9 turns for the first quarter of 2005 and 2.2 turns for the full 2005 fiscal year. Quarterly days sales outstanding improved to 65 days in the first quarter of 2006 compared with 80 days for the first quarter of 2005 and 69 days for the full 2005 fiscal year. Accounts receivables were 6.2 million as of the end of the first quarter 2006.

Looking ahead to the full year 2006 we expect to achieve double-digit revenue growth, improved gross margin, and accelerated earnings growth excluding the impact of 123R. 123R expenses will be approximately between 400 and $500,000 per quarter for the rest of 2006. As most of you know, historically Q1 is usually our weakest revenue quarter of the year and fourth quarter is usually the strongest. We expect the same cyclical pattern this year as hospitals reach year-end and sometimes have budget left for capital equipment. Ophthalmologist practices often purchase capital equipment for cash purposes and the timing of the American Academy of Ophthalmology which is being held in November this year. And with that, I'll turn it back to Barry.

Thank you, Larry. Following up on my commentary about the first leg of our growth strategy, I'd also like to make some comments about the other two legs. And first of all would be that second leg of our growth strategy, which is growing through product innovation. During the quarter as you know from our press release we hired our new vice president of product innovation, Deborah Tomasco. I am very pleased that she has joined our team and believe that she will provide the leadership and vision necessary to drive rapid product innovation.

Also during that hiring process we had another very strong candidate and I'm very pleased that we were able to also bring this candidate, Ray Choye, as the new director on our product innovation team. Ray has many years of experience in both dermatology and ophthalmology laser devices. The product innovation team has developed a plan to introduce two new ophthalmology laser consoles at the American Academy of Ophthalmology this November. We also have plans to introduce six to eight new disposable products during the year. Now that we've rounded out our product innovation team and established a research department under the guidance of [Dave Lazoa], one of our cofounders, we believe that we can successfully launch products that meet the unmet needs of the market and drive our revenue and gross margin growth.

We now have our executive management team in place. So you won't hear me talking about anymore hires that we've made in that respect, but I'm very pleased with our team and the skill set that we have to move forward. When you look at our team, we have much more experience and ability than a typical $40 million medical device company would warrant. We will use it as we grow this business to the $100 million level in the next three years. During the quarter we also made some real progress on our third leg of our growth strategy, and that is adding new technologies through acquisition or merger. Though we do not have anything to announce today, we continue to engage in very meaningful discussions with several companies. As a reminder of our acquisition criteria, there are basically four different parts. Number one, that it be accretive to earnings. Number two that it enhance our retinal product offering and/or broaden our presence in general ophthalmology. Three, we would like for it to have some recurring revenue opportunities associated with it. And fourth, gross margins in excess of 50%.

With a record first quarter under our belt and strong progress made on our growth initiatives, we iterate our expectations for 2006. First, double-digit revenue growth. Second, enhancing our core business gross margin. Third, increasing our EPS growth. And fourth, executing upon our acquisition strategy. With that, we will open the line up for questions.

Ladies and gentlemen if you wish to ask a question please press star followed by one when your touchtone telephone. If your question has been answered or you wish to withdraw your question, please key start two. Press star one to begin. We will stand by for the first question. And your first question comes from the line of Ryan Rauch from Jeffries. Please proceed.

Hi guys, congratulations on a solid quarter.

Thanks very much.

Yes, just a couple quick questions. So Barry, can you give us a brief outline of your current sales force? If you did, I apologize; we were knocked off the call.

Well, join the club [inaudible] we were knocked off too. That was the second peck we were knocked off. Anyway, yes Ryan, we are increasing our ophthalmic sales force to 10 direct in the US, and we added a new director of sales of ophthalmology. So I believe we are only -- we have every position in place with the exception of one in ophthalmology. We currently have six territories in dermatology and that's the same as we had prior year.

