IRIDEX Corp (IRIX) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the IRIDEX third-quarter conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Tuesday, December 26 of 2006.

I would now like to turn the conference over to Doug Sherk of EVC Group. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. Thank you for joining us today for the IRIDEX third-quarter financial results conference call. With me today is Barry Caldwell, IRIDEX's President and Chief Executive Officer, and Larry Tannenbaum, the Company's Chief Financial Officer. If you have not received a copy of today's earnings release which was issued pre-market this morning, please contact Susan Bruce at the Company at 650-962-8848, extension 3052. You can also access the release at the website, www.iridex.com.

This conference call is also being webcast on the IRIDEX website, and the press release has information about how to access the replay of the teleconference.

Before we begin, I would like to note that this conference call will contain 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 recent results of studies relating to products and development in the business of users of the products. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, and 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 result 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 AMD 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 cost and improve its operating efficiencies and the timing of the release and actual results of studies related to its products. Risks and uncertainties to which the Company is subject to may include but 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.

In addition, during today's discussion, management will comment on both actual results and certain non-GAAP results. The Company will be using these non-GAAP measures because management believes it provides a meaningful sense of the underlying business and operational results. Reconciliation between GAAP results and these non-GAAP results are provided in today's earnings release. Please see a detailed discussion of these risks, as well as the non-GAAP reconciliations in the Form 10-Q, as well as the Form 10-K for the fiscal year that ended December 31, 2005. Forward-looking statements contained in this announcement are made as of today and will not be updated, and the Company may not undertake to update them in the future.

Now with that out of the way, I would like to turn the call over to Barry Caldwell, President and Chief Executive Officer of IRIDEX.

Thank you, Doug, for the introduction, and thanks to all of you on the line for joining us for our quarterly call updating our progress here at IRIDEX.

Unfortunately it has been too long since our last earnings conference call. As most of you know, that delay was caused by our investigation into revenue recognition issues. This investigation started over six months ago and will end up costing us over $500,000. You may recall that this started with an allegation by an ex-employee concerning an order taken during the fourth quarter of 2004. Though the customers order on file in our office was clean, we took that allegation seriously and began an investigation.

I would like to review briefly what we found, why we think it happened and what we're doing about it to prevent it from happening again.

First, what we found. This investigation covered a period of 12 quarters from the third quarter 2003 up until the current third quarter 2006. There were over 2400 orders reviewed at least three times during the investigation. Over 10,000 pages of documents and 13 GB of electronic information were also reviewed. There was no evidence that revenue was recognized which should not have been recognized but rather whether revenue should have been properly recognized. There was no evidence of intentional misrepresentation of actual revenues.

The errors of revenue recognition which were found fell into basically four different buckets, and I would like to explain those to you. First was a bucket of transactions where an error occurred during the billing process. Secondly would have been orders with an incorrect accounting for delivery and receipt by the customer. For example, FOB destination on the paperwork versus FOB doc on our purchase agreement. The third bucket would have been orders which had a verbal or written nonstandard modification which was not properly identified. The last bucket was transactions which provided for the delivery of multiple elements which were not properly identified.

Why did these errors happen? There was clearly a lack of companywide understanding of changes which have occurred to the revenue recognition policies over the years. There were some administrative and process breakdowns. Much can be attributed to basically an old school attitude that as long as the revenue was good -- I'm sorry -- that all the revenue was good and any issues would be cured. Since our return rate historically has been less than 1%, most of those issues were hidden.

What are we doing about this? We are going through a process overall in our transaction procedures. We are evaluating the responsibility for revenue oversight and making changes. We are enhancing our audit procedures to provide additional review. We are spending considerable time and education on these issues to all individuals involved in the revenue recognition process. This process has been very time-consuming, but we have learned a lot. We have made and will continue to make positive changes in our processes, policies and practices in an effort to prevent any reoccurrence in the future.

With this, I will pass to Larry for some of the specifics about the quarter and year-to-date. After which I will return to add some color to those results and strategies going forward before we proceed to questions. Larry?

Thanks, Barry, and good afternoon, everyone.

Revenues for the third quarter ended September 30, 2006 were $9.2 million, a 2% increase from the $9.1 million reported for the third quarter of 2005. As you may recall, during Q3 2005 we recognized an atypical large OEM sale for a Phase I clinical trial. But when excluding that OEM sale, we experienced double-digit growth for the quarter.

