IRIDEX Corp (IRIX) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing and welcome to the IRIDEX second quarter conference call. At this time all participants are in a listen-only mode. Following today's presentation instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today Thursday, August 3, 2006. I would now like to turn our conference over to Jennifer [Bugleman] with [EDC Growth].

Thank you, Rose, and thank you all for joining us today for the IRIDEX second quarter financial results conference call. This is Jennifer Bugleman with 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 earning release, please contact Susan Bruce at 650-962-8848, extension 3052, to get a copy or you may also view the earnings release through the website www.iridex.com. This conference call is also being webcast on our website. The press release also has information about how to access the replay of this teleconference.

Before we begin, I would like to go over our Safe Harbor statement. Please note that this conference call contains forward-looking statements within the meeting of Section 27 A of the Securities Act of 1933 as amended, Section 21 E of Securities Act of 1934 as amended, related to the Company's growth prospects, sales, revenues, gross margin, operating efficiencies and profitability. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. These statements are subject risks and uncertainties and action results could differ materially from those projected in the forward-looking statements. Some of these factors that cause results to differ include the actual order and shipment rate of the Company's ophthalmology and dermatology product lines, the rate of introduction and market acceptance of the Company's products, the final consequences of states not reimbursing for all Company's procedures, the impact of any continuing weakness and uncertainties related to general economic conditions or weakness in overall demand of 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 costs, improve its operating efficiencies, and the timing of the release of and action results of studies related to any 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 independent distributors, the risks associated with bringing new products to market, the results of any clinical trials, and competition in the market. Please see a detailed discussion of these risks contained in the quarterly reports on Form 10-Q and annual reports on 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 would like to turn the call over to Barry Caldwell.

Thank you, JB, for the introduction and thanks to you on the line for joining us on our quarterly call updating the process here at IRIDEX. During the second quarter though we continue to make progress on many of the key elements of our strategy, we did not meet our quarterly goal for revenue. Despite this, we have experienced a very strong start to our third quarter, and we do not see the second quarter results preventing us from achieving our overall guidance for the full-year which is for double-digit revenue growth.

Let me discuss first the two segments that negatively impacted our results during the quarter. Domestic dermatology revenues, they continue to disappoint and were below our expectations for the quarter. We have not yet achieved the turnaround for this second segment, despite the fact that we have made quite a bit of progress. Some of the factors include, we had several orders at the quarter which just didn't get closed as we thought they would. As we said during the first quarter call, we were forced to make some personnel changes in the sales team based upon a lack of productivity. We weren't able to make the replacements early enough during the quarter to have an impact for us during second quarter.

Looking ahead, there are a few strong reasons that lead me to believe that we can get this business back on track. First, we filled all the territories, with the exception of one, and we're currently interviewing actively in that territory. Secondly I do feel very good about the new additions that we have made on our team, and I believe that they will be productive during the third quarter.

In addition we have undertaken several other initiatives to get our dermatology business back on an increase track. We have a focused derm team, as we call it, which meets every Monday morning at 8.15 to discuss plans of action, strategies and progress we are making in this segment. I am a member of that team, as is the vice president of sales, general manager of dermatology, vice president of marketing, our market manager for dermatology, and the entire domestic sales team.

We also recently sponsored a full day focused group with dermatology specialists in San Francisco. We believe this has allowed us to pinpoint our marketing strategies to areas that can lead to increased sales. Last week we attended the midsummer American Academy of Dermatology meeting in San Diego, where the interest level for our products was high, and we received good qualified leads.

From these events I think we have learned that our new VariLite laser which now, in addition to 532 wavelength, includes the new 940 wavelength, it has a clear position in the portfolio of products for dermatologist -- dermatology specialist. Our vice president of sales now is even more focused on the dermatology side of our business as we go forward.

I am confident that we will have increased sales during the second half of the year, compared with both the first half of this year as well as the second half of last year.

Secondly, on our international of ophthalmology side, our equipment business was slightly down during the quarter. Some of the reasons were that there were several orders for the equipment which were delayed at quarter end because of letters of credit. There were also some shipping issues to a few countries which required additional paperwork which we weren't able to complete prior to the end of the quarter.

