10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

Or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                          to                                         

Commission file number: 0-27598

IRIDEX CORPORATION

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	77-0210467 (I.R.S. Employer Identification Number)
1212 Terra Bella Avenue Mountain View, California (Address of principal executive offices)	94043-1824 (Zip Code)

Registrant’s telephone number, including area code: (650) 940-4700

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ      

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

APPLICABLE TO CORPORATE ISSUERS:

The number of shares of common stock, $.01 par value, issued and outstanding as of August 1, 2007 was 8,213,749

TABLE OF CONTENTS

Items	Page
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)		1
Condensed Consolidated Balance Sheets		1
Condensed Consolidated Statements of Operations		2
Condensed Consolidated Statements of Cash Flows		3
Condensed Consolidated Statements of Comprehensive Loss		4
Notes to Unaudited Condensed Consolidated Financial Statements		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3. Quantitative and Qualitative Disclosures about Market Risk		24
Item 4T. Controls and Procedures		24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		27
Item 1A. Risk Factors		27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		48
Item 3. Defaults Upon Senior Securities		48
Item 4. Submission of Matters to a Vote Security Holder		48
Item 5. Other Information		49
Item 6. Exhibits		49
Signature
EXHIBIT 10.1
EXHIBIT 10.7
EXHIBIT 10.8
EXHIBIT 31.1
EXHIBIT 32.1

PART I FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (unaudited)

IRIDEX Corporation

Condensed Consolidated Balance Sheets
(in thousands)

	June 30,			December 30,
	2007 (1)			2006 (2)
Assets
Current assets:
Cash and cash equivalents	$	3,551		$	21,051
Restricted cash		3,800			—
Accounts receivable, net		10,208			6,052
Inventories		13,973			9,499
Prepaids and other current assets		4,152			1,264
Total current assets	$	35,684		$	37,866
Property and equipment, net		1,836			1,087
Goodwill		9,903			—
Other intangible assets, net		15,250			—
Other long term assets		294			1,224
Total assets	$	62,967		$	40,177
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	6,075		$	1,830
Short term debt		3,863			—
Accrued compensation		2,244			1,517
Accrued expenses		8,251			2,392
Accrued warranty		2,335			866
Deferred revenue		4,239			1,415
Current portion of long term debt		5,508			—
Total current liabilities	$	32,515		$	8,020
Commitments and contingencies
Stockholders’ equity:
Common stock		83			79
Additional paid-in capital		33,273			29,697
Accumulated other comprehensive loss		(22	)		—
Treasury stock		(430	)		(430	)
(Accumulated deficit) retained earnings		(2,452	)		2,811
Total stockholders’ equity		30,452			32,157
Total liabilities and stockholders’ equity	$	62,967		$	40,177

(1)	Unaudited
(2)	Derived from the consolidated audited financial statements included in our report filed on Form 10-K with the SEC for the year ended December 30, 2006.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IRIDEX Corporation

Condensed Consolidated Statements of Operations
(Unaudited, in thousands except per share data)

	Three Months Ended						Six months ended
	June 30,			July 1,			June 30,			July 1,
	2007			2006			2007			2006
Sales	$	15,249		$	8,804		$	27,815		$	17,647
Cost of sales		8,665			4,145			16,023			8,726
Gross profit		6,584			4,659			11,792			8,921
Operating expenses:
Research and development		1,588			1,328			3,317			2,449
Selling, general and administrative		7,546			3,864			15,820			7,796
Total operating expenses		9,134			5,192			19,137			10,245
Loss from operations		(2,550	)		(533	)		(7,345	)		(1,324	)
Legal settlement		2,500			—			2,500			—
Interest and other (expense) income, net		(293	)		177			(418	)		356
Loss before income taxes		(343	)		(356	)		(5,263	)		(968	)
Provision for (benefit from) income taxes		—			(178	)		—			131
Net loss	$	(343	)	$	(534	)	$	(5,263	)	$	(837	)
Net loss per share — basic and diluted	$	(0.04	)	$	(0.07	)	$	(0.65	)	$	(0.11	)
Shares used in computing net loss per share — basic and diluted		8,196			7,694			8,138			7,641