Ophthalmology revenues were $8 million for the third quarter of '06, an increase of 1% compared with $7.9 million for the third quarter of 2005. Global direct ophthalmic sales were led by the US organization, which accounted for a 20% -- 26% increase in direct ophthalmology revenues for the quarter. Q3 2006 international direct ophthalmic sales were basically unchanged from Q3 2005.

This continues to be a strong year and quarter for our disposables. Total disposable growth grew 21% during the quarter. Q3 2005 US disposable growth increased by 21% over the same quarter a year ago, while international disposables grew by 20%. Derm revenues of $1.3 million for the third quarter of 2006 grew 6% from the $1.2 million reported for the corresponding quarter in 2005. Domestic revenues of $5.7 million decreased 1.5% over the $5.8 million reported in the third quarter of 2005.

It should be noted that the OEM revenues are reported as part of domestic ophthalmology. Based on the increase in international derm business, international revenues grew to $3.5 million, a 7% increase compared to $3.3 million for the third quarter 2005. As a reminder, since international sales are dominated in US dollars, foreign currency fluctuations had no material impact on sales growth. GAAP gross margins were 52.8% for the quarter compared to 53.7% in Q3 2005.

As reported earlier, gross margins in Q3 '05 were fueled primarily by unusually high gross margin on that OEM business we have already discussed. Operating expenses in the third quarter of 2006 were $6.4 million, a significant increase from the $4.2 million reported during the third quarter of '05. GAAP operating expenses were negatively impacted by $700,000 in litigation spending, $400,000 in costs associated with the revenue recognition audit, $400,000 for stock option compensation and $300,000 in due diligence expenses for a potential opportunity in ophthalmology. Excluding these expenses, total operating expenses would have been $1.8 million lower.

Primarily based on higher operating expenses, net loss for Q3 were $1.1 million, or $0.15 per share, a significant decrease from the third quarter of '05. For year-to-date numbers, revenues for the first nine months ended October 30, 2006 was $26.9 million, a 1% improvement compared with the $26.6 million reported during the same period of '05. Again, excluding that third quarter 2005 OEM sales, total revenues increased by 5% during the first nine months of 2006. Year-to-date ophthalmic revenues were $23.2 million, an increase of 6% compared with the $21.8 million for the first three quarters of 2005.

It should be noted that this comparison was also impacted by the strong OEM sale recorded in the third quarter of '05. And when excluding that OEM sale, global direct ophthalmic revenues again showed year-to-date over year-to-date growth -- double-digit growth. Year-to-date increases in global direct ophthalmology sales were led by the US organization, which accounted for a 21% increase year-over-year. Year-to-date international ophthalmic increased 4% for the first nine months of 2005.

Disposable sales grew 25% during the first nine months of 2006 compared with the comparable periods of 2005 with domestic revenues growing by 29% and international increasing by 20% year-to-date over year-to-date. Based on headcount, turnover and lower derm sales productivity, year-to-date 2006 derm revenues of $3.7 million were down $1.1 million from the $4.8 million reported for the corresponding quarter in '05. Year-to-date domestic revenues of 16.1 decreased 1.9% over the 6.4 reported year-to-date '05. Again, it is worthwhile to note that OEM revenues are reported as part of domestic ophthalmology.

Based on the increases in both the international derm and ophthalmic business segment, international revenues grew to $9.7 million, a 5% increase compared to $9.3 million reported for the first quarter of '05. Year-to-date 2006 GAAP gross margins were 51.3% compared to 49.2% reported in year-to-date 2005. That is an improvement of 2.1 percentage points. Operating expenses in year-to-date '06 were $16.6 million, a significant increase from the $12 million reported during the first three quarters of '05.

Year-to-date GAAP operating expenses were negatively impacted by $1.4 million in stock-based compensation expense, $1.3 million in litigation expense, $400,000 for audit expense and $300,000 for our due diligence efforts in ophthalmology. Excluding these expenses, total operating expenses would have been $3.3 million lower. Again primarily based on higher operating expenses, year-to-date 2006 net loss was $2 million or $0.26 per share, a significant decrease from year-to-date 2005.