Heading into the third quarter, however, we have had a very strong start in international ophthalmologist sales. Part the region for that is these delayed orders for the second quarter, all of those have already shipped during the third quarter. I'm confident that the third quarter revenue for international ophthalmology will have us back on track.

Now we are making good progress in many other areas of our business. This progress will support the overall long-term health and success here at IRIDEX. So to some of those highlights, first of all, our overall ophthalmology business is quite strong and disposable laser probes are exceeding our expectations. In domestic direct ophthalmology, revenues increased by 12% during the quarter. For the third consecutive quarter we have established a new Company record in disposable sales.

During the second quarter domestic direct disposable revenues increased by 38%, and this represented the seventh consecutive record quarter in terms of domestic disposable sales. Our international disposable sales during the second quarter increased by 15%. Overall, our disposable sales increased by 24% during the quarter. Since the market growth in this segment is estimated 8% to 10%, it tells us we're certainly gaining market share.

Of all our total disposable share -- sales during the quarter and again that was with a 24% increase, 20% of the total sales in probes were from new probes that we have introduced during the past 18 months.

As many of you know, recurring revenue is a measure that we look at and it represents the total of our disposable sales and our technical service revenues. You may recall, we started the year with a target of gaining recurring revenues or getting recurring revenues to a level of 40% plus, and that is measured against our total revenue base. We since increased that model to 45% plus. During the second quarter our recurring revenue reached the 45% of total revenue level.

Larry will speak to some of the other areas in which we have made progress and will help drive our results for several quarters to come. These include our improving gross margins, our record cash position and our decreasing DSO levels. He will also give you some perspective on expenses that we regard as unusual and how you should analyze them on a go-forward basis. After Larry adds his comments, I will return to present some additional -- operational comments before we proceed to questions. Larry?

Well, thank you, Barry and good afternoon everyone. I hope everybody back East isn't dying from the heat. Revenues for the second quarter July 1, 2006 were $8.7 million, compared with $9.4 million reported in the second quarter 2005. As Barry mentioned, total revenues for the quarter were below our expectations primarily based on lower-than-expected sales in the domestic dermatology business and to a lesser extent delays in finalizing sales transactions during the second quarter in our international ophthalmic equipment segment. In fact, ophthalmology sales represented 88% of our total business during Q2 2006, compared to 82% in Q2 2005.

We continue to achieve steady growth in our U.S. direct ophthalmic business which was up 12%, Q2 '06, compared to Q2 '05. In addition, direct U.S. direct ophthalmic business sales of disposable probes grew by 38% Q2 '06, over Q2 '05. International ophthalmic sales were $3.1 million in the second quarter of 2006, representing a $200,000 increase from the $3.4 million posted in the year ago period. International sales of disposable probes increased by 15% Q2 '06, over Q2 '05.

Since international sales are dominated in U.S. dollars -- or denominated in U.S. dollars, foreign currency fluctuations had no material impact on sales. Recurring revenue which includes both disposable and service revenues ranged $3.1 million, or 45% of total Q2 '06 revenue, which is up significantly compared to the $3.3 million, or 36% of total Q2 '05 revenues.

Dermatology sales declined to $1.1 million in the second quarter of '06, compared to $1.7 million in the second quarter '05 as nearly half of our dermatological sales positions were unfilled for most of the second quarter. This decline primarily impacted domestic sales.

For the second quarter gross margin expanded by 4.6 percentage points to 53% in Q2 of '06, from a 48.4% reported in the year ago period. This equates to almost a 10% improvement in gross margins quarter-over-quarter. In fact, this is the seventh straight quarter over quarter gross margins hasn't shown improvement.

Our sales, general and administrative expenses increased to $3.7 million in Q2 '06, from $3.1 million in Q2 '05. The increase in sales, general and administrative expenses was due primarily to a $400,000 charge for 123 (R) expenses. Increase in payroll and legal expenses accounted for the balance of the increase.

Net income for the quarter was $48,000, or $0.01 earnings per share including the effect of FAS 123 (R) expensing of stock options, compared with net income of $430,000 in the year ago period, or $0.05 earnings per share which excluded the effect of FAS 123 (R).