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IRIDEX Corporation

Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)

	Six months ended
	June 30,			July 1,
	2007			2006
Cash flows from operating activities:
Net loss	$	(5,263	)	$	(837	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		1,803			251
Non-cash stock-based compensation		740			935
Provision for doubtful accounts		42			68
Provision for inventories		432			16
Changes in operating assets and liabilities, net of assets and liabilities acquired:
Accounts receivable		1,147			486
Inventories		(2,169	)		(299	)
Prepaids and other current assets		224			108
Other long term assets		(41	)		(26	)
Accounts payable		4,243			262
Accrued warranty		(302	)		—
Accrued expenses		(813	)		(1,115	)
Deferred revenue		938			152
Net cash provided by operating activities	$	981		$	1
Cash flows from investing activities:
Purchases of available-for-sale securities	$	—		$	(18,519	)
Proceeds from maturity of available-for-sale securities		—			8,778
Purchases of property and equipment		(502	)		(185	)
Purchases of intangible		(170	)		—
Restricted cash		(3,800	)		—
Cash from acquisition owing to seller		4,021			—
Acquisition of business		(28,152	)		—
Net cash used in investing activities	$	(28,603	)	$	(9,926	)
Cash flows from financing activities:
Proceeds from issuance of common stock	$	827		$	1,008
Proceeds of credit facility, net of issuance costs		11,900			—
Repayment of credit facility		(2,629	)		—
Net cash provided by financing activities	$	10,098		$	1,008
Effect of foreign exchange rate changes	$	24		$	—
Net decrease in cash and cash equivalents		(17,500	)		(8,917	)
Cash and cash equivalents at beginning of period	$	21,051		$	12,655
Cash and cash equivalents at end of period	$	3,551		$	3,738

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IRIDEX Corporation

Condensed Consolidated Statements of Comprehensive Loss
(Unaudited, in thousands)

	Three months ended						Six months ended
	June 30,			July 1,			June 30,			July 1,
	2007			2006			2007			2006
Net loss	$	(343	)	$	(534	)	$	(5,263	)	$	(837	)
Other comprehensive loss:
Change in unrealized loss on available for sale securities, net of tax		—			5			—			14
Foreign currency translation adjustments		(13	)		—			(22	)		—
Comprehensive loss	$	(356	)	$	(529	)	$	(5,285	)	$	(823	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IRIDEX Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of IRIDEX Corporation (“the Company”) have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and pursuant to the instructions to Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement of the financial statements have been included.

     The condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 30, 2007. The results of operations for the three and six month periods ended June 30, 2007 are not necessarily indicative of the results for the year ending December 29, 2007 or any future interim period.

     The Company expects that its current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will not be sufficient to meet the Company’s operating requirements, except for the near term and for a period substantially less than 12 months. Unless the Company is able to modify its planned operating requirements and raise additional capital, the Company’s current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will not be sufficient to meet the Company’s operating requirements, except for the near term and for a period substantially less than 12 months.. These planned requirements include amounts owing to American Medical Systems, Inc. (“AMS”) due to the acquisition of the assets of the aesthetics business of Laserscope (“Laserscope”), a subsidiary of AMS, including the return of cash to AMS obtained through the acquisition of Laserscope’s foreign subsidiaries and payments for inventory under the product supply agreement (the “Product Supply Agreement”) the Company entered into with Laserscope in connection with the asset acquisition (see Note10 below). In addition, for the second fiscal quarter ending June 30, 2007 the Company was not able to satisfy certain restrictive financial covenants contained in its credit facilities with Mid-Peninsula Bank and the Export-Import Bank (the “Lenders”) as well as an affirmative covenant regarding the preparation and delivery of quarterly financial statements within 45 days of quarter end (see Note 4). The Company has received a one-time waiver from Mid-Peninsula Bank with respect to its inability to satisfy the financial covenants contained in its loan agreements with the Lenders for the period ended June 30, 2007, but can provide no assurance that the Lenders will grant any additional future waivers if requested. The Company was also not in compliance with its debt covenants at the end of its first quarter but it was successful in obtaining a waiver of default for that period. In the event of noncompliance the Lenders would be entitled to exercise their remedies, under these facilities, which include declaring all obligations immediately due and payable and disposing of the collateral if obligations were not paid. The Company has modified planned operations in order to increase cash flows from operations, and intends to raise additional capital through equity or debt financing in order to enhance liquidity. However, there can be no assurances that the Company will be successful in these efforts or that any additional capital raised through debt or equity financings will be available on favorable terms or at all. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty

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2. Summary of Significant Accounting Policies

     The Company’s significant accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 30, 2006 which was filed with the Securities and Exchange Commission on March 30, 2007. During the six months ended June 30, 2007, the Company has implemented an accounting policy for the valuation of goodwill and intangible assets.

Revenue Recognition

     Our revenues arise from the sale of laser consoles, delivery devices, disposables and service and support activities. Revenue from product sales is recognized upon receipt of a purchase order and product shipment provided that no significant obligations remain and collection of the receivables is reasonably assured. Shipments are generally made with Free-On-Board (FOB) shipping point terms, whereby title passes upon shipment from our dock. Any shipments with FOB receiving point terms are recorded as revenue when the shipment arrives at the receiving point. Up-front fees received in connection with product sales are deferred and recognized upon the associated product shipments. Revenue relating to extended warranty contracts is recognized on a straight line basis over the period of the applicable warranty contract. We recognize repair service revenue upon completion of the work. Cost is recognized as product sales revenue is recognized. The Company’s sales may include post-sales obligations for training or other deliverables. When these obligations are fulfilled after product shipment, the Company recognizes revenue in accordance with the multiple element accounting guidance set forth in Emerging Issues Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables.” When the Company has objective and reliable evidence of fair value of the undelivered elements, it defers revenue attributable to the post-sale obligations and recognizes such revenue when the obligation is fulfilled. Otherwise, the Company defers all revenue related to the transaction until all elements are delivered.

     In international regions outside of the United Kingdom and France, we utilize distributors to market and sell our products. We recognize revenues upon shipment for sales through these independent, third party distributors as we have no continuing obligations subsequent to shipment. Generally, our distributors are responsible for all marketing, sales, installation, training and warranty labor coverage for our products. Our standard terms and conditions do not provide price protection or stock rotation rights to any of our distributors.

Valuation of Goodwill and Intangible Assets

     The purchase method of accounting for acquisitions requires estimates and assumptions to allocate the purchase price to the fair value of net tangible and intangible assets acquired. The amounts allocated to, and the useful lives estimated for, other intangible assets, affect future amortization. There are a number of generally accepted valuation methods used to estimate fair value of intangible assets, and we use primarily a discounted cash flow method, which requires significant management judgment to forecast the future operating results and to estimate the discount factors used in the analysis. If assumptions and estimates used to allocate the purchase price prove to be different based on actual results, future asset impairment charges could be required.

     Goodwill and intangible assets determined to have indefinite lives are not amortized, but are subject to an annual impairment test. We intend to conduct an annual goodwill impairment test in the fourth quarter of our fiscal year. To determine any goodwill impairment, a two-step process is performed on an annual basis, or more frequently if necessary, to determine 1) whether the fair value of the relevant reporting unit

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exceeds carrying value and 2) to measure the amount of an impairment loss, if any. We have identified the aesthetics medical device segment as the appropriate reporting unit for this analysis. We review our intangible assets for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. An asset is considered impaired if its carrying amount exceeds the future net cash flow the asset is expected to generate. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. The Company assesses the recoverability of its long-lived and intangible assets by determining whether the unamortized balances can be recovered through undiscounted future net cash flows of the related assets. The amount of impairment, if any, is measured based on projected discounted future net cash flows.

