IRIDEX Corp (IRIX) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Iridex Fourth Quarter and Full-Year 2006 Financial Results Conference Call.

[OPERATOR INSTRUCTIONS]

This conference is being recorded today, Tuesday, April 3rd, 2007. I would now like to turn the conference over to Jennifer Beugelmans with the EVC Group. Please go ahead.

Thank you, Mae, and good morning to everyone. Thank you for joining us today for the Iridex fourth quarter and full-year 2006 financial results conference call. With me today are Barry Caldwell, Iridex's President and Chief Executive officer, Larry Tannenbaum, the company's Chief Business Officer and Meryl Rains, the company's Chief Financial Officer.

If you have not received a copy of today's earnings release, which was issued premarket 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'd 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 related to products and developments in the business.

All statements other than statements of historical fact or statements that could be deemed as forward-looking statements, and these statements are subject to risk 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 line, the rate of sales to OEM customers, the rate of growth in sales of disposables and services, our ability to reduce expenses. The financial consequences of states not reimbursing for all of the company's AMD procedures, our ability to remediate material weaknesses in our disclosure controls.

And, 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, improve its operating efficiencies and the timing of the release and actual results of studies related to its products.

Risks and uncertainties to wish the company is subject 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 risk associated with bringing new products to market, the results of clinical trials and competition in the market. 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'd like to turn the call over to Barry Caldwell, President and Chief Executive Officer of Iridex.

Thank you, J.B., and welcome, and good morning. Thanks for joining us on our call. I'd like to go through the format that we will have this morning. First of all, as you know, Meryl Rains joined us as Vice President and Chief Financial Officer just about two months ago, and she will begin by discussing the fourth quarter results and 2006 financials.

Then I will get on the line and discuss a couple of the operational issues. Then Larry Tannenbaum, our Vice President and Chief Business Officer, as you may recall, he went into that role just a few months ago. And in that role his primary focus is the Laserscope integration process, new business opportunities, OEM relationships and investor relationships. And Larry will speak on the progress that we've made in the integration thus far, and what we have ahead of us.

So, with that said, I'll pass it to Meryl to discuss the financials.

Thanks, Barry, and good morning, everyone. As you are all aware, we filed our 10-K for 2006 on Friday, and published our fourth quarter and full-year 2006 press release before the market opened today. Because we have just completed our first fiscal quarter of 2007 and have not yet finalized our results, I am going to have to contain my comments to our fourth quarter and full-year 2006 results.

Revenues for the fourth quarter and full year 2006 were $9 million and $35.9 million, respectively. Domestic ophthalmic equipment and probe sales, as well as international probe sales grew during the quarter and full year. However, we were below plan in our dermatology and international ophthalmic equipment business.

In addition, as we have previously mentioned, we recognized approximately 1.8 million of OEM revenue in fiscal 2005 not recurring in 2006 that influences our year-over-year comparisons. Let me give you some additional detail on the results of our two business segments.

Ophthalmic revenues for the fourth quarter of 2006 were $6.7 million, compared with $7 million in the fourth quarter of 2005. Domestic ophthalmic sales in the fourth quarter 2006 accounted for 59% of total ophthalmic revenue, and grew 12% over the fourth quarter of 2005. Within that number, U.S. disposable probe sales increased 27% and U.S. equipment sales were up 2% in comparison with fourth quarter 2005 results.

Q4 2006 international ophthalmic sales were 2.7 million, a decrease of 23% from fourth quarter 2005 levels. International disposable probe sales grew 12%, comparing Q4 2006 with Q4 2005. For the full year 2006, ophthalmic sales in the U.S. accounted for 72% of revenues and were driven by a 28% growth in disposable probe sales and a 10% growth in equipment sales over 2005 levels. Total international ophthalmic sales were 13.2 million.

International ophthalmic equipment sales were down 11% for the full year, while disposable probe sales were up 18% for the same period. As previously mentioned, our international ophthalmic equipment sales were impacted adversely by a series of healthcare reform efforts in China during 2006. Dermatology revenues were $1.2 million and $4.3 million in the fourth quarter and full year, respectively. Although overall revenues in the dermatology business were down in 2006, we did experience a 7% growth in international dermatology sales.

Gross margins were 55.5% for the fourth quarter of 2006, up from 48.8% reported in the fourth quarter of 2005. For the full year, gross margins were 52.4% compared with 49.1% in 2005. 2006 gross margins were driven in large part by the strong growth we achieved in disposable probe sales and other product mix benefits, coupled with a reduction in our warranty expense associated with a reduction in our standard domestic warranty term to one year.

Operating expenses in the fourth quarter of 2006 were $7 million, a $2.6 million increase from the $4.4 million reported during the fourth quarter of 2005. Operating expenses for the full year 2006 were $23.6 million, up $7.2 million from the $16.4 million reported in 2005. Operating expense in 2006 included a $1.7 million stock compensation expense reported in the year.

Operating expenses in the fourth quarter were negatively impacted by $1.2 million in additional legal and audit expenses, including $1 million in a spending associated with litigation, and approximately $200,000 in expense associated with our internal investigation regarding revenue recognition. We also reported $425,000 in the fourth quarter related to stock option compensation.

For the full year 2006, we incurred approximately $2.9 million in legal and audit fees, including $2.4 million of expense related to litigation support and $530,000 for an internal investigation related to revenue recognition. The company also reported $1.7 million in stock-based compensation expenses during 2006. In addition, in fiscal 2006, we reported a tax provision of $1.7 million, which included reporting a full valuation allowance on the deferred tax asset balance of $2.4 million.

Net loss for the fourth quarter was $3.8 million, or $0.48 of net loss per basic and diluted earnings per share. For the full year 2006, net loss was $5.8 million, or $0.75 of net loss per basic and diluted earnings per share. Turning to the balance sheet, cash and cash equivalents as of December 30, 2006 were $21.1 million, compared with $21.4 million at December 31, 2005. At December 30, 2006, inventory was 9.5 million, compared to 8.6 million at December 31, 2005.