In Q2 '06 the Company reported a net tax benefit of $270,000. Also during Q2 '06, the Company reported a pretax charge related to FAS 123 (R) of $478,000 and, in addition, booked over $700,000 in legal, relocation, and Innovatech patent acquisition expenses that negatively impacted net income. When you add the 123 (R) charges together with the atypical or unusual spending, this equates to about $0.09 in after-tax earnings per share.

Turning to the year-to-date results, for the six-month period ended June 30, 2006 sales were $17.7 million, a slight increase from the $17.5 million reported for the same period of '05. The core of our business, the ophthalmology sales, continued to grow very nicely during the first half of 2006. For the first six months of 2006, total ophthalmic sales were $15.2 million, up 9%, compared with $13.9 million reported for the comparable period of 2005.

Year-to-date domestic ophthalmic sales of $8.6 million increased by 12% from the $7.7 million reported in year-to-date 2005. U.S. direct ophthalmic business, which excludes OEM, was up more than 18% during the first six months of 2006 compared to 2005, with U.S. direct ophthalmic sales of disposable probes growing by 32% during the first six months of 2006 compared to 2005.

Year-to-date international ophthalmic sales of $6.6 million increased by 7% from the $6.1 million reported year-to-date '05. International sales of disposable probes increased by 20% during the first six months of '06, compared to the same period in '05. During the first six months of 2006, we grew our disposable probes sales by 27% and we believe that at a minimum we can maintain this growth trajectory throughout 2006. New disposable probes introduced during the past 18 months represented 19% of the total probes sales year-to-date.

Recurring revenue which includes both disposable and service revenues reached $77.7 million or 44% of the year-to-date 2006 revenues, which is up 20% compared to the $6.4 million or 37% of total year-to-date 2005 revenues.

Domestic dermatology shares yield to date of $1.9 million declined by $1 million from the $2.9 million reported during the same period in 2005. As Barry mentioned, for the first six months of 2006 we were effectively operating at only half strength in our domestic dermatology sales force. As previously stated, one of the key goals going forward is to move the gross margin percentages into the mid 50 range, as it has been in the mid 40 range during the past few years.

Increased sales of disposable probes helped fuel higher gross margins as gross margins for the first six months of 50.6% grew by 3.7 percentage points, compared to the 46.9% margin reported in the year ago period. Including the effect of 123 (R), net loss for the first six months of 2006 was $215,000 or loss of $0.03 per share. This compares to a profit of $410,000 or $0.05 per basic common share for the first half of '05, which of course did not include any cost associated with FAS 123 (R).

When making this comparison, please keep in mind for the first six months of 2006, the Company recorded a pretax charge related to FAS 123 (R) of $935,000. In addition, we booked over $1.1 million in legal, relocation and Innovatech patent acquisition expenses that we believe could be atypical expenses that negatively impacted net income. When you add these two categories of expenses together, they equate to about $0.15 in after-tax earnings per share.

This should illustrate for you in the progress made in key parts of our overall business. If the R&D tax credit gets reenacted, we believe that the tax rate for the year for the Company 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 very strong. Cash and cash equivalents and available for sale security as of July 1, 2006 were $22.3 million, up from a $21.4 million at December 31, 2005 and up $4.6 million from the $18.7 million reported a year ago. Inventories were $8.8 million, compared with $9 million at the end of the second quarter '05 and $8.6 million on December 31 '05.

Inventory turns were 1.9 in the second quarter of '06, compared to 2.1 for the second quarter of '05 and 2.2 for the full-year per 2005. Our target operating model calls for inventory turns to be at 2.5. Accounts receivable was $6.3 million as of July 1, '06, compared with $6 million on December 31, '05.

Quarterly days sales outstanding improved to 65 days in the second quarter of '06, compared with 68 days for the second quarter of '05 and 69 days for the full 2005 fiscal year. Our target operating model calls for DSO's in the low 60 days.

Looking forward to the full year 2006, we expect to achieve double-digit revenue growth, improved gross margins and accelerated earnings, excluding the impact of 123 (R). FAS 123 (R) expenses will be approximately $400,000 to $500,000 per quarter for the rest of 2006, or $0.03 to $0.04 in after-tax earnings per share. We expect that legal expenses for the second half of this year will be below what we spent on legal during the first half of this year. And with that, I would like to turn it back over to Barry.