OK. And then I know that one of your areas of focus has been strategic alliances. I mean do you still hope to have something consummated or completed by the end of the second quarter at least the end of the third quarter?

It's all -- Ryan, it's always difficult to put a timing on these things. We have had and are in very meaningful discussions with several different companies, and each one of those could take us in different directions, but they are all very exciting. So as I've learned I can say, I will be disappointed if we don't make an acquisition or make a move in this area within this year.

And then can you give us some details about your new VIP program and were you able to book revenues for that program in the quarter? And if not, what would that have added to your top line?

OK, good question Ryan. Yes, we've been talking about our VIP program, the value of the Iridex Partner Program, and we did begin selling on that program during the first quarter. So that was initiated and we did make progress in that area. We have been working with our auditors to determine whether we can recognize the revenue up front on products that we ship under this program and thus far we've not been able to satisfy the auditing team and being able to recognize revenue. We are working on that. It may take a couple of minor changes in our agreement, so we are hoping that maybe in second quarter we will be able to recognize the revenue up front. If not, this turns out to be deferred revenue. And it did have some impact during first quarter. I don't think our intent will be just for competitive purposes to talk about how many VIP plans we do. So we will probably try to stay away from that, but I think it's fair to say the program is in place. We had a sales meeting in Dallas about three weeks ago for additional training to our sales force. Some of our sales guys have had prior experience doing this, and so they are running with it. Some of the others, it's a new experience for them. So we are making progress. We believe it's been a key part of our disposable increase of 31% the first quarter.

Got you, but I mean is it fair -- I mean would this be 100,000, $200,000 or would it be a lot less minor than that?

You know, I think if we get into saying how much it is, it will signal maybe too much from a competitive perspective. If once we get the -- Ryan, I think once we get the final accounting rule in place, we will either start talking about what is the deferred revenue. We will find a bucket to put it in so that it will make some meaningful sense.

OK, and then finally can you give us an update on your lawsuit with Synergistics?

With Synergetics, yes. I guess there are two issues there. Number one, the litigation we filed against them for patent infringement on our connector to the laser system. Some of you may know that as a part of that in the federal court there is a mediation process. That did take place, that was a one-day meeting that took place with both parties and all counsel involved with an independent mediator in between. We are hoping that that was a meeting that will be productive and adding to potentially a settlement in the case, but we are certainly not at that point today. The next milestone is the Markman hearing, where a judge will determine the language interpretation of the claims in our patent, and that will begin later this month and we expect within 45 to 60 days from that date, to have the judge rule on what those claims would be.

OK, thanks a lot. Have a wonderful afternoon.

You too, thank you Ryan.

And your next question comes from the line of Larry Haimovitch from HMTC, please proceed.

Barry, the disposables were a very pleasant surprise you achieved your goal very, very quickly. How much was the emphasis that the compensation emphasis that you put on with the sales reps a big factor? I know you mentioned changes in the compensation. At least I think you did some time ago.

Yes Larry, you are right. Beginning of this year that compensation changed quite dramatically. In the past, they would earn about 10 to 20% of their commissions based upon disposable sales. That's about half of their commissions now. In addition, we are paying them a bonus for every one of these VIP plans that they do, which are contractual agreements on our disposable business. So I think it certainly has been an impact, and as I said, you know, when I first saw these numbers I was very pleasantly surprised and I do believe we are a couple of quarters ahead of the pace I thought we would be.

I think, Larry, what's encouraging is it's not just the disposable, it's on the laser system sales themselves, there is good momentum developing there. So finally on all cylinders in the ophthalmology area.

Well, let's talk about unfortunately the other side, where Barry you said you were flat out disappointed in dermatology. Can you give us a little more color? Is it competitive issues?