Inventory turns were calculated at 1.8 turns for 2006, compared 2.2 terms for 2..5. Accounts receivable, net, was $6.1 million as of December 30th, 2006, compared with $6.6 million on December 31, 2005. Days sales outstanding improved five days, to 64 days in 2006, compared with 69 days in 2005.

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

Thank you, Meryl. I'd like to review a couple of operational areas. First of all, let me talk about areas of concern from '06, areas in which we definitely know we need to have improvements upon and we're focused on in '07. First of all, not meeting our revenue and our profit projections is certainly an area that we're focused on for '07 and know what we need to do there.

Secondly, a part of that is the international laser equipment revenues. Those were slightly down year-over-year despite some of the issues that we faced there, some of the new product introductions we've had on the ophthalmic side, plus some structural changes we're making we think will be helpful going forward.

Obviously, the revenue recognition issue was time consuming, and also was a financial burden for us during the year. And we've learned a lot from that, which we think will help us as we go forward and grow the company. We also had some unusual spending levels, which some of this we don't believe will repeat in '07. The biggest one of that would be legal expenses, and we believe that the majority of our legal expenses should be behind us by midyear 2007.

Some of the highlights during '06, of which we're quite proud, is first of all, our disposable sales growth, it continues very well, overall about 25% year-over-year. Our recurring revenue levels got to 43% for the year. That's up from 36% in '05 and 33% in '04. Our gross margin improvement was very nice. Overall, the year was at 52.4%. That compares with 49% in '05 and 45% in '04.

Of particular note is the fourth quarter at 55.5% gross margin, which is about a seven point improvement over fourth quarter of 2005, despite the fact we had some very profitable OEM shipments during fourth quarter of 2005. Our new product introductions that we had in 2006 at the American Academy of Ophthalmology, we introduced two new laser consoles. And during the year, we also introduced a total of six new disposable probes.

We continued on our DSO to have an improvement, a five-day improvement on that, and also a highlight for the year was the Laserscope acquisition. You have probably noted that in our 10-K we mentioned -- and in our press release, our growing concern regarding current liquidity and capital resources.

We certainly did get somewhat of a late start on the Laserscope acquisition. Our models had been designed around a plan to close that in the first part of December, and as you know, that ended up being mid January, so they got a little bit late start on that. We've also particularly had some difficulties in sorting out through system integrations issues like service contracts, and getting those billed properly, which we finally got done the last week of the month.

And we've also not yet completed the pro forma, even though we're getting closer and closer every day. We've had discussions with the bank about the covenants, and we'll have ongoing discussions with them. And, as we previously said, our plans during the year were to look for additional funding during the year, so we will follow through on that plan.

2007 will certainly be a transitional year for the company. We're focused on successfully integrating the Laserscope business, which basically is a doubling of the size of the company. And a key part of that is finding the manufacturing synergies, so we can work on cutting the cost of goods and spreading the overhead that we have here in our facility.

We'll be focused on our operational expenses, eliminating those unusual expenses that we had in '06 and focus on all spending levels that we have. On the ophthalmic side, we want to continue the nice growth pattern that we had in 2006, and focus on getting our international ophthalmic business back on a growth line.

Our longer-term growth, we're focused on both the revenue and the profit and following the strategic outline that we've laid. First of all really focused on growing our core business through enhanced sales and marketing efforts. Number two, through new product introductions, and third, through acquisitions.

So with those operational comments, I will pass it on to Larry for his comments regarding the integration, and then he'll pass it on for questions. Larry?

Great. Thank you, Barry, and good morning, everyone. As you know, we did the acquisition of Laserscope on January 16th, which was a little bit later than we had anticipated, but within two weeks we were able to pull together a national sales and service meeting, where there were approximately 40 Laserscope employees, including the entire Iridex aesthetic sales force, and the marketing departments of the two companies.

We did HR introductions, and we had full product cross training and some team-building exercises to pull together the group. We've also in the acquisition, acquired 23 international aesthetic distributors in combination with our five, we would now be up to 28 international distributors. All those distributors were trained on our product as of the end of March.

There was the initial data transfer, as Barry has mentioned. We hired a full-time consultant to help us with that integration of adding the customer files, the installed base of approximately 2,100 lasers and approximately 2,000 customers. The customer service contracts were loaded. And on the asset transfer side, we've transferred service parts, the finished goods, and we're trying to finalize the customer files with equipment costs and [bonds].

Beginning day one, we started taking all orders and supporting sales here at Iridex, and towards the end of March we also transferred the customer service completely here, including the technical support. So now if you call Laserscope's 800 phone number, you'll have an option to be transferred to Iridex for answering your questions.

We are now shipping finished goods directly from Iridex, as opposed to where we were drop-shipping for Laserscope. As Barry mentioned, we did build the service contracts and we believe we're on cycle, continuing on that. A big, big effort this quarter was the facility preparation and getting that ready for the move and I think we've just about completed those efforts there.

And we also have merged the quality systems of the two groups. On the financial side, we've been working, of course, on the valuation, which we have a preliminary estimate of, working again, on carving our the financials and getting to that final balance sheet of January 16th. We are collecting receivables, and we've been working on cost accounting standards.

On the supply chain efforts, we've been coordinating purchasing with Laserscope. That will begin to kick in, more so in the second quarter here. We've been reviewing suppliers to see where we have similar suppliers and similar products that we will be transferring, as well as who provides the different manufacturing materials such as fibers and chillers and molds and crystals and things of that nature.

As I mentioned, we have been shipping from Iridex here, and we've also made a couple trips over to the subs, one after the acquisition, set up the management structure there, and are in the process of integrating employees.

And with that, I'll turn it over for questions.