Thank you, Larry. As you may recall, we have implemented a three-legged strategy in terms of our growth potential going forward. We have been discussing the first leg of that strategy, which is our core business. The second leg of our growth strategy is new product innovation. This includes not merely extensions of our current product offerings but expansion into areas which we do not currently compete. Our innovation teams are in place and are very focused on exceeding our new product innovation targets. As a matter-of-fact, I just came back from the new lab area which we built, which we said we physically have put both of our engineering teams together. And I found three different groupings of engineers all working together on our new product innovation products and that was exciting to see.

Because we are on target, we introduced two new laser consoles in November at the American Academy Ophthalmology. We also remain on target to introduce a total of six to eight new disposable probes during the year. We have seen the immediate and positive impact that new probes have on our current revenue base. During the quarter we did announce our new OtoProbe to be used with the OR laser for ENT surgery. We also announced that we had acquired the patent application on the intuitive probe which we currently market. This will help reduce our cost in the future and allow us to explore extensions to this product line internally.

The third leg of our growth strategy relates to the addition of new technologies through acquisition or merger activities. We continue to make progress on evaluation of alternatives for this strategy. We also continue to be pleased by just the sheer number of opportunities available for us to explore. Though we do not have anything to announce today we are making progress and have narrowed our options considerably. We remain focused on not just making a decision in this area but making a quality decision which will help guide future growth for the Company.

Finally, I would like to add a few comments regarding the recent ruling from the Markman Hearing in our litigation with Synergetics, Inc. The judge did rule in our favor on 13 of the 14 claims, terms in dispute on our 492 patent. The 14th claim ruling was actually one which the judge split the difference between the two sides. The Markman Hearing is only one step in this process. This ruling does set the interpretation of our patent for the jury in deciding if there is infringement. It does not guarantee we will win, but it certainly puts us in a very positive position.

The next stage of litigation involves the expert witness testimony on the economics of the case and, specifically, on the measure of damages. This testimony is due to the Court by August 25. You may recall that we are seeking loss profits for the six plus years that Synergetics has been marketing the products in question. The trial date has been set by Judge Perry for April of 2007.

During the last few days Synergetics filed litigation asking the Court for a declaratory judgment that their new different connector probe which they suddenly introduced the next business day after the Markman ruling does not infringe our 492 patent. This new connector design could have been added to the current litigation anyway, but this move could actually delay a ruling on this new probe.

This filing has been assigned to the same court and the same judge. We anticipate that the ruling from the just completed Markman Hearing will be the same that will be used as a measure for infringement on this litigation. Synergetics did not announce a new different connector until the Monday after the Friday Markman Hearing. Though one might argue that the new different connector does not infringe as much as their now obsolete connector, we still believe the Court will determine it infringes our 492 patent. We remain committed to defending our patent estate as it is a key component of our growth strategy. To date, we are pleased with results of this pending litigation. With those comments, we'll open line for questions.

(OPERATOR INSTRUCTIONS). Larry Haimovitch, HMTC.

On the international, which is obviously one of the key points where you did not deliver, how much was the shortfall -- what was the comparison this year -- Larry, I think you said and I may have missed on the call. Would you just mind repeating that?

Sure. For the quarter, it was a couple hundred thousand dollars that we were under -- versus prior.

So when I look at the 8.7 versus the 9.4, I see roughly $600,000 is made up in the derm business, short fall in the derm business; another $200,000 in the international ophthalmic, so that gets me to flat basically if I assume that those met last year, that gets me to flat. I'm a little confused because there were certainly several areas in the business which were very strong. What am I missing?

Well, I think you are exactly right. As we said, the domestic ophthalmology business was up.

Yes, it grew 12%, right?

Right, exactly. Our service revenue was down somewhat year-over-year.

Why was service down?

It's funny, but actually we are seeing more reliability from our products out in the market and we're actually seeing less in-house out of warranty service.

You have got to stop that.