The balance sheet remains very strong. Cash and cash equivalents available for sale as of September 30, '06 were $22.1 million, up from the $21.4 million at December 31, '05. At the end of Q3 '06, inventories were $8.5 million compared to $9.3 million at the end of the third quarter '05 and $8.6 million on December 31, '05.

Inventory turns were at two turns in the third quarter of 2006 compared to 1.8 for the third quarter of '05 and 2.2 turns for the full fiscal 2005 year. Accounts Receivable were $6.4 million as of September 30, '06 compared with $6.6 million on December 31, '05. Quarterly day sales outstanding improved to 62 days in the third quarter of 2006 compared with 70 days for the third quarter of '05 and 69 days for the full 2005 fiscal year.

As may be noted in the press release, we did have estimated that litigation expenses for the next three quarters will be around $300,000 each.

And with that, I would like to turn it back to Barry.

Thank you, Larry. As you may recall, we implemented a three-legged strategy for growth here at IRIDEX over a year ago. I'm now happy to say we are executing on all three of these legs to various degrees, and I would like to discuss that for a few minutes.

First of all reflecting on the quarter, the overall revenue growth in the quarter was only 2%. Year-over-year we did show strong direct growth, which was at a double-digit rate. And direct sales in my mind certainly more accurately reflect the progress a company is making and also the potential they have for growth in the future.

We have been exploring other OEM opportunities to replace that one time large OEM order taken in the third quarter of 2005. But we have yet to close on any one of those opportunities. I might add though given the acquisition news that we recently announced, we will reevaluate that strategy given that our manufacturing facilities will be -- the capacity will be increased based upon that acquisition news.

Let me cover some of the key operational elements of the business and add a little bit more color to the numbers. First of all, our US ophthalmology business. That has been a real success story this year. Our new organization in sales and marketing are really working very effectively and working very well together. As Larry reported, overall revenues for US ophthalmology were up 26% for the quarter and they were up 21% year-to-date.

I might also add that they are having a very strong fourth quarter.

We are currently analyzing plans to increase headcount by two or three reps in 2007 in order to repeat and increase the success in 2007. Our international ophthalmic business, it has certainly been weaker than expected. During third quarter, it was flat, despite coming into the quarter with a backorder. Our year-to-date growth has only been 4%. We certainly have to improve on this and evaluate all the key areas in which our distributors focus in 2007.

Overall our ophthalmology disposable business has been very strong. As Larry pointed out, it has increased by 25% year-to-date with the US experiencing an increase in disposables of 29% and international experiencing an increase of 20% year-over-year.

In our dermatology business, overall there was an increase for the quarter. Though at 6%, we believe now that our US business is stabilized. We have now hired seven representatives to replace the six that we started the year with, and we have hired a new director of sales for dermatology. He was brought on at the end of the third quarter. He is an individual with whom I have worked for many, many years, and I believe he will really bring the mentoring and the development skills that are necessary to that group of individuals.

You may recall in dermatology our international focus is very narrow, and despite that being very narrow, we have shown an increase this year in those sales.

Our gross margins have certainly improved and improved quicker than we had anticipated. Last year you may recall during third quarter we experienced gross margins at a level of 53.7%, and we really warned at that time that that gross margin was fueled primarily by this onetime OEM sale, which had unusually high gross margins.

We also said we did not expect to reach that level of gross margins for a couple of years. During the third quarter of this year, our margins were at 52.8% on a GAAP basis and 53.1% without stock-based compensation. That certainly compares very favorably to our margins last year and shows the overall progress we are making in this area.

The second leg of our growth strategy, the first having been improved sales and marketing of our core products, core businesses, the products that we currently had, the second leg of our growth strategy was new product innovation. This includes not merely extensions of our current product offering, but expansion into areas in which we do not currently compete. We were very proud that we were able to introduce two new laser consoles at the American Academy of Ophthalmology in November. We introduced the new IRIDEX OcuLight TX, which is a new 532 with more power and more features, more patient friendly and with a lower cost of goods. We also introduced a totally new wavelength to the Company, and that was the 577 true yellow -- first time ever that this has been obtained in a solid-state fashion for ophthalmology. We will be shipping the new TX during this week, and we expect to ship the 577 second quarter of 2007.