Thank you, sir.

[OPERATOR INSTRUCTIONS]

And our first question comes from Mark Richter with Jefferies & Company. Please go ahead with your question.

Good morning, guys.

Good morning, Mark.

So I guess my first question revolves around guidance, so if I can ascertain what you're saying, are you withdrawing 2007 guidance, or are you reiterating prior guidance?

Mark, I don't think we're doing either. We're not in a situation we could comment on guidance at this point in time. As you know, we had delayed this call, hoping that the carve-out pro forma would be prepared. It's not finished yet. There's still a lot of moving parts in that. So at this point in time, I don't think we're ready to comment on that.

So for modeling purposes, I guess asked a different way, should we assume the prior guidance that you gave? Or, how would you suggest that we look at guidance going forward under those circumstances?

I would suggest that at this point in time that you not use prior guidance, and we just need to get a better handle on the pro forma carve-out. As I said, those numbers have been moving considerably, and we had delayed this call, anticipating we'd be able to discuss those, but we don't have those at this point in time. I think it's realistic that we can have those in the next couple of weeks, but there's still a lot of work being done on that.

But now you have a quarter behind you. You should have some sense, I would assume, of how your business is tracking, Laserscope is tracking. I mean, do you feel at least generally, form a 30,000 foot level, confident in the top line, costs aside, or --? Could you answer that?

I think, Mark, one of the moving parts that we don't have a good handle on yet on the top line is the service revenue, which I mentioned before. We got the business in mid January. It's still unclear how much they have billed the first part of the year, how much of that we may even have an opportunity to take recognized revenue for during the first quarter. It is -- percentage-wise, well, it's over 20% of the total business. So that's kind of a moving number.

Also historically, first quarter -- fourth quarter's a big quarter in the business, as it is in our ophthalmic business, so first quarter's a little lighter, so getting a late start on that and basically the U.S. force just got trained at the end of January. European group just got trained last week. So, I think it's better for us to say we'll just have to wait until we have better information.

So you feel like you have less information now than when you provided guidance prior?

I'm just saying, Mark, the numbers are moving around a lot.

Got you. And then just the quarter -- obviously, you preannounced, we already knew the numbers. But can you just help us better explain the weakness internationally, and then if you're seeing that pick up in the first quarter, or had seen it pick up in the first quarter.

Yes, as I'd mentioned a couple of times, we were disappointed in the international ophthalmic equipment number. Our disposables did a very nice job year-over-year. They were up about 18%. Obviously, as Meryl mentioned, China was a bit factor. That was over $1 million last year-over-year as a comparison. And other major countries, we did very well, but we are focused on that.

I have personally been out and met with our distribution managers and distributors. I've made a commitment that I'll be out there every quarter, meeting with them. We've also had all of our other managers that we didn't get to in the field that manage the distribution channels, we've had them in here. So we're focused on turning that around.

Got you. So is it fair to say that you've seen a reacceleration in the first quarter, or are you still seeing stagnating sales?

It's hard to comment on first quarter numbers, but I think we've got things moving in the right direction.

Okay, and then a question for Larry. Can you just give us a sense for timeline in terms of moving manufacturing, and then what kind of synergies you're going to expect going forward?

Sure, I'd be glad to, Mark. Our goal is to transfer manufacturing by the middle of the year. We'd like to have it done in July, the middle of July. In terms of the timetable, that's a little closer to the second quarter end, so it may slip a month or so from that.

I think what we're seeing, especially in the first pass of going through, like, the suppliers on some of the products, that there's a lot of common suppliers, especially in the most expensive part of making the laser -- the crystals, which actually gives us additional leverage that we didn't have before with this supplier.

We also have found that there are a lot of similar smaller parts that we can leverage on as well, and leverage on shipping rates, both domestically and international with the increased business that we've seen. The processes themselves in terms of what goes on in manufacturing are very similar. The quality inspection procedure that they do is very similar to ours.

We are investigating at this point, doing some of the manufacturing of some of the raw materials to put together in printed circuit boards, and seeing if we can get those assembled at vendors that we've been using, assembled and tested at those vendors, as well as outsourcing some other opportunities like molds and putting together the initial chassis of the product.

One of the things I might add, Larry and Mark, is one of the things that is not necessarily good is our inventory levels today, but in terms of transitioning this manufacturing, it is helpful. It's going to allow us to use more of our current employees in the shadow manufacturing learning process and dedicate their time to this manufacturing transfer. So, it just gives us a little more flexibility.

But it is fair to say you see significant operational expense synergies to be realized.

When you put twice as many products through the same facility, same square footage, you're obviously going to see the spreading of the overhead having a positive impact. And, as Larry mentioned, if we can find the leverage with some of the common companies that we purchase products from, that will also be an additional help.

Perfect, thanks, and then last question. Can you just give us an update on the SURG lawsuit? And thanks for taking my questions.

Okay, Mark. Yes, that trial is scheduled to start two weeks from yesterday, and that will be in St. Louis. We feel very good about the position that we're in regarding the summary judgment motions and rulings that the judge has taken, where our estimate is it's probably about another $300,000 to get through the trial, and we're anticipating that trial will be about a week to a week and a half now that it's down to basically just four issues.

And those four issues would be the willfulness of infringement, the amount of damages we would get on infringement, the 492 patent, which is our patent, the issue of validity based upon obviousness. And latches and estoppel, which is heard by the judge only.

Thanks.

Thank you, and our next question comes Larry Haimovitch with HMTC. Please go ahead.

Good morning, gentlemen, and lady.

Hi, Larry.

Good morning. A couple questions on the financial side. Trying to understand these covenants a little bit better. It sounds like, if I read the press release correctly, Barry or Meryl -- I guess Meryl should probably respond to this, that if you go into a loss situation, that triggers a violation of the covenants. Is that correct?