     Goodwill and purchased intangible assets were initially recorded in the first three months of 2007 in conjunction with the acquisition of the aesthetics business of Laserscope (Note 3). We did not identify any events since the date of acquisition that that would indicate that there has been an impairment in the carrying value of these assets. However, if there are changes in events or circumstances, such as an inability to achieve the cash flows originally expected from the acquisition, which indicate that the recorded value of the intangible assets will not be recovered through future cash flows, or if the fair value of the aesthetics business unit is determined to be less than its carrying value, the Company may be required to record an impairment charge for the intangible assets or goodwill or change the period of expected amortization for the intangible assets.

Deferred Revenue

     Deferred revenue related to warranty contracts is recognized on a straight line basis over the period of the applicable contract. Cost is recognized as incurred. A reconciliation of changes in the Company’s deferred revenue balances for the six months ending June 30, 2007 and July 1, 2006 follows:

	Six Months Ended
	June 30,			July 1,
(in thousands)	2007			2006
Balance, beginning of period	$	1,415		$	1,072
Additions to deferral through acquisition		1,870			—
Additions to deferral		4,153			822
Revenue recognized		(3,199	)		(670	)
Balance, end of period	$	4,239		$	1,224

Warranty

     The Company accrues for an estimated warranty cost upon shipment of products in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies.” Actual warranty costs incurred have not materially differed from those accrued. The Company’s warranty policy is effective for shipped products which are considered defective or fail to meet the product specifications. Warranty costs are reflected in the statement of operations as a cost of sales. A reconciliation of the changes in the Company’s warranty liability for the six months ending June 30, 2007 and July 1, 2006 follows:

	Six Months Ended
	June 30,			July 1,
(in thousands)	2007			2006
Balance, beginning of period	$	866		$	1,128
Warranty accrual acquired through acquisition		1,771			—
Accruals for warranties issued during the period		497			335
Settlements made in kind during the period		(799	)		(534	)
Balance, end of period	$	2,335		$	929

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Accounting for Uncertainty in Income Taxes

     Effective January 1, 2007, the Company adopted Financial Accounting Standards Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in a company’s income tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 utilizes a two-step approach for evaluating uncertain tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS No. 109). Step one, recognition, requires a company to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. Step two, measurement, is based on the largest amount of benefit, which is more likely than not to be realized on ultimate settlement. The cumulative effect of adopting FIN No. 48 on January 1, 2007 is recognized as a change in accounting principle, recorded as an adjustment to the opening balance of retained earnings on the adoption date. As a result of the implementation of FIN No. 48, the Company recognized no change in the liability for unrecognized tax benefits related to tax positions taken in prior periods. Upon adoption of FIN No. 48, the Company’s policy to include interest and penalties related to unrecognized tax benefits within the Company’s provision for (benefit from) income taxes did not change. The Company’s total amount of unrecognized tax benefits as of January 1, 2007 (adoption date) was $517,733. Of this amount, none would affect the Company’s effective tax rate if recognized.

3. Business Combination

     On January 16, 2007, the Company completed the acquisition of the aesthetics business from American Medical Systems, Inc. (“AMS”) and Laserscope, a wholly owned subsidiary of AMS pursuant to the terms of the Asset Purchase Agreement dated November 30, 2006 between AMS, Laserscope, and Iridex Corporation. These financial statements include the results of operations for the acquired business from the acquisition date.

     Iridex purchased the aesthetics business of former Laserscope from AMS due to its complementary fit with the existing Iridex laser business. Under the terms of the Asset Purchase Agreement, Iridex Corporation purchased the aesthetics business for the following consideration:

(in thousands)
Cash paid on closing	$	26,000
Issuance of common stock		2,014
Post closing adjustment to purchase price		(2,766	)
Acquisition costs		3,219
Total purchase price	$	28,467

     Issuance of common stock included 213,435 shares of common stock valued at $9.43 per share.

     Acquisition costs include investment banking, legal and accounting fees, and other external costs directly related to the acquisition.