We also introduced a total of six new ophthalmic disposable probes at the American Academy of Ophthalmology. We have certainly seen the impact and being quite positive that new probes have on our current revenue growth in disposables.

The third leg of our growth strategy relates to the addition of new technologies through acquisition or merger activities. We were certainly very pleased to announce the agreement to acquire the Laserscope Aesthetics business just a few weeks ago. I have had the opportunity to meet virtually all of employees who will be joining the IRIDEX team, and I can tell you I am very impressed with them. I'm impressed with their attitudes. I'm also impressed with their level of commitment to move the business forward successfully. And quite honestly, they are just very excited about having someone who cares about the aesthetics business.

We expect to close on this transaction in the next few weeks.

We are now only one week from the close of fourth quarter and year-end for 2006. While we are having a record-breaking quarter in sales this quarter, this will not allow us to reach our objective of overall double-digit growth for the year. We expect to end the year at between 38 and $39 million in revenues. We should be prepared to provide preliminary revenue and profit guidance for 2007 early in January after we have closed on the Laserscope business. We are planning to use our presentation on January 12 at the Needham conference in New York as a platform for that guidance.

With those comments, we will open the line up for questions.

(OPERATOR INSTRUCTIONS). Keay Nakae, Unterberg.

With respect to fourth-quarter expenses, can you give us an estimate of what the auditing costs will be in the fourth quarter?

Well, I think through the third quarter we have reported about $400,000 in expenses. I would expect about another $100,000 will come through during the fourth quarter.

Okay. And with respect to the Company's ability to be compliant with Sarbanes-Oxley -- I know that is a moving target now -- can you give us your latest thoughts on the timing of that?

Well, you're right. It is a moving target. There are some hurdles that we need to reach by the end of '07, and there are others that we need to reach by '08. Certainly what we learned through this investigation of revenue recognition has helped us in terms of some of the processes and procedures that we need to develop in order to be compliant there.

So we are on target to meet both the '07 deadlines in '08. Actually we may be a little bit ahead of schedule. But, as you say, it is a moving target, and that could change.

With what you are planning on doing now, can you give us a sense of what the additional expense related to those activities might be in '07?

I would think in talking to other folks that it might be as much as $0.5 million from what we have got left to do.

Okay. Based on your comments on the color of the current quarter, it looks like you are having a great Q4 with -- by my quick math, even though you have a very tough versus last year's Q4, you could see some positive growth versus that revenue number?

That is correct.

Okay, great. With respect to the 577 wavelength, you mentioned a second-quarter launch. Where are you on the clock with respect to 510-K clearance of that product?

We expect to get that late Q1.

Okay. And then finally, with respect to the acquisition of the Laserscope business, can you give us a sense of what investors should expect you to accomplish in, say, the first 90 days post the closure of the acquisition?

Good question. I think we have already started it, and one of the things that we really insist upon with AMS is that even though they are closing their year out, that we get an opportunity to meet with the individuals face-to-face. And I have been in Wales. I have also been in Paris. I have been in Atlanta, and I have been here in San Francisco to meet with all the employees who are transferring over. And it just excited me more beyond just the financials to see why this deal makes a lot of sense for us.

So, in the next 90 days, we will be focusing a lot on those people, making sure they are in the rights spots. Making sure their compensation is correct. Making sure the direction is set. We will also be focusing a lot on new products.

One of the things that hit me right square in the face when I was having lunch with the eastern director of sales for Laserscope in New York a few weeks ago and what he was telling me was exactly what the ophthalmic rep said when I joined IRIDEX. And that was, we need somebody focused on our products. We need some new products, and we need to show them at the next major show.

I think what we have done the last year and a half in terms of processes in new product innovation and also in terms of working effectively with marketing and sales to develop product specs that can deliver successful products to market, all of those things are going to help us to focus on the aesthetics side of the business, and we have already made commitments to these folks that at the American Academy of Dermatology meeting the first quarter of 2008 we will have new products there from the IRIDEX aesthetics product line, and I believe we will be able to achieve that by relying on those processes and practices we put into procedure the last year and a half.

Okay. So certainly Laserscope had some things under development. So at this -- so what we really should expect is you to really decide which ones you want to greenlight to go forward?