Yes, yes. Good question Larry and you are right, I'm disappointed. None of us here are pleased, but I'm also encouraged, and let me tell you why I'm encouraged. 85% of our sales first quarter in the US came from three of our sales reps. And I said we have six. So that tells me two things. Number one, it tells me that our products are being accepted by dermatologists and plastic surgeons, it tells me that reps can have a good productivity level within their territories. I might also add that one of those three reps was a brand new rep. He actually moved to a geography he wasn't familiar with and he started in dermatology, which was an area he was not in. He actually wasn't even in medical area, and he alone accounted for more sales than total in the three other territories. So we've been watching those productivity rates, they've not improved, so we are in the process of making the changes, and that's why I say if we had been firing on all six cylinders, our dermatology sales should have been double what they were.

Larry, what was the derm number versus last year?

We were at 1.42 million versus 1.95 million. We were down about four or 500,000.

So roughly 1.5 million versus 2 million.

Yes.

And that was on the backs of three reps? So, right, if you had six reps all firing like that, you would have had a smashing quarter.

Exactly. That's what is encouraging, and the fact that a new rep can jump in and have impact if they are out there working.

Yes. Now, on the income statement side, Larry, the gross margins were -- saw a nice increase. Was that primarily because the mix was richer with more disposables?

Right, exactly. That was it exactly. The disposable mix was a higher percent, as well as we had better gross margin in dermatology area than we've had in the past.

OK, and then the only disappointment to me on the income statement side was the SG&A. The SG&A was considerably larger than I thought it was going to be. Of course, you did explain some of the reasons, and it seemed like that number was higher than either guidance you had given or what people were expecting, and I wonder if we should expect that kind of SG&A increase through the rest of the year or -- I would assume we should, given that a lot of it was probably hiring of some new people.

Yes, Larry, let me comment first. You are exactly right, in terms of the operating expenses being high, but I will tell you that it was only $100,000 over what we had budgeted for first quarter. So it's not so much out of line in terms of what we expected, and I think it's also fair to say that historically first quarter, while it's our lowest revenue quarter, it's usually our highest expense quarter. Isn't that fair, Larry?

Yes, it has been, certainly, and it's budgeted to be that way.

Yes. So you know there are some factors going forward that will have the rest of the year, and G&A in particular, one of those are legal expenses. Those are hard to estimate. Depending upon how far the Synergetics litigation might go, but we've budgeted that for the entire year. You might also recall that in the compensation agreement with Ted, that basically the company is paying for two CEOs now, whereas first quarter of last year we were only paying for one. And that will continue to have an impact the rest of the year. Our spending levels hopefully will be at a less level the remaining three quarters of the year than what they were the first quarter.

Is Ted's program and ongoing severance package or how does that work, Barry?

Yes, well, I think that Ted is Chairman of the Board and as such, has a salary associated with that, that the rest of the Board agreed with.

Yes, and does that continue indefinitely?

No, I think it was a three-year period.

Yes.

OK.

From starting about June 1 of last year.

OK, very good, thanks very much.

Thank you, Larry.

Just to clarify, though, I did go back and look at SG&A expenses, and typically they are not the highest of any of the quarters that we have. You know, it fluctuates a lot depending on some of these other expenses here, but usually third and fourth quarters are our most expensive quarters.

But I think we may see a little difference this year in the fact that, as Barry mentioned, we had some relocation expense, some headhunting fees, legal fees, that were above and beyond what we expected since last year. And also auditing fees were up as well, so ...

Thank you.

Thank you.

And your next question comes from the line of William Moore of BlueLine Partners. Please proceed.

Hi guys, how are you doing?

Hey, good, Will, how are you?

I'm doing OK. Hey, you probably know what my question is going to be involved in, it's one of those legs to your stool which talks about EPS growth.

Yes.

Congratulations on the increases on sales. And it's obviously that under control, but you know where I am always headed, do you make money on profits?

Yes.

So can you kind of shed some light on that, given that the last comment that both Larry's were talking about, in regards to expenses, one, we were thinking this might be the highest quarter, but maybe third or fourth quarter.