We have three covenants that apply to us in the first quarter. We had a tangible net worth covenant, we have a debt service covenant and a debt service ratio covenant and we have a requirement to maintain a minimum amount of cash.

Okay, so that's cash -- cash was number one?

A tangible net worth covenant.

Tangible net worth, okay.

And a debt service ratio covenant.

So it's not related to profitability.

We do not have a requirement to maintain profitability in our first quarter.

Okay. So now I gather that in one of these three main categories, Meryl, you just highlighted that you are in violation of those covenants and need to renegotiate with the bank to presumably renegotiate the covenants, or how will you deal with this?

Well, exactly as you said. We have identified that we do expect to be in violation of the tangible net worth covenants and debt service ratio covenant. One of the contributors to our tangible net worth measurement was the accounting for our deferred tax assets, where we were required to book a full valuation allowance in the fourth quarter, so that in effect did impact and reduce our tangible net worth as of that date.

So the strategy certainly is to work with our bankers to try to restructure these covenants in a way that we believe is workable for the business model.

Barry, were you as surprised -- or Larry, since I guess this probably happened on your watch as CFO, are you surprised that -- you made some agreements with the bank, and it sounds like now you're unfortunately in violation. Is it because, as Meryl mentioned, mainly the deferred taxes, or there are other things?

Obviously, you went into an agreement with the bank thinking you weren't going to violate the covenants and now you have --

Exactly right, Larry. This is Barry. Let me comment on that. I think a lot of it goes to the fact that at the end of the year we were really hustling, trying to get this business closed, and we wanted to get it closed early in December. We liked the idea of recognizing some of the revenues from fourth quarter in December and, as it pushed out further and further and we still dealt with the issues to close, we didn't change our modeling with the bank at all. And, in hindsight, I should have gone to the bank and said, hey, they model's changed here a little bit.

I didn't realize it would be close on these issues, and as Meryl mentioned, the tax deferral, that obviously triggered one we did not foresee.

Yes, are there significant penalties to you as a result of violating, let's say, the tangible net worth covenant, Meryl?

There's no significant financial penalties per se. I think the issues are in our ability to renegotiate these in a way that works.

Because you read the press release and it's easy to get frightened, but I'm just trying to understand, is there a practical reason to take this more seriously than just, oh my God, they've violated the covenants. People get scared and there's bankruptcy and this and that, and obviously we're not even talking about them. I just want to make sure I have the right perspective on what this means in a really practical -- not in a headline sense, but in a really practical sense.

Right, well, certainly being in violation of the covenant does result in a technical default on the credit facility. That's the technical answer, but I think from a practical perspective, as we've stated, we certainly intend to work closely with our bankers to attempt to renegotiate these covenants.

And, Larry, if I might add, too, that when you're talking about a tax asset, that's really a non-cash asset that's on the balance sheet, but it does affect the net worth ratio. In addition, that 2.4 million can come back when we can prove more profitability to the auditors and ourselves.

Yes, I might also add, Larry, that this is a local bank that we're dealing with. It's one that the company has had a relationship for many, many years. Can't guarantee anything, obviously, but we think our relationship with them is in a positive working condition.

Okay, second question, related to the first question, which is you mentioned the need to raise money. You've already talked about that in the past, but certainly we all thought with the Laserscope acquisition at some point you would need to raise money to reliquify the balance sheet. Does the violation of any of these covenants force your hand, so to speak? Could the bank now say, well, okay, guys, you've got to go raise money?

Obviously, with your stock at 7.5 right now, or something near there, as we speak, you're not going to want to raise money here. Are your fundraising initiatives going to be affected at all by these covenant issues?

That's a good question, Larry. I don't think we totally can answer that for you, but certainly hope not. We've been kind of entirely on a timetable and we've spoken with several bankers about the opportunities during the year, and certainly if possible, we'd like to stick to that timeframe. It's hard to answer the question right now if we need to move that up a little bit or not, but we'd like to stay on our current timeframe.

Okay, and then final question, let me jump back in queue. I don't want to dominate here too much. I noticed I think it was the press release talked about the release of the yellow laser in the second half of '07. And it's my understanding from previous discussions, presentations, et cetera, you've had Barry, that we were talking about Q2. Has something slipped, or am I just misinterpreting -- ?

Well, I thought it said midyear, but with all the back and forth with the press release, I'm not sure what it said. But we're now targeted in July, and we're waiting for the 510K, so that's a pacing item.

Is there anything else that prevents -- if you had the 510K today would you be ready or are there manufacturing ramp ups, et cetera, that need to -- ?

No, we wouldn't be ready today. We're still working through some of the design issues and the manufacturing transfer, and so I think July is a good date.

Okay, I promised I would stop, but I'm going to ask one more. I promise, I'll let someone else ask. And the question is on the Laserscope, the Durham sales force. I know when you acquired Laserscope, a lot of territories weren't filled. I know you've been [inaudible] territories. Where are you at in that regard?

I think today in the U.S., Larry, we're at about 20 reps. We've hired five new, and we did lose some of the Laserscope reps after the acquisition, which you might expect. I think one of the things that is of interest that we noticed during first quarter, is that several of the Iridex reps on the dermatology side have really picked up and sold some of their first Gemini units, so we're very encouraged by that.

So I have to jump up for just one sec. So there's 24 territories I think you're trying to fill, if I recall correctly.

Yes, that's correct. I think we're at 20 right now.

Okay, 20, and you're working, obviously, to fill that as quickly as possible.

That's correct.

Okay, I promised I'd stop.

Thanks, Larry.

Thank you.

Thank you, and the next question is from Anthony Vendetti with the Maxim Group. Please go ahead.

Thanks, good morning.

Hi, Anthony.

Hi. Welcome aboard, Meryl.

Thank you.