You are exactly right, but it takes involvement from a lot of folks. One of the nice things that Laserscope does have is they have a very rich medical advisory board. So we're going to be working with that medical advisory board. We are going to be working with the sales and marketing folks who have had quite a bit of experience in the aesthetics market, and we will be spending time in normal practices. So, in the first 90 days, we need to have the specs put together on the products that we will introduce first quarter 2008.

And in saying that, will that also involve some decisions about some of the existing products that are perhaps giving much slower growth as to whether you want to keep those going forward?

Yes, that is a good point. We said during the first half of '07 we have to rationalize the product line. We are acquiring five products from Laserscope, and of course, IRIDEX had two products in the same area. So that is seven total products. We will probably sell out some of those in '07, but I would anticipate going into '08 we won't have all seven of those products in our bag, but we will have some new products, as I said, that we will introduce at the Academy of Dermatology.

[Mark Richter], Jefferies & Co.

A couple of quick questions. First, the revenue shortfall in the quarter seemed primarily due to -- was completely due to OEM shortfall. Can you help us better understand or give us some color on what you're planning on doing with this -- with the OEM relationship, and where you stand in terms of making progress with other relationships on the OEM front?

Okay, good question. First of all, it is hard to distinguish, and in the past, as Larry said, we have lumped together all OEM sales with our ophthalmic sales. And I believe with the acquisition of Laserscope, we're going to have an opportunity to kind of reevaluate how we segment and report our sales going forward. I think we will probably make a decision to do something differently there, so you can see some visibility to it.

But remember within our OEM bucket overall, we had an ongoing relationship for several years with Bausch & Lomb. And that has been a very constant, very reliable, quarter after quarter, slightly growth business. The OEM order we are referring to in Q3 of last year has nothing to do with Bausch & Lomb. It was totally separate. It was a onetime deal with another company that were -- they were acquiring laser products to use in clinical one trials. Now if things go well, that could create an opportunity for us going forward to supply laser products for them. But they are still in Phase I, and that will take some time to find out. But that is not a repeatable one, at least not for the near-term.

I do believe, though, we have got to reevaluate our OEM strategies. We have been aggressively looking for OEM opportunities to fill our plant here. As we have repeatedly said, over time we have got 37,000 square feet here. We only one run one shift. We can add more production. As we fold in the Laserscope manufacturing into our own facility here, obviously our capacity -- some of that capacity will be used. So we will have to evaluate how many more OEM opportunities we might pursue in the future given the fact that our plant will be filling up with these new products as we transfer them over.

Okay. Perfect. That is helpful. That is actually a great segue into my question about Laserscope. Can you just help me better understand the manufacturing efficiencies that you believe you can garner from that transaction? Do you plan to keep the relationship with Henry Schein, and what sort of additional manufacturing utilization do you still have at your facilities?

Okay. Two questions. I will take the manufacturing first, and then I will come back to Henry Schein. When we first began our due diligence of Laserscope, I told our Vice President of Operations that it was going to be very key what he told us based on his observations at their facility in terms of competencies required for manufacturing and assembly of lasers. And then secondly, looking at the space required to do what they currently do, could we fit it into our current facility?

And he came back, along with his director, and said two things. Number one what they are doing in terms of the skill set we currently do, and we also think we can do some of those things better as we would transfer product into this facility here in Mountain View.

Secondly, he told me that from a capacity point of view we can take the products that they are currently manufacturing, and we can fit it into our 37,000 square feet here in Mountain View. So that makes sense not only from the aesthetic side of the business, but it also gives us the opportunity to enhance our gross margins in opthamology and that now we will have twice the amount of revenues to spread overhead than what we had before this acquisition. So we are anticipating an improvement of about 3 basis points in our gross margin on the ophthalmic side of the business because of the manufacturing capacity issues with the new anesthetics products we acquired from Laserscope.

Now, on the Henry Schein front, certainly in the past we have not used a marketing vehicle like Henry Schein. We have learned a lot of things during due diligence about that relationship and how it has been growing. It seems to be becoming more and more effective. They are just ending the first year of their relationship.

So we will go into the relationship with them very open-minded. We have meetings planned the second week of January with them after close. We have also along with AMS made some decisions about going forward with AMS -- I'm sorry with Henry Schein in the future -- that AMS did not feel comfortable making by themselves, and we will look forward to trying to make that relationship even more successful than it has been in the past.