Well, I think a lot of -- Will, a lot of factors will come into play in terms of third and fourth quarter on the expense side. I think what we expect to see, as we've seen every other year, and probably even more so this year, with our added sales and marketing team, is that our revenues will increase more as we get into the year and even at a higher percentage level than what they did in prior year. And our expectations are that that will generate the kind of EPS that we expect to see.

OK, so when we talk about the double-digit growth stacked on your products, are we going to be able to try to maintain this level of expenses now? Are you going to cross a threshold so it will start to leverage the EPS?

Yes, I think you are exactly right. And in general the only other difference would be these items that may come in and out and ones that have a lot of variability the rest of the year.

I think as we've said Will, that in terms of our budget, Q1 was where we budgeted the most money. You know, we have the audit fees in there. You know, again, we had some of these headhunter fees and things like that and I think that will tend to offset higher commissions in future quarters, when people get increased sales, so I think at this point we are pretty much on track with the plan that we had, although we are focused on earnings as well. Historically it's been difficult in the first quarter for us to really make money. We are usually right around breakeven. I certainly would like to be stronger than that, but historically that seems where we've been.

OK. Now, I hate to put you on the spot, Barry, but you mentioned double-digit growth on revenue. Do you have any kind of growth rate on EPS?

As a percentage higher than bottom-line, yes.

Than top-line you mean?

Yes I'm sorry, yes, the bottom line would grow at a percentage higher than our top-line revenue growth, and the revenue growth we've said is double digit.

OK, thanks guys.

Thank you, Will.

And your next question comes from the line of Anthony Vendetti, from Maxim Group. Please proceed.

Thanks, good afternoon guys.

Hi Anthony.

Hi. Just a couple more quick questions on SG&A. FAS 123R, was any of that 3.9 million from FAS 123R? Or was that taken out after the line item there?

No, the 3.9 million included about $450,000 of 123R expense.

OK, so most of -- so basically it was 457,000 of FAS 123R, so everything but 7000 went into the SG&A line?

I'm sorry, it was 422 really in the SG&A line, but 33 went other places, so -- or 35, and a good part of that was in prior costs, so ...

OK. And then you had mentioned, Barry, that the dermatology sales reps were six at the end of the fourth quarter, there were six in the first quarter, but I guess there was a little bit of turnover there because one new rep you say accounted for more sales than three of the others, was that correct? 85% of sales were from three reps in total?

Exactly, Anthony. And the new rep was a rep who started during fourth quarter, so first quarter was his first full quarter.

OK, so it sounds like that although you intend to keep the number the same, it sounds like there could be some additional changes there?

There have already been some.

OK. And then on the ophthalmology side, you ended this quarter with nine to 10, is that right? Around nine or 10? Nine or 10 and a director of sales?

Sales reps, yes.

Yes, exactly. Sales reps plus the director of sales.

OK, and what was it at the end of fourth quarter?

It was probably seven or eight, with the director -- the director came onboard fourth quarter.

I see, I see.

Late in the fourth quarter.

And in combing through the release, I don't know, Larry, if you gave the exact revenue number for ophthalmology. I think you rounded to 7.6. Do you have a little bit greater figure than that or, you know, out to another decimal or so or no?

Lets see ...

That's a technicality, I mean ...

It's really close to that. Yes, we will be reporting -- filing our Qs tomorrow, so you will have it down to four places on that one.

Even better. All right, now, just quickly on the sales reps, where you are at this quarter, where you ended this quarter, is that a number that you are comfortable with? I know you said all your senior management in place. Do you expect to be adding, in addition to maybe replacing some of the underperforming reps, do you expect to be adding significantly to either the ophthalmology or dermatology reps?

No, the number 10 for ophthalmology, that's where we intend to be, and six for dermatology for the year.

OK. And then lastly, a little bit, Barry, I know you outlined what the acquisition profile would be for some of the companies that you are looking at. With about 21 million and change on your balance sheet, can you talk a little bit about the size of an acquisition you are looking to make or are you looking to make a number of small acquisitions to kind of get to your stated goals?