Just to first follow-up on Laserscope and then I have a question on covenants. You mentioned, I guess, Barry, that in terms of new products for the combined Laserscope Iridex, it was most likely going to be an '08, most likely at AAD '08 event. Can you talk about kind of where that's progressing in general terms, and what areas you're focusing on? And then, are you going to have a combined presence at ASLMS and Grapevine in April?

Right, let me take the last question first. We'll certainly have a combined -- I'm not sure if we have two booths or not. I'm not sure if we were able to switch that around, so I can't totally answer your questions. But we may be in two spaces combined, instead of just one. And then in regards to new product, we're really honing in on what the product specs would be for that. We spent a lot of time on that last week, and we actually have a presentation to our board today.

I don't want to get specific about anything at this point in time, but we do have our preliminary plans and how to proceed so that, as you said, we are showing new product at the American Academy of Dermatology first quarter 2008.

And on the covenants, I know you have a good relationship with the bankers that you're working with there, and you expect to be able to renegotiate that. Do you have sort of a timeframe in mind? When do you think this will be resolved, as best as you can tell at this point?

I'll make some comments, and then Meryl may have some additional. I don't think we have a timeframe in mind right now. Meryl and I and one of the members of the board, we're meeting with the bank tomorrow, and we have had discussions prior to this with the bank to let them know. In these types of situations, communication is the best thing, and so that's proved to be quite positive up to this point.

I think we need to finish out the carve-out pro forma, but timing, I'm not sure. Meryl, I don't know if you have anything to add.

Well, I think we certainly intended to try to reach an agreement on these restructured terms in the next 30 days or so, would be our objective.

Okay, so let's assume, A) we could do that. But let's take a look at worst-case scenario. Is -- what do you think the worst case scenario is, and if you could put kind of a probability on that? I mean, obviously you expect, it sounds like in the next 30 days, to be able to restructure this. But, obviously, in general, the lending environment has changed. What's the worst-case scenario if you can't renegotiate? What do you see as the worst-case scenario?

I don't think I'd want to speculate on worst-case scenarios. I think it's just important to understand that our strategy as it relates to addressing this liquidity issue is threefold, and that the first point that we've been discussing is that we do want to work with our banks to restructure the current credit facility to work with our business model.

We certainly plan to work to modify our plant operations to focus more significantly on expense reductions and improve our cash flow from operations. And then we also in tandem, are going to review our options related to raising additional capital to add additional financing to the business.

Let me add two more comments on the last part. I think, Anthony, one of the things it could affect, is going back to Larry's answer, or Larry Haimovitch's question earlier, is it could force us to go out and raise money sooner. Certainly one of the things I've learned from having a going concern in your 10-K is you get a lot of calls from bankers.

But we have had ongoing discussions with several different investment additional funding opportunities for the company. And so, I think we've had good discussions with those bankers and have developed good relationships. And so, I think we'd have certainly the opportunity, if we had to move sooner, to do that.

Okay, so it sounds like worst-case scenario, you're confident that you'll be putting a plan in place, and, Meryl, you were going through reasons why, including cutting expenses and some sort of meeting, maybe the renegotiated covenants that you hope to renegotiate with your current credit facility. Hopefully, that will be sufficient.

Worst-case scenario is that you may have to raise money at a price maybe that may not be the one that you would like to raise it at, but worst case, that's what you would do. Is that about accurate?

Yes, I mean, I think you summarized our strategy to pursue.

Okay, okay, excellent. All right, thanks a lot.

Thank you, and the next question is from Dalton Chandler with Needham & Company. Please go ahead.

Hi, good morning.

Dalton, who's the coach?

I almost registered as Billy Donovan for this conference call, just to make your day.

Sorry, just to let everybody in on it, Dalton and I are big University of Kentucky basketball fans, so we'll leave it at that.

First of all, just to clarify, the 300,000 you mentioned for legal, was that just for the trial itself, or would that the whole quarter's expense related to this issue?

That would be, Dalton, from this point until the end of the trial.

Okay.

There are still quite a few filings that are due on Friday, and then the cost of -- I think what we're guesstimating is it's probably a seven-day trial at this point, but it could be less, it could be a few days more.

Okay. So your total spending for the quarter will be in excess of $300,000 or whatever.

Yes.

Okay. And then just on the acquired aesthetic product lines. Have you made any decisions on rationalizing those?

Yes, we have. I don't think we'd want to make those announcements at this point in time for a couple of reasons. Number one, we have decided two of the products will be phased out, and we're not transferring the manufacturing of those products here, but we're purchasing enough product to serve us the next 18 months, I would say, depending upon the number of sales that we have in those products.

And then there's a third product that we're looking that we will certainly for some period of time, at least, not continue to sell until we can get a handle on some reliability issues.

Okay. And then, I know you had a lot of user group meetings at AAD. Can you share with us anything that came out of that in terms of what people liked, what they didn't like, what sort of changes we might look for in products going forward?

Right. Good question, Dalton, and we did have some great meetings there with some very influential physicians. And we used them basically as helping us to draw out what product specs would be for new products that we need to add in the next couple of years.

We had one-on-one meetings. We're also following that up with focus group conference calls with traditional aesthetic equipment users and nontraditional aesthetic equipment users. So all of that process is going to help us define the product specs for '08, the product we have at the academy first quarter and beyond.

Okay, so that new product was part of that discussion, as well as the existing product lines?

Yes, it was, exactly. Probably the main focus was what the new product was or might be, and then secondarily it was what changes we might want to make in current products that we have. And we got very good feedback on both of those.

Okay, and then final question here. You updated us on the aesthetic sales force, could you give us the update on where the ophthalmic sales force stands?

Yes, good question, Dalton. In the U.S., because of the continued growth we've had from the strategy of putting more feet on the ground and enhancing our sales and marketing efforts, we've increased the sales force, which was ten sales reps in '06 to 12 in '07, and all 12 of them are on board. We had a national training meeting about three or four weeks ago with that group. So they're up and running, and we're very pleased with the organization and the management we have in place there.