Perfect. And then can you maybe help clarify something for investors? There seems to be a lot of confusion about American Medical put out a press release on what they believe that they have sold the assets to you for. If you do the back of the envelope math, it looks like you paid more along the lines of $21 million, which is significantly less than they are recording. Can you best help investors understand what you have got and the discrepancy there because it seems like you have paid significantly less then at least they are out there saying?

Yes, good question. And we knew there would be some confusion and we understand that. We will try -- I will try to do my best to explain it. The purchase price is $28 million, of which $26 million in cash and $2 million is in IRIDEX stock.

Now at the close there is a bucket of net assets that are required to be between $7.3 million and $9.5 million. The vast majority of those net assets are Accounts Receivable. At the close there will be a true-up, meaning that if the net assets are less than $7.3 million, the actual purchase price will go below 28. If the net assets are above $9.5 million, the purchase price would go above 28 by whatever that number would be.

So, as we look at it -- and they are having a very nice quarter, fourth quarter by the way. As we look at it, the orders that they are shipping now becomes our Accounts Receivable in first quarter. And just call it -- call it at the lower end of the bucket. Say it is only $7 million. That is cash we're going to take back in, and we would certainly anticipate most of that cash would come back in first quarter.

So, as we look at the purchase price, it is just about as you said there a net of $21 million. Maybe a little bit less, but let's just say $21 million.

Now we also have a product supply agreement with AMS. That is separate from the asset purchase agreement. And for a period of time, AMS through their facility 8.8 miles away from here that Laserscope occupied, they will continue to make product for us based upon forecasts. And we will be working with them on forecasted purchase of materials. We will also start to purchase raw materials here as we start the manufacturing here in Mountain View.

At the end of that purchase agreement period, it could be six -- it could be four, it could be six, it could be as long as nine months. Both sides hope that it's shorter rather than longer, and that is our objective. But at the end of that period of product supply agreement, they will have some raw materials. They will have some work in process that they were working on to get the finished goods. We will be required to buy that from them, and we will certainly work with them and are forecasting and in their purchase of materials to keep that number as low as possible.

The agreement says it can be no more than $9 million. So if they had $15 million of raw materials, we would still only pay 9. But we will work with them. They have been very cooperative in all parts of this transaction. The fact that they are so close makes it obviously more convenient. The folks in the San Jose facility have been very open. So our people being in there and having basically open communications as to what is going on. So we will work with them to make sure the raw materials are at kind of the same level we would need to start the manufacturing up here in Mountain View.

Okay, thanks a lot. That is very helpful. There has been a lot of miscommunication about that, so thanks for setting the record straight.

I guess the last name, and I'm sure it goes without saying, but just I want to ask it any way. This clearly now puts any delisting risk behind us? Is that fair to say?

Yes, that is correct. That is thankfully behind us.

Perfect. All right, guys. Thanks for taking my questions, and I appreciate it. Thanks.

Anthony Vendetti, Maxim Group.

I wanted to tell you, I know you mentioned about the AAD in 2008 and having maybe some new products on the dermatology side there. Can you talk a little bit about -- I know you may only have a couple of weeks before AAD 2007 to kind of joint market -- Laserscope and IRIDEX. Can you talk about how you intend to do that at AAD 2007, and then just a quick question on the litigation expenses what you expect that to be going forward and what the exact number was for this quarter? I think I missed that.

Okay, great. First, go back to the American Academy of Dermatology which is the early part of February, which is unusually -- I mean sometimes it can be later during the first quarter, but we got an earlier one this time.

We are somewhat limited to how much we can do because we really needed to know this a couple of months ago, that this was going to be done. There has been in the last week since we have gotten over all the hurdles we think to closing the transaction. There has been some very concentrated efforts by both the IRIDEX and the Laserscope marketing teams to put together proper communications of the acquisition and the fact that it is now the IRIDEX aesthetics business.

Anthony, I think as you know there will be a phasing out of the Laserscope name. We did not acquire that, so that will take a lot of marketing on our part in order to effectively communicate that. We will have different products. There will be a VariLite in their booth, and I'm sure we will have a Gemini in our booth. We will still have separate booths. We will have signage though that will help folks understand that, and we are planning a dinner with the advisory board of Laserscope to work on these product specs and product ideas. We are also planning a cocktail reception for all the attendees to help them get the message of Laserscope as IRIDEX and what our plans are to go forward.