Yes Anthony, it could -- sorry I can't get more specific, but it could go either way. We are looking at some businesses that would bring immediately some revenues as high as 30 to 60 million immediately on an annual basis, and some of the other things we are looking at would be much smaller, so if we did one in that 30 to 60 million range then probably we'd do one of them, and if we did one and the small area we would probably do two or three of them.

I see, I see.

But we are at a stage where we are having some very meaningful discussions with companies. So you never can guess when these things can happen, but we have quite a bit going on.

OK, and would it be safe to say with 21 million in cash you'd have to either finance this with debt or equity or a combination thereof?

Yes exactly right, and I can tell you that we have had very good discussions about how that would be done in each one of these instances that we are looking at. So we have you know we are very confident that we can do any of these deals in which we are having discussions.

OK, and it sounds like based on I think number two in your profile, it would definitely be in the ophthalmology space, is where you are looking at?

Yes, that's where we are being proactive, Anthony, but I would say on the other hand that we've also had some inquiries that have come to us about dermatology products and we are looking at those, but we are just being -- we are being proactive on the ophthalmic side, in that it's 80% plus of our business and that's where most of our management experience comes from, but we wouldn't turn away from a dermatology opportunity if it made sense.

OK, OK. And you definitely got to -- you know, based on what you said in the fourth quarter, a higher percentage of recurring revenue. Like you said, probably a little bit ahead of schedule. Is there a reason why at this point that that didn't result in higher gross margins? I know you have some ramp up and expenses on the SG&A line, but in terms of gross margins, any reason why that didn't result in a little bit higher gross margin?

Well, it was a three-point improvement over first quarter of last year.

Three percentage points.

Yes, three percentage points.

With the 123R expense, and actually 3.4 percentage points without 123R.

Yes.

So you know, a good 3.5% improvement.

Yes. I think also one of the things, Anthony, to watch out for is, and we have to check ourselves here too, remember third and fourth quarter of last year we did have some impact from this one and two-time OEM business, which did improve our gross margins. So if you look at our gross margin versus fourth quarter it was very close, which is very encouraging because we didn't have any of that similar OEM business in first quarter.

I see, I see. So that obviously that OEM business boosted your fourth quarter gross margins, so that's not a good comparison.

Yes.

OK.

Yes, so comparing quarter to quarter, first quarter '05 versus '06 is a good comparison.

OK, great. All right, thanks guys.

Thank you Anthony.

And your next question comes from the line of Mike Bosman from Peninsula Capital. Please proceed.

Good afternoon, Barry and Larry.

Hi Mike.

I was wondering if you could just clarify a little bit further the change that you made in the dermatology, is that personnel, basically?

Yes it is.

OK, and then on the pricing of -- you know, you mentioned that the laser consoles are picking up and the disposables are increasing as a percentage of revenue. Are you doing anything different there from a pricing standpoint? Is there any bundling or discounting? Or is this just adoption?

Good question, Mike. We have not -- I think the number one reason is having more feet on the ground, having more sales reps out there and uncovering these opportunities that maybe we didn't get the exposure to in the past, but we are -- the VIP plan is a bundling type program. Now it's not a discounting program though, it's just a way that by signing the contract on disposable products you can get access to additional products like a laser console or additional warranty or whatever it might be.

OK, great. And then you attributed the shortfall in derms from the later date of the AAD. Were you at least happy with the turnout at the trade show? And were you generating a lot of leads that you were confident that you can convert over in later quarters this year?

Yes, good question, Mike. We were pleased by the traffic at the Academy of Dermatology Meeting. It was held here in San Francisco and I say that, even though we were in the back of the hall, we were right across from a rather large competitor in this space, and I think any day of the weekend that you were to look, you would have found that there was much more flow in our booth than some of those competitive booths, so we felt very good about it. What we don't feel good about it though is that in only three territories were we able to really take advantage of those leads during the first quarter.