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     The preliminary allocation of the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed was based on their estimated fair values at the date of acquisition as determined by management. These estimates are subject to further review by management upon completion of the audit of the aesthetics business of Laserscope for the year ended December 31, 2006. Independent valuation experts assisted the Company in determining the valuation of the intangible assets acquired. Further adjustments to these estimates may be included in the final allocation of the purchase price, if the adjustment is determined within the purchase allocation period (up to twelve months of the closing date). The excess of the purchase price over the tangible and identifiable assets acquired and liabilities assumed has been allocated to goodwill. The purchase price has been preliminarily allocated as follows:

(in thousands)
Accounts Receivable	$	5,309
Finished Goods Inventory	$	2,691
Other current assets	$	311
Property and equipment	$	681
Intangible assets	$	16,447
Deferred Revenue	$	(1,870	)
Accrued Warranty	$	(1,771	)
Accrued Liabilities	$	(3,234	)
Fair value of net assets acquired	$	18,564
Goodwill	$	9,903
Total purchase price	$	28,467

     In addition, the Asset Purchase Agreement signed with AMS calls for a post-close adjustment mechanism which in effect allows for an adjustment to the final purchase price based upon the parties’ agreement to the final closing balance sheet and several other items. The Company has recorded $2.7 million due from AMS as an adjustment to the purchase price as determined under the terms of the asset purchase agreement and based on an agreement with AMS regarding this post close adjustment dated August 14, 2007. The total purchase price recorded has been reduced by $1.8 million in the second quarter, based on a $2.0 million decrease in the estimated purchase price adjustment, less $0.2 million of additional acquisition costs recorded this quarter. As of June 30, 2007 amounts owing to AMS for cash obtained through the acquisition of the foreign subsidiaries, but not included in the asset purchase agreement was $3.9 million. This cash will be netted against the payment of $2.7 million owed to the Company under the post close balance sheet adjustment. Pursuant to the Settlement Agreement reached with AMS, this amount of $1.2 million will be paid to AMS in weekly installments over the course of the next year. (See Note 10)

     The components of the Company’s intangible assets are as follows (in thousands):

				Gross				Net,
	Useful	Annual		Carrying		Accumulated		Carrying
Intangible Asset Acquired	Lives	Amortization		Value		Amortization		Value
Gemini Handset — Core Technology	10 Years	$	299	$	2,995	$	136	$	2,859
Gemini — Current Technology	4 Years		1,282		5,129		581		4,548
Other Products — Current Technology	1 Year		341		341		154		187
Accessories — Current Technology	4 Years		15		62		7		55
Services — Contractual Customer Relationships	10 Years		532		5,318		241		5,077
Contractual Distribution Agreement	5 Years		370		1,848		167		1,681
Trade Name	5 Years		151		754		68		686
Other	3 Years		57		170		13		157
		$	3,047	$	16,617	$	1,367	$	15,250

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     Amortization for the technology related intangibles is being recorded in cost of goods sold and amortization for marketing related intangibles is being recorded in selling, general and administrative expense.

     Through this acquisition, the Company plans to increase its sales into the aesthetic laser market and augment its core ophthalmic business with enhanced revenue and marketing opportunities. These factors primarily contributed to a purchase price which resulted in the recording of goodwill. Goodwill of $9.9 million represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” goodwill will not be amortized but will instead be tested for impairment annually or more frequently if certain indicators are present.

     Estimated future amortization expense for purchased intangible assets from the acquisition is as follows:

(in thousands)
2007	$	2,893
2008	$	2,723
2009	$	2,706
2010	$	2,662
2011	$	1,413
Thereafter	$	4,221
Total	$	16,617

     The Company has agreed under a Settlement Agreement dated August 14, 2007 with Laserscope which amends the Product Supply Agreement which was entered into at the time of acquisition to purchase at the end of such agreement, quantities of work-in-process, raw and packaging materials, or spare and replacement parts that have an aggregate book value of $4.1 million. The Company believes this commitment as defined will result in the acquisition of material useable in its ordinary course of business through the sale or servicing of aesthetic laser products. (See Note 10)

     Supplemental pro forma information that discloses the results of operations for the current interim period and the prior year comparable period as though the business combination had been completed as of the beginning of the period being reported on is not available because the preparation of the financial statements of the acquired business are not complete.