So that is about as much as we can do in the short period of time that we have. We would obviously like to do more, but I think the academy in '08 first quarter will be a real coming out, not just in name but in products.

And secondly was your question about litigation. During the third quarter, our total litigation expenses were a little over $700,000. Year-to-date that is $1.3 million. Now not all of that has been the Synergetics litigation, but going forward, the Synergetics litigation is the only expenses that we have. And we are anticipating those. We budgeted $2 million for the litigation. We spent about 1.2 in total since we started this in the fourth quarter of 2005. So we have about $800,000 left in expenses. So we projected I think if you figure $300,000 a quarter going forward for fourth quarter of this year and first quarter and second quarter of next year, that will certainly be in the ballpark.

Okay. And you expect obviously the trial barring any delay to be concluded by then?

The trial date is set for April '07, and the judge has been very helpful in making sure we keep that date in place. That certainly has been our objective. We just about completed the deposition stage. I think it will likely run maybe 10 to 15 days into January. Summary judgment motions have been filed. That is all done. We expect to hear from that in probably mid to late January, maybe even into early February and trial date mid-April.

[Michael Kay], Maxim Group.

Most of my questions have been answered already. I just had one quick questions with regard to your derm sales. Are they fully up and running as of fourth quarter?

Yes, Mike. We hired two additional reps I think it was the last week of the third quarter. So they have been on board all of fourth quarter. Of course, they did have a little bit of training. It is exciting as these new reps are bringing orders in for the quarter, and I also might add that it has also been helpful to have a director of sales who is really focused on the derm group. That has been very helpful as these new reps have come on board and start to get their sales maybe a little quicker than normal.

And what is that timeframe? About two months?

No, actually it is not -- you know, the two products we currently have in dermatology are not that complicated. The VariLite being a 532 and a 940 combination and the DioLite XP being merely a 532. So we are seeing reps who will make sales their first quarter that they are out in the field.

Okay. Great. Well, thank you very much. That is all I have.

Dalton Chandler, Needham & Co.

Good afternoon and congratulations. I just wanted to ask about the Laserscope productlines. I know that the Company had been much more focused on their urology product lines. I was wondering what you might be doing apart from the new products you already talked about, let's say, with marketing or with the sales force to sort of reinvigorate those product lines over the coming year?

Well, that is a good question. It would be very interesting to look at a slide which would show the Laserscope business for the last four years as the urology business was basically doubling every year. And certainly the more that we got into due diligence and the more that we have met folks after the announcement, we have really seen that there was almost total focus within the Laserscope business on urology. Obviously that paid off for them and that made sense.

Now I think we are the benefactors of that in that I believe the aesthetics organization at Laserscope has done really a very fine job. I would say an outstanding job of holding sales at the level they were mid $30 million towards $40 million, between 35 and $38 million. Anytime you go through an announcement that someone has bought you and they intend to sell you again, that is pretty tough for sales and marketing folks to go through. And despite that, they have done very well. They are having a very strong fourth quarter. We are hoping that Laserscope or AMS is able to ship a few of those product, but maybe some of them might even holdover into the first quarter of next year.

But I think what we are going to see -- just these folks having a management focus on them and attention being paid to them certainly will happen here. Our aesthetics business will probably end up in '07 being 52 to 54% of our total business. So that is going to be very important to us. Just being in that type of position for these guys makes them feel very, very good. And you can see it in their eyes and these guys are very committed to growing the business. So we are really excited about working -- about having the opportunity to work with them and move the business forward.

Okay. Most of the companies you will be competing with or you have been competing with have been putting up growth rates year-over-year in the 20 to 40% range. Is it your expectation that you can get this business into that sort of growth profile?

Yes, I do with new products. I think though to be fair in '07 and I think as you know I have had the opportunity to make quite a few acquisitions in my career, and typically the first year after an acquisition if you can keep the business where it is, you have been very successful. And we will sell out as we decide certain products we will no longer have. We will sell some of those products out. But I think as we head into '08, we will start to anticipate the kind of growth rate that the market experiences.

All right. Thanks a lot. Congratulations again.