Well, overall I mean those are the objectives we're wanting to meet and we are tracking that in terms of our reliability so long term, we think that will help us.

And how much was service down versus the year before? What was the comparison on service?

Service was down about 30% year-over-year.

So the shortfall then comes in international, derm and service?

Yes.

Basic part of the business domestic ophthalmology actually was quite strong.

Yes.

Now in the international market you explain that you had some timing orders and obviously those things happen. That's one of the things about capital equipment obviously you get things shifting from quarter to quarter. Do you think you lost any market share?

No, we don't. And I even checked this morning, just to make sure, every order that didn't end up shipping at the end of second quarter has already shipped this quarter.

Barry or Larry, can give us some flavor of how big these orders were? Are we talking several hundred thousand dollars?

Yes, we're talking several hundred thousand.

Like 500, that kind of number?

Maybe a little less than that. Four to five.

-- a big difference than in the quarter.

Yes.

So you would have picked up another $400,000 if those orders had come in, which gets you to 9.1. Still have the derm shortfall; you still have the service shortfall.

Right. Now, the orders were in. We just couldn't get them processed because of letters of credit that weren't finalized and some shipping licenses to a couple of countries.

Barry, it was my understanding that we were going to do better this quarter in derm. Obviously, I know you and I know how terribly disappointed you must be and all of you must be. Did something happen later in the quarter that things that kind of fell out of bed because the impression I had, just an impression -- no one told me, but the impression I had, things were improving in the second quarter.

Well, I think you are right. There is certainly a tone within the dermatology group that things are improving, but when you -- and dermatology is basically all capital equipment and unfortunately as many ways as I have tried in my career, products like this always come at the end of the quarter and until -- virtually until a day before the quarter, we didn't know we were going to have this kind of shortfall.

I will ask one more question and then let jump back in queue, and let others. On the legal expenses, how much specifically are you spending on the Synergetics situation?

We actually haven't said that. We have kind of averaged -- it is going to be $150,000 to $200,000 a quarter and I think that is a range it has been in.

So it is running you incrementally $700,000 - $800,000 a year?

Yes.

I am sure you will be delighted when that is finished.

Yes.

Okay. I'll jump back in queue. Thanks.

Anthony Vendetti, Maxim Group.

I'm sorry if I missed this. Did you give the actual breakout of total ophthalmology revs and total aesthetic revenues?

I don't believe I have, but let's see.

I think you gave the total derm while you're looking for that.

I gave a total term.

I think it was 1.1.

1.1 and ophthalmology was 7.6.

And you said Synergetics was $150,000 to $200,000 K in legal. The other $700,000 in expenses -- I mean I guess the other would be about $500,000 in expenses that you are categorizing as -- are all those considered unusual because you're going to have some ongoing legal expenses, right?

Well, you are right, you will have some ongoing. But those are the ones we consider unusual. We shouldn't have typically relocation expenses like we had and we did decide to expense the acquisition of the patent application during the quarter.

Okay. So that's a onetime.

Right.

How much was that?

We didn't say how much it was --

Prefer not to.

And for competitive reasons, we prefer not to, as does the company we acquired it from.

Okay. But what about relocation? Are you able to talk about that?

Well, we did have some additional some -- some of the hiring of the vice presidents that we had during the year came to fruition in terms of spending this quarter.

For the relocation.

For their relocation.

Vice president of marketing and vice president of product innovation.

I see, I see, I see.

Those were hires that were made like last year and then early this year.

Marketing and product -- I recall that, but that -- that would be -- I mean that is part of running a company, right? I mean you -- that is just part of your G&A because actually your G&A wasn't higher than I was expecting. It's just -- I mean, right? Other than the -- other than the patent acquisition, it seems like that would be.

I would say, Anthony, I wouldn't expect going forward that during a quarter we would be relocating two vice president level executives.

I see what you're saying.

We have got our team together now.

And sometimes people fall out and you do have to replace them. I understand what you're saying, but you wouldn't expect you would have to have two of them hit you in one quarter.

I see what you're saying. And what specifically because, obviously, I follow all of these aesthetic laser companies, and it's a very competitive space. What specifically are you doing to kind of turn that business around? Is it just hiring sales? Is it specifically product innovation in the derm business or is it a product innovation is focused mostly on ophthalmology?