4. Bank Borrowings

     On January 16, 2007, the Company entered into a Business Loan and Security Agreement with Mid-Peninsula Bank, part of Greater Bay Bank N.A. and Exim Bank. The Credit Agreement provides for an asset-

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based revolving line of credit of up to $6.0 million (the “Revolving Loans”) and a $6.0 million term loan (the “Term Loan”). Of the Revolving Loans, up to $3.0 million principal amount will be guaranteed by Exim Bank. The Company’s obligations under the Term Loans and the Revolving Loans are secured by a lien on substantially all of the Company’s assets. Interest on the Term Loan and the Revolving Loans is the prime rate as published in the Wall Street Journal, minus 0.5%. Indebtedness outstanding under the Term Loan and the Revolving Loan was $5.5 million and $3.9 million respectively at June 30, 2007. These facilities contain certain financial and other covenants, including the requirement for Iridex to maintain profitability on a quarterly basis, tangible net worth of $15.5 million, maintain unrestricted cash/marketable securities of $3 million and maintain a debt service ratio of 1.75 to 1.00 on an annual basis. At March 31, 2007 and June 30, 2007, the Company was not in compliance with certain of the financial covenants contained in these agreements.

     On April 19, 2007, the Company and Mid-Peninsula Bank entered into amendments to each of the loan agreements. Pursuant to the Amendments, the Company agreed to deposit and maintain $3.8 million in cash in a segregated deposit account with Lender as collateral in support of the Term Loan and to restrict up to $2.2 million of the combined borrowing base from the Line of Credit in support of the Term Loan. The parties agreed to eliminate the requirement that the Company maintain a minimum of $3.0 million in aggregate domestic unrestricted cash or marketable securities. In addition, the Lender increased the credit extended by Lender to the Company under the Exim Agreement from $3.0 to $5.0 million; however this increase only resulted in a potential increase in a guarantee by Exim Bank and did not impact the total borrowing availability under the line. In connection with the Amendments, Lender also agreed to a one-time waiver of certain financial covenants contained in the loan agreements for the quarter ended March 31, 2007. In addition, the Company was not in compliance with certain financial covenants contained in the amended loan agreements at the end of its second fiscal quarter ending June 30, 2007. In addition the Company was in violation of an affirmative covenant regarding the preparation and delivery of quarterly financial statements within 45 days of quarter end. In anticipation of this violation Mid-Peninsula Bank and Export-Import Bank on June 19, 2007 waived the default from the expected non-compliance at June 30, 2007 of the tangible net worth covenant, the minimum debt service ratio and the minimum income covenant. This waiver related only to the breach of financial covenants occurring on June 30, 2007 and did not cover any subsequent breach, should one occur, of the financial covenants contained within the loan agreements.

     In the accompanying balance sheet, all debt under the five year term loan is classified as current portion of long-term debt due to the fact that a covenant violation has occurred at the balance sheet date or would have occurred absent a loan modification and it is probable that the Company will not be able to cure the default (comply with the covenant) at measurement dates that are within the next 12 months.

     In conjunction with the issuance of this debt, the Company incurred $0.1 million of debt issuance costs which have been capitalized and will be amortized on an effective interest basis over the term of the debt which is sixty months.

5. Inventories

     Inventories are stated at the lower of cost or market and include on-hand inventory, sales evaluation inventory and service loaner inventory. The Company includes evaluation units held for sales within inventories. The Company carries the evaluation units at cost less amortization over their estimated economic life of four years. Amortization related to evaluation units is recorded in cost of sales and reflects the physical deterioration, usage and obsolescence of the products. Proceeds from the sale of evaluation units are recorded as revenue and all costs incurred to refurbish a system prior to sale are charged to cost of sales.