Do you think 12 is a good number for this year, or would you anticipate that increasing over the course of the year?

I think the gating item for us will be the rollout of the 577, and we have conservative estimates in our budget for that, but we've got to watch it closely, because that product does have some nice potential, and if we start to see it earlier than we anticipate, then we may have to consider adding more reps.

Okay, great. Thanks, very much.

Thank you.

[OPERATOR INSTRUCTIONS]

The next question is from [Stan Manny] with Manny Family Investment. Please go ahead.

Thank you. Could you give us a timetable on the 2007 revised outlook? I have several questions.

I'm sorry, I didn't catch who this was.

Sam Manny, Private Investor.

Yes, okay, Stan.

I'm a long-term, large Laserscope holder, ex-holder.

Good, good, good. I'm sorry, Stan. Your question was --?

2007 revised outlook, top, bottom line, when, when do you estimate?

I think, Stan, first we've got to get the carve-out pro forma before we could come up with what an estimate would be on that, combined with the rationalization of the product line that I discussed earlier from Dalton's question, and the manufacturing transfer in terms of it being on time and what it's going to provide. So I couldn't tell you at this point in time what that's going to be.

June, July, May, you have no --?

No, I'm sorry, Stan. I don't know at this point in time.

Okay, secondly, cash. I'm trying to figure out what you're using for cash, since you've used it all up in the purchase of the asset, the Laserscope asset. Could you speak to where your sources of cash are currently running, before you renegotiate?

Well, if you'll recall, we needed the year with $21 million in cash. That was before the deal was done, and we have borrowed $11.4 million. We spent $26 million in cash on the transaction.

And you picked up some receivables and cash in the transaction the other way, from Laserscope?

Yes, sir, we did, and those receivables are turning to cash. You're right.

Okay, approximately 4 million or 5 million?

Again, those are still some moving numbers, and to help you understand the problem with the moving numbers is that Laserscope, and Stan, as you say, you've known them, they never did any segment reporting, so they never segmented out the aesthetics business from the urology business.

So, for example, in A/R, we got some accounts that turned out to be urology accounts, had to turn around and send them back. Same thing has been true with inventory. We just in the last few days had a $2 million move in inventory, because it was some urology product instead of aesthetics product.

So you sold it back to AMMD, I assume.

So that's kind of what we've been going through, to help you understand it. So it's not as easy as a typical carve-out pro forma might be.

Plus, if I might did, Stan, that we're talking about three years of financials, but for 2006 they actually have to do two audits, one under Laserscope and then after the transition of AMS. So, we've got four major audits going on.

Okay, second or third question, Laserscope distribution was primarily through Henry Schein and I think PSSI or McKesson. You've changed that to direct in aesthetics.

No, Stan, thanks for bringing that up. I've got to be more proactive, because this is a very interesting opportunity for us. We have an agreement with Henry Schein. We inherited that from Laserscope. Henry Schein has over 300 reps out there calling on the nontraditional market. They also have over 200 telemarketers.

We increased our relationship with them in 2007, and became one of their premier or elite companies which they deal with. And we are very much focused on finding ways to make that relationship work better in two regards.

One, in helping us get qualified nontraditional physicians to the seminars we put on, and secondly, in generating and understanding how to generate quality leads from nontraditional physicians that can turn into aesthetic laser sales. And so, that's an opportunity that we're really working on to improve, and we think it can fit very nicely in our future as we move forward.

Didn't they have a second with Henry Schein? I thought they had another relationship.

They had prior, Stan, had a relationship with McKesson.

McKesson that they cancelled.

That's correct, and went to Henry Schein.

Question on -- you said that this transaction quote in this call, doubles your sales. I mean, you did say that.

Yes, I said in essence it should double the size of the company.

Which means that you're going to go from $39 million or whatever to $80 million. I assume that's all from this transaction -- $36 million to 72, which alludes, it says, the total transaction you're expecting is $36 million from aesthetics business of Laserscope, service and hardware.

Yes, I think what I said is in essence it's about a doubling of the size of the company. Until we really have those carve-out pro formas, I couldn't tell you exactly what that number is, but in essence both companies did within 10% of each other last year.

Okay. So, and 20% you had said is service.

Yes, maybe a little bit more, but it's a moving number.

Okay, was that business profitable under the Laserscope/AMS flag?

I can't answer that, and without this carve-out pro forma, there's no way I could.

Well, I'm sure they had it broken out, so you looked at -- in your due diligence.

No, Stan, they really did not, because they never separated their service out before between aesthetics and urology. So we had a due diligence estimate, and the numbers are certainly in line with what we saw in due diligence that we've seen thus far from a top line, but again, it's moving around a little bit, so it would be unfair to comment.

But your business that you bought is continuing to be what you expect it to be from the Laserscope aesthetics side.

At this point in time, I think I'd say yes, but still we need to see more of the business to understand it. It's just more of a timing issue and having the information.

Were there any disposables -- my last question, in the aesthetic business that Laserscope transferred to you? I know in their regular business for the urology, the green light was a disposable fiber.

No, there really was not, Stan. And certainly that's an area as we look in the future for products that we'd like to find a model to take into our product portfolio.

Okay. Thank you, good luck.

Okay. Thanks, Stan.

Thank you, the next question is from Jason Mills with Canaccord Adams. Please go ahead with your question.

Hey, Barry, most of my questions have been asked and answered. Just maybe you can go back and talk about -- a lot of detail on the covenants. I understand where the concern is there and you've gone over that, so we'll just have to wait and see how that goes. But assuming you're able to work that out with the local bank and get that to where you can operate your business and really try to win in your marketplaces, and given your expectations for the true yellow launch -- could we talk --?