Right, yes, I was actually at your booth, it was quite busy. And then lastly can you just comment about the -- you know, you may have mentioned this earlier. What were the legal expenses in this quarter? And have you disclosed the budgeted amount for the entire year?

We haven't disclosed what the exact legal expenses are. We have said that we felt that they would be between 100 and 200,000, you know, roughly 150,000 a quarter I think is what some of the estimates we talked about. And those just kind of wax and wane depending on when these activities start to pick up. You know, the Markman hearing for example in Q2 might be fairly -- you know, would have us incur some legal fees that perhaps we wouldn't incur in the third quarter, but you never know, we do some more mediation in the third quarter it might pick up to, so it's very hard to project. I think on average we felt like that could be 600,000 or so for the year, and I think we are pretty much online on that budget.

OK, great. And then last question if I may, the 6 to 8 new disposables that you are planning to offer later, are those going to be all complementary products? Are they going to be replacing any existing ones? Or can you maybe just give us an idea of what type of opportunities you have with those?

Yes, if you look at the laser probe business, there has been quite a bit of product innovation the last few years. Surgeons are looking at different designs, different sizes, different functions, and we've got a probe team that now is focused on really getting good feedback from surgeons in creating both new probes and also improving the cost of our current probes along with maybe adding to our line probes that we haven't had in the past, even though they may not be new to the market.

OK, thank you very much for taking the questions.

Right. Go ahead Mike, did you have another question.

No, I was just going to say thanks for taking my questions and great quarter.

Thank you, Mike, thank you.

I was just going to say that there might be some differences in materials and things like that that will help to change costs or the feel in the doctor's hands.

Right, thanks guys.

And you have a follow-up question from [Matt Hicks]. Please proceed.

Hey guys, good quarter.

Thanks.

Two quick questions. One, obviously congratulations on kind of reaching the goal for the disposables, but I'm wondering if you have kind of reset that bar and if you've publicly announced what that new bar would be for disposable as a percent. And then secondly, how do you anticipate that impacting gross margins on a go forward basis?

Yes, good questions. You know, I've tried to -- every time I talk about what our goal is for recurring revenue, I try to bump it up a little bit. We originally started talking about getting it to the 40% level and I immediately put a plus behind that, and we've said we'd like to get into the mid-40% level. You know, if you look at the fact that at least, according to market research, in the past we only enjoyed about half of the laser probe business when our laser is used, there is an opportunity to potentially double our laser probe business. So we want be happy until we get the market share up to that kind of level and if we do that, then we should be able to get, even on an increasing revenue number, we ought to be able to get to mid-40s or even higher.

Great, and then lastly, put you off speaker, sorry about that. The mix between the ophtho and the derm obviously a little bit lower this quarter, given kind of your comments on it being about half what you anticipate. Do you anticipate it being around this 18% level on a go forward basis or closer to if you doubled it, 27, 28%?

I don't think it will get to the 27, 28%, because our ophthalmic revenue will be growing also at a significant rate, but I do see it getting back into the 20 to 25% range, and that will depend upon how quickly our new reps get up and going, but again, I'm very encouraged by the new rep that we did hire and how quickly he has been able to catch on.

And your next question comes from the line of Anthony Petrone, from Maxim Group. Please proceed.

Thank you. Just a question on the acquisitions you mentioned that you have in the pipeline and possibly one large acquisition and several small ones. If you went the smaller acquisition route would you be able to complete two to three in say the next 12 months or does that extend the timetable as to when you will actually have these acquisitions added on to the company and integrated?

Good question, Anthony. I don't think it would change the timeline. The triggering of the first one is what will determine the timeline. We currently are looking at about 13 to 15 opportunities of which six I would say are at a meaningful level of discussion.