Yes. Good question, Anthony. It is first initially in the sales area and in the marketing area. That is why we brought in eight different dermatology specialists into San Francisco for a full day back on July 15, where we just -- we asked them a lot of questions, their inputs so we could develop better our marketing strategies in order to meet the targeted market.

I think one of the things we have clearly seen that this new 940 wavelength, which is in the VariLite, as you know, combined with the 532 at a higher power, but the 940, that is really the only 940 out there in the space.

And I had dinner the other evening with an owner of a new VariLite, and he is getting results from the 940 that he can't get from other wavelength. So we've got to find the right way to communicate that. Part of that is through having the feet on the field through the sales force and as I said the reps we have hired, I am very pleased with them and getting the right of marketing message.

Yes, because you specifically I think spoke about the reps that you hired last quarter where they were at, some that you had replaced and some that were on board and already contributing. Can you -- I mean, did that business just for whatever reason also have some slippage or was it just -- it was just a tough quarter in general?

No, no, we really didn't get those territories filled until later in the quarter. And we were trying to cover them here from home office and we just weren't able to close as much as we thought we would from a distance.

Okay. So based on kind of this meeting and now that they are under kind of -- under the Company's wing, so to speak, for a full quarter, you are expecting pickup from the sales piece.

Yes and I would also add, Anthony, that our vice president of sales who has had responsibility for both ophthalmology and dermatology and you may recall a couple of quarters, we hired a director of sales in ophthalmology and we've got a lot of confidence in him. He is coming up strong so we're basically having our vice president of marketing focus at least -- I'm sorry, vice president of sales focus 90% of his time on dermatology now as we work to get this back on track.

Okay. And what about in terms of anything on the product innovation side on the derm?

Sorry, sorry about that. No, our product innovation right now in terms of what we're doing internally is dedicated on the ophthalmic side.

Okay. And you mentioned that -- is it 6 to eight probes that you are still targeting?

Yes.

By the end of the year, two platforms at the AAO, and anything else that you can talk about?

That will be our main focus at the Academy, and we certainly believe we will have a strong meeting there based upon what we have in process right now.

Okay. What about -- and last question is in terms of new therapeutic categories, is there anything on the horizon that you are looking at or excited about in the ophthalmology space?

You mean in terms of current applications of what the products we have out there?

Yes.

We are looking at a couple of new therapies. As you know, from my experience on the TTT, I like to box those into the research area and we are doing some work there, but I prefer not to talk about that until we can see some light at the end of the tunnel.

Ned [Sheets], [Afineon] Capital.

A couple of follow up questions here to some previous questions. I just to understand you mentioned that the derm slots were filled late in the quarter. What is the time frame for those guys to get up to speed and do you expect kind of a spill over effect into Q3 here? Do you think you can solve it in Q3?

It's a good question, Ned. The startup time particularly with a caliber of reps we have been able to hire, the startup time is not long at all. And we have revived -- revisited and revived our training process so that we can do these quicker with a turnaround and part -- we do have two very good reps out there who are helping us in the training process so that is also very helpful. So 30 days or less, these reps should be being productive for us and we're trying to do some things in-house to help their startup in terms of getting leads on their plate as soon as they are on the street.

And a second question in terms of the international issues, the shipping and paperwork issues, have all of those been resolved and are you kind of moving forward in Q3 along previous guidance?

Yes, Ned, exactly -- all of those have not only been resolved, all of those orders that lingered at the second quarter have already shipped.

Great. And two last questions. One, are you changing guidance for '06?

No, we are not changing guidance at all. Certainly, the quarter makes it more of a challenge for us, but if we just make our planned numbers that we have here, we will meet our guidance.

And lastly what percent of revenues does this service component represent at least in this quarter compared to last quarter?

What we have done in the past, Ned, is we have lumped service and disposables together in that recurring revenue number and recurring revenue -- of course, the problem is it gets disguised because our disposables are growing so much and our recurring revenue for second quarter was 45%, compared to 41% or 42% during the -- during the first quarter, first quarter of '06 was 41% or 42%.