Really what the story comes down to from an investor standpoint is the top line, and understanding the need to cut operating expenses near term with respect to your need for generating better cash flow from operations and satisfying the covenants -- longer term, top line will drive that profitability line.

So maybe you could spend a few minutes, and help us out during a conference call where obviously you've been bogged down answering questions, rightly so, about the covenants. Maybe give you a chance to spend some time talking about the opportunities you have in your marketplaces from a top line perspective.

And I know you don't want to reiterate or otherwise your guidance, but with respect maybe to your core business, your core Iridex business, irrespective of the Laserscope acquisition, understanding you've got a lot of moving parts, maybe you could talk about what you're doing to reinvigorate the OUS business, and how your U.S. ophthalmic business is tracking, to give us some semblance of an idea of how your core business is doing, and maybe what we should expect over maybe not the next quarter, but maybe the next 18 months.

Good, a nice short, simple question, Jason. But I appreciate the question and the opportunity, because there are some things that we're obviously excited about and believe provide opportunities for us in '07 and '08, not just top line, but also bottom line. We did the last day of the year ship our new green laser.

The OcuLight TX. It has more features, it has a better cost of goods, and that product has been accepted into the marketplace very well, as we've also spoken to the fact that the 577 product will be introduced sometime around midyear and we're anticipating the back half of the year that's helping us in our growth in ophthalmology.

We're continued to focus on new disposable products, and our objective is to have at least six new disposable probes again this year for ophthalmology. The growth we experienced last year was very nice, and was obviously very much a contributing factor in our growth in gross margin. And that's something we're quite proud of in terms of the progress we've made from '04 where we were a 45% gross margin company and to be at over 52% last year and 55.5% fourth quarter is very encouraging and certainly headed in the right direction.

From the aesthetics side of the business, the Gemini product is really a nice product. And that's one of the things that, as Dalton mentioned, some of the key industry leaders we met with at the American Academy of Dermatology meeting, we really understood more how viable that technology is. It's been quoted by several physicians using the word workhorse. It's the go-to product they have in aesthetics treatments, because it can do so many different things.

One physician was quoted, and this physician had 35 lasers in her practice, and her comment was if her facility were to burn down today, the Gemini would be the first unit that she would replace. So we're very excited about that product. There's some new countries in which it's being approved, internationally, so there's fertile ground for us with that product in '07 and '08. We've got some very nice distribution channels established internationally and there are some new markets that are really starting to catch on fire for us on the international side.

And add to that the VariLite, which is the Iridex product which was a 532/940 wavelength for dermatologists. We had very, very limited distribution outside the U.S. and now we are up. And we've trained all the European distributors just last week on it, and we've got some more distributor training to do, but we feel like that's going to provide nice new opportunities for that product. And all of that said, top line, all of that sounds good, but the most important thing is using that to leverage and drive our bottom line.

Right, no, I understand that. It seems like you'd given guidance for at least $75 million in revenue previously, and you're telling us we should probably wait for updated guidance when you get the pro forma carve-out, and can understand that. And correct me if I'm wrong, Barry, but that seems to be reflective of really the service component, which is a large component of Laserscope.

And it seems to me the question is whether or not you can recognize for Iridex that revenue in 2007. If that's the case, then when we look at 2008, well, then you'll certainly be able to recognize it then. So it's not that revenue in perpetuity is at risk, it's whether or not you can recognize it this year. That's point number one.

Point number two would be your U.S. ophthalmic business showed growth this year in the single digits, but against the $2 million comp OEM you didn't have, and then the OUS business was facing the issues it was facing. In '07, it doesn't have those issues, with two new lasers and six new probes, with a market growing [68%], even if you don't gain share, it grows, you would think.

And then in '08, you'll have your first full year of all that, so even if you're assuming market growth rates -- so you see what I'm getting at is --. What I'm wanting you to maybe do, if you can, is look, it looks like the story is pushed out a year with all the moving parts at Laserscope. And the stock's down 20% because of those issues, which I think are very important issues and concerning issues near term, if you're able to -- if we assume you're able to work it out with your banks, then we start to look at the things I'm talking about.

So maybe just another chance to get you to talk quantitatively. If you can't, you can't, I understand, but it's a second try.

Jason, maybe we should change the role. You answer the questions very well, so maybe I'll ask them.

I wouldn't be good at that.

But you do point out several of the opportunities that we do have. I think 2007 is a transition year for us. It's a step in where we've said that we want to get this business to in terms of top line, and we have to leverage that in order to get us to the bottom line. This business has to make a decent profit, and we see the ability to do that as we move down the road. And so, we've just got to stay focused on that from all areas.

When you in essence double the size of a company, everybody's job in the company changes. There are a lot of moving parts here within the company, and that takes transition on everybody's part individually.

I'll tell you a funny story that happened to me the other day. As Larry said, we spent the first quarter really transitioning the facility to get ready for bringing in more product to assemble and manufacture here. And I had been down in our break room twice in the morning to get coffee, and there's a door that's always there that leads back to manufacturing.

Well, the afternoon, we had a group that was touring through manufacturing. I went back to meet them. I go through the break room. I just about ran into a wall. The door wasn't there anymore. And things are changing that quickly. It's all good, but obviously it's challenging, and we'll go through our ups and downs in the process, but we're going to get there, and we're very confident about that.

Our folks are very excited, both the folks on the Iridex side, and the folks that we acquired at Laserscope. I went by our marketing department the other day and a lady stopped me, and she said, Barry, I want to thank you.

I figured I had done something. I didn't know what I had done. I asked her to explain. She said, I want to thank you for acquiring the Laserscope business. She said we really have a home now, and I feel good about the future, and I'm happy coming to work every day, whereas that might not have been the case before.

That's good to hear. Obviously, you have to execute on your deliverables, and so I'm sure you have -- last question here. I'm sure you have sort of a report card for yourself both near term and long term. We've talked a little bit about long term. Could you help those of us out here evaluating the company, or for me thinking about evaluating it, and give us your internal report card as to what you're going to hope to check off over the next -- let's just say next -- three months.