OK, thank you very much. All of my other questions have been answered, thanks.

Thank you Anthony.

And your next question comes from the line of [Brian Kowalchyk], from WestPark Capital. Please proceed.

Good afternoon guys, thanks for taking my questions.

Hi Brian.

Hi there. Just want to make sure, Larry, that I understood the breakdown that you gave in the recurring revenue segment. You said 42% of total revenue. But 40% of ophthalmology revenue was recurring?

No I think actually Larry's script had the wrong number on it. It is 42% of total revenue. That was our recurring number for first quarter. Whereas historically last year it was at 36% for the year and '04 was 33%.

OK, very good. In the past you've provided some further detail into that level of recurring revenue. Can you help me understand what the recurring base is within ophthalmology?

Well, I think the majority of that recurring revenue takes place in ophthalmology, I think as we've said.

Yes.

You know, we have derm service, which as we've said has been about 20% of our revenues, but I don't think it's even 20% of this recurring number.

No, no, no. So the vast majority of it, Brian, is against the ophthalmic sales numbers.

OK, very good. Help me understand where you think you are with regard to the functionality of the probes that are currently available for the new revamped and expanded sales force? Are you at the point in time where you think you are at the level of the competition or do you think you are kind of a step ahead of them right now?

Well, good question, Brian, and I do think that we had fallen behind competition. I think right now, and I don't want to give our team too much pleasure or any room to rest, I'd say we are getting close to competition and our objective is to be ahead of them. So I certainly would think by the Academy we should be in a position that we can say we are ahead of them. And we've got a team that actually this week there's a big focus on probe innovation here at the company; we've got several meetings going on regarding that.

Excellence. And since you've now got competing probes you are only getting about half the disposable sales that you think you can get when your console was used. Help me understand, you know, how you go through the sales process and commit to that, to make the switch from a competing product on a 150, $200 piece of equipment to use your piece?

Good question. First of all, it comes from having a probe line that is competitive, as you've suggested, but more importantly I think it's the focus that the sales force has on it, and in the past, not only through compensation, but through direction we were really more focused on the box than we were on the probe disposable side of our business. And now I think we are very balanced and equally focused on both sides. So we are now -- you know, we are looking at this disposable number virtually every day, whereas in the past we looked at the total number.

Well, very good, looks like there is a pretty large opportunity for you guys and I look forward to future calls with very good results.

Thank you, we do too, Brian.

Thank you.

I think we can also say that when a sales rep goes into an account, even if -- especially a hospital, if they are not able to convince them to buy a new laser, they also have the opportunity to talk to them about the probe business and I think, as Barry said, with more feet on the street, that that's helped give the increase that we've seen in disposables in recurring revenue.

Thanks guys.

Thanks.

And gentlemen, you have a follow-up question from the line of Mr. William Moore of BlueLine Partners. Please proceed.

My question has already been answered thank you.

That was an easy one.

Ladies and gentlemen, this concludes the Q&A session and I'd like to now turn it over to management for closing remarks.

Well we would like to thank everybody for attending this afternoon's conference call and apologize for the technical difficulties. We would also like to invite you to our annual meeting which will be held June 8 here at Iridex in Mountain View, and as some of you know, we are presenting at three conferences coming up in the month of June. We will be at the Pacific Growth Conference, which is between June 12 and 13th, and then flying to New York for the Needham Conference later that week on June 14-16, and then over to Jefferies later in the month, June 26 through June 28. If you would be interested in chatting with us at any of those meetings, we will certainly be in your neighborhood if that's where you are at. So with that, Barry and I would like to thank you very much again for attending and as always, please feel free to give us a call.

Thank you.

The replay for the Iridex 2006 financial results conference call will be available one hour after the call has ended. The replay will be available for seven days. the toll-free dial-in number is 888-286-8010 and the pass code is 12628609. Thanks for your participation in today's conference. This concludes the presentation. You may now disconnect, have a great day.