In fact, I misspoke when I was talking here. The recurring revenue for year-to-date reached $7.7 million, or 44% of the 2006 revenues, which was up to 20% compared to the $6.4 million or 37% of the year-to-date revenues in '05.

It is not a significant enough number in service that we have reported it in the past.

Larry Haimovitch

A question on the new products. I know you've got -- you have announced previously some new products coming in November at the Academy of Ophthalmology. Barry, how do you view those? I mean, are these significant additions to the product line or line extensions. I mean should we view these as very significant to IRIDEX going into '07 and '08.

I believe one of these consoles should be or will be considered very significant. This will be a console that has not been introduced in the ophthalmic community before.

And then going back to the service business, Larry, just to clarify, you said the business was down. How big is this service business?

That's what Barry was skirting around a few minutes ago is that we really haven't given out that amount, but it's --

What we have, Larry, is we have lumped it together with disposables in the past in terms of reporting recurring revenue because the volume, even though it has been a nice part of our business and been growing nicely, it hasn't been high enough that it is a reportable segment.

Shouldn't service revenue also reflect the expanding base of capital equipment, that is when you sell equipment, you typically get a three-year or five-year warranty? Or do you provide that warranty free or cost free because you are so confident of how well it will perform?

We traditionally have given our products with a three-year warranty and we accrue for what we expect the warranty expense to be over that three-year period. And starting at the beginning of this year, we moved to a one year warranty.

One year warranty for free, Larry.

Right. Basically for free. And what we have seen though is that the average cost per repair over that entire three-year period or one or two or three-year period that these things are under warranty has come down and we are seeing less of them.

A good example of that and this goes into good design work in implementing reliability into your design upfront. Our IQ 810 product which has been on the market for a year and a half, we have yet to have one of those returned for any warranty issues.

So you've gone from a three-year warranty to a one year warranty this year.

Yes.

It seems that all the products on this year's sales after year then start potentially to generate some service revenue for or warranty revenue for you.

That's correct. It wouldn't be fair to say all because there are some contracts that have been out there in place with different groups that we have had to honor that three-year commitment for a little while.

So we shouldn't be seeing really any good news on the service revenue side until January of '07, the first quarter of '07.

You look for the second half of year then to see continued weakness in the service business?

It's a good question. We're trying to understand that better and some analysis is certainly going on there. That is why we have received the information about the reliability good news -- good news, bad news kind of thing, but we are looking at that closely to make sure that we are making or getting as much advantage out of that segment of our business as we can.

Sometimes when people send their laser to us when it is out of warranty for service for repair, that is also a sales opportunity for us. So where we might not get the service revenue, we sometimes get a new laser revenue.

One other question and then I will jump back in the queue, if there any other questions, and that is, Barry, when you look at the quarter what is the thing that is most disappointing to you about the quarter and, conversely, and certainly answer the second part first, what made you the most pleased about the quarter?

No, I'll answer the first part first. And you have already said it. You can see my blood pressure rising. This is dermatology business. I thought we would do better than that second quarter and when you come down to the last two days of the quarter and it doesn't end up where you thought it would, that's very disappointing, so clearly in my mind it's there. It is not in ophthalmology because we've got a lot of good stuff going on there. The thing that is probably the most pleasing to me is our gross margins. Getting that to 53% and recognizing that we now have had seven consecutive quarters that we have improved our gross margin is allowing our P&L to look a lot better and what we get the revenues in place that should be there, then we were really be able to benefit from it.

Actually, it's not seven consecutive quarters but if we look at the quarter-over-quarter, year-over-year comparison, I think is what Barry was talking about.

Yes, said either way, it's very good.

Obviously the gross margins allow you more flexibility on the expense line too.

Right.

Some of it is obviously mix because as you say, the derm business is capital equipment probably lower margin but still --

You're right.

But still a very nice performance and it's good to se.

Thank you.

I'll jump back in queue.

(OPERATOR INSTRUCTIONS). Management, there are no further questions at this time. Do you have any concluding comments?

We would just like to thank everybody for taking time out this afternoon to listen to the conference call and we look forward to talking with you again for the Q3 conference call.

Thank you. Have a good day.

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