You've got the Synergetics litigation, you've got these issues with the banks. What would be wins for you over the next three to six months as far as taking care of things, and knocking them off your list so you can get off to Europe, and run your ophthalmic business and reinvigorate that and so forth?

I think I would probably put about four things in that bucket in the timeframe in which you speak, Jason. First, would be successful integration, and that's really focused on the people and the processes, and the transition, particularly, of manufacturing and quality and regulatory into our facility.

Second, would be the banks and our financing going forward. Third, would be the new product introductions, and that relates not just to the true yellow, but to the new products we expect to show at the American Academy of Ophthalmology during fourth quarter this year and a new product for dermatology first quarter of next year at the American Academy of Dermatology meeting.

And, as you mentioned, the litigation, coming to a successful judgment, verdict in that case, I think could be very helpful to us and get that behind us so we can focus our resources on all the other opportunities that we have before us.

Okay, thanks a lot for answering my questions. Good luck.

Thank you, Jason.

Thank you, and the next question comes from Michael Davidoff at Thomson Horstmann & Bryant. Please go ahead.

Hi, guys. I won't belabor a lot of the points and questions that have been asked so far. Just so Q1 is complete. I know you need to do the Laserscope carve-out and probably total up some other things, but can you give us an idea of when we can expect some preliminary Q1 results.

One of the things that we're dealing with for the first time is having a subsidiary, so we have to go through that process. There are some issues, I think as I mentioned, on service recognition for the first half, particularly of January. So I don't anticipate we're going to have any preliminary release, but it would be within the required timeframe, probably the last half of May.

Okay, my other question is obviously the balance sheet, which people are very interested in kind of getting a post-Laserscope kind of pro forma balance sheet, especially with respect to where you stand today. Is there any way you guys can give a little bit more granularity, just on the --?

Well, we'll be filing our 8-K, which will contain the carve-out financial audited statements, as well as pro forma statements, which will show the combined business, and we certainly hope to have that filing completed within the next couple of weeks.

Okay. And on a positive note, Barry, the Q4 gross margin, 55%, just maybe walk us through some of the drivers there and --?

Well, I think there are a couple of factors. One is, the product mix with disposables, which continues to be very nice, and we also did build some inventory during fourth quarter. And some of that relates to not having hit the number that we projected in fourth quarter, and also trying to prepare ourselves for the integration of the Laserscope products into the facility in terms of giving us more flexibility.

Okay. Okay, that's all I have. Thank you.

Thank you, Michael.

Thank you, and the next question is from Keay Nakae with Unterberg. Please go ahead.

Hey, Barry.

Keay, how are you?

Good. With respect to the Laserscope assets, now that you've had a full look under the covers, so to speak, is there anything there that is causing you any concerns that you have a greater appreciation for now that you perhaps didn't before the acquisition?

Well, I think, Keay, one of the things that I mentioned is there are a couple of reliability issues, one in a product that -- in the rationalization process that we're likely not going to sell in the short term until we can correct some of those situations, so we've got to look into that.

I think there are a couple of other reliability issues that we had some insight into, but now understanding them more, and have put some targets with our product innovation group and our engineering team to enhance some of those issues. So from a product point of view, yes, we've seen a few things that we didn't fully know before January 16th.

Okay. And then in terms of the pro forma numbers, maybe specifically the amount of accounts receivable, is that number still going to come into I guess what you had thought it was before, the $7.5 million to $9.5 million area?

I think we had a bucket that was like 7.3 to 9.5, something. The total asset bucket were to drop into net assets, of which a portion of that was accounts receivable. And I don't know that we could really put more color to what the A/R number is until we get this finalized, but I think it's fair to say that it's pretty much in the ballpark that we thought, at least what we see right now, but we haven't seen it all.

Okay. And then question for either you or Meryl, with the establishment of the valuation allowance for the deferred tax assets, now, obviously, you were in a loss position last year, and perhaps that's greater negative evidence, but the fact that you had to establish that, what does that say about your expectations for future profitability?

Well, I'm not sure it says a whole lot. I think clearly the fact that we were in a net loss for the last two out of three years, was pretty significant negative evidence for us to try to overcome.

I think coupled with the liquidity issues that were discussed, it made it a difficult -- it put us in a difficult position of being able to justify our ability to realize these deferred tax assets more likely than not. So, I think those are really the key drivers that led us to putting up a full valuation allowance on that asset.

As we mentioned, we will be evaluating that asset on a quarterly basis going forward, and when we get to a situation where we feel comfortable with our forecasted projections of the business, and we feel confident that we can reach that threshold of more likely than not, we will be able to basically reverse this valuation allowance back through the P&L.

And at the end of the day, were you leaning, perhaps giving more evidence to your forward-looking performance, given the addition of the Laserscope assets and its impact on profitability, and were just perhaps overruled by the auditors?

I think it's just a very tough argument to make when you've had a history of two years of losses out of the last three, and you're facing a liquidity issue and potential going concern opinion.

And I think add to that the fact that the carve-out pro forma wasn't complete.

Okay. All right, well, very good. Thank you.

Thank you.

Thank you, and at this time I would like to turn the call over to management for closing remarks.

Again, we'd like to thank all of you for joining us on our call, and if you have any follow-up questions you'd like to address to the management team, please feel free to call us, or call EVC and they'll find us. Thank you, very much, and have a good day.

Ladies and gentlemen, this concludes the Iridex Fourth Quarter and Full-Year 2006 Financial Results Conference Call. If you'd like to listen to a replay of today's conference call, please dial 800-405-2236, followed by the pound key. Once again, the number is 1-800-405-2236, followed by the pound key. I would like to thank you for the participation for today's call. You may now disconnect.