(OPERATOR INSTRUCTIONS). Larry Haimovitch, HMTC.

Just checking on the close of the Laserscope deal, it sounds from everything you have said that it is pretty much a done deal. Are you pretty confident it will close before year-end?

I would say certainly within the next couple of weeks. If we can make it by year-end, we will do it. We are all working hard this week on that type of objective. But the sooner the better from both AMS and IRIDEX.

So it is possible that it will not occur in '06 because I know you were originally helping to close it before the end of this year?

Well, we certainly would like to close it on December 30 and that is our objective, but given that we don't want to disappoint, we are going to get it done as soon as possible.

Okay. In the press release when you announced the acquisition, there was mention of Laserscope's annual revenues, and I think they were declining from '05 versus '04. Can you take a shot at just a ballpark number about what you think Laserscope's derm revenues might be for the year that is just ending in the next few days?

That would be a wild guess. But knowing -- I'm not sure exactly how much they are going to be able to ship, because they are having such a strong quarter in terms of sales. But my guess is it is going to be around 35 -- mid-30s.

Okay. So fairly stable versus '05 essentially? It will kind of hold its own versus '05?

Right. Right, which the last three years it has been between 35 to 38.

Right. What percentage of their business is we would call recurring either service or any kind of disposables -- I know there is not much disposables as I recall to their productline.

There really is not any disposable business, but there is a service business, which would be about 6 of that 35.

Okay. And to what do you attribute the strong growth in Q4? I mean it just seems unlikely considering that they are being acquired that they would grow so slowly. It seems kind of counterintuitive.

Yes, you're right. AMS has put on a lot of commission incentives for them to close business. They did lose several experienced reps earlier this year as the word got out that they were going to be sold and likely to someone who was not interested in anesthetics. But they have replaced them with some very good aggressive reps.

I met a representative in the Carolinas who third quarter -- and he has only been with the company six months -- third quarter he closed $1 million in business. And he believes this quarter he is going to be right at $1 million. I had dinner the other night with a rep from Dallas who believes he will be close to $1 million this quarter.

So some of these reps -- and it does take longer for their reps to get up and started than it historically has taken IRIDEX reps. The products are obviously much more complicated, much more involved, and the market is much broader where as we have been more narrowly focused. So some of this has to do with the incentives they have in place, but also some of these newer reps are really starting to kick in now.

So it is conceivable that on its own without your help, it could even -- the business could even be a little stronger next year?

I hesitate to say that just because of all my experience in acquisitions. I would certainly like for that to be the case, and I'm certainly not going to tell the guys not to grow. And they will probably have objectives to grow. But I do know that first year of an acquisition, it is always rocky, and you will always have challenges you don't anticipate. And the ones I have been through if you hold where you are, that is pretty good story.

Yes. On another topic, the Synergetics legal situation, has a court date been actually set yet?

Yes, it is. I believe it is April 16.

And that, as I recall, is a jury trial.

Yes, it is. You are correct.

So it sounds from conversations you and I have had and also comments you're making here that it is pretty much definitely heading to a trial?

I would certainly think so. I have heard comments made by their CEO about things that we were going to see during the deposition stage and their summary judgment motions. We have not seen anything that unsettles us at all in thinking about how strong our case is. And, as I have said before, we have already spent over half of our budget. So I hate to say it is just another $800,000, but that is it -- that is what it is. And the upside has been publicly announced through their summary judgment motion that the expert witness testimony was $8.4 million in actual damages through a quarter or so ago. And if there were treble damages, that would be at $25 million, even though I'm not expecting treble damages. But I certainly am expecting that our patent will be ruled valid and that they will be ruled to have infringed the last six years.

Okay, great. Thank you.

Management, there are no further questions at this time. Please continue with any closing remarks you may have.

Well, great. We really appreciate everybody joining us, especially with all of the holiday festivities. We guarantee we will have our third-quarter conference call next year before the end of the -- I mean we will do it earlier next year. And have a happy new year. We look forward to a good year with you next year. Thanks very much.

Thank you.

Thank you. Ladies and gentlemen, this concludes the IRIDEX third-quarter conference call. If you would like to listen to a replay of today's conference call, please dial 303-590-3000 or 800-405-2236 with access code 11079849 followed by the #.

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