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     Cost is determined on a standard cost basis which approximates actual cost on a first-in, first-out (FIFO) method. Lower of cost or market is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolescence or impaired inventory and are charged to cost of goods sold. Factors influencing these adjustments include changes in demand, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates. The components of inventories consist of the following:

	June 30,		December
(in thousands)	2007		30, 2006
Raw materials and work in progress	$	6,244	$	4,000
Finished goods		7,729		5,499
Total inventories	$	13,973	$	9,499

6. Contingencies

     Patent Litigation — On October 19, 2005, the Company filed a suit in the United States District Court for the Eastern District of Missouri against Synergetics, USA, Inc. for infringement of a patent. The Company later amended its complaint to assert infringement claims against Synergetics, Inc.; Synergetics USA, Inc. was dismissed from the suit. The Company alleged that Synergetics infringed the Company’s patent by making and selling infringing products, including its Quick Disconnect laser probes and its Quick Disconnect Laser Probe Adapter, and sought injunctive relief, monetary damages, treble damages, costs and attorneys’ fees. On April 25, 2006, Synergetics added the Company as a defendant to a then existing lawsuit in the U.S. District Court for the Eastern District of Pennsylvania. In that litigation, Synergetics alleged that the Company infringed its patent on a disposable laser probe design.

     Trial in the Missouri litigation was scheduled to begin on April 16, 2007, however on April 6, 2007 the parties reached settlement on the claims. Under the terms of the settlement agreement, the parties agreed to terminate all legal proceedings between the parties and to a fully paid-up, royalty free, worldwide cross licensing of various patents between the two companies. In consideration of these licenses Synergetics agreed to pay the Company $6.5 million over a period of five years. The first payment of $2.5 million by Synergetics was received on April 16, 2007 and was recorded as other income in the consolidated statement of operations. Additional annual payments of $0.8 million will be received on each April 16th until 2012.

     Management believes that claims which are pending or known to be threatened, will not have a material adverse effect on the Company’s financial position or results of operations and are adequately covered by the Company’s liability insurance. However, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management’s attention and the incurrence of significant expenses.

7. Computations of Net Loss Per Common Share

     Basic and diluted net loss per share are computed by dividing net loss for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share includes the dilutive effect of potentially dilutive common stock provided the inclusion of such potential common stock is not antidilutive. Potentially dilutive common stock consists of incremental common shares issuable upon the exercise of stock options and a warrant to purchase common shares.

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     During the three months and six months ended July 1, 2006, options to purchase 2,056,448 shares of common stock at a weighted average exercise price of $5.80 as well as a warrant to purchase 25,000 shares at a weighted average exercise of $6.07 were outstanding but were not included in the computations of diluted net loss per common share because their effect was antidilutive. During the three and six months ended June 30, 2007, options to purchase 2,238,142 shares at a weighted average exercise price of $6.49 were available as well as a warrant to purchase 25,000 shares of common stock at a weighted average exercise price of $6.07 were outstanding but were not included in the computations of diluted net loss per common share because their effect was antidilutive. These options and warrant could dilute earnings per share in future periods.

8. Business Segments

     The Company operates in two reportable segments: the ophthalmology medical device segment and the aesthetics medical device segment. In each segment the Company develops, manufactures, markets and services medical devices. Our revenues arise from the sale of consoles, delivery devices, disposables and service and support activities.

     Information on reportable segments for the three and six months ended June 30, 2007 and July 1, 2006 is as follows:

	Three Months Ended June 30, 2007							Three Months Ended July 1, 2006
	Ophthalmology		Aesthetics					Ophthalmology		Aesthetics
	Medical		Medical					Medical		Medical
(in thousands)	Devices		Devices		Total			Devices		Devices		Total
Sales	$	8,389	$	6,860	$	15,249		$	7,681	$	1,123	$	8,804
Direct cost of goods sold		2,365		3,876		6,241			2,213		475		2,688
Direct gross margin		6,024		2,984		9,008			5,468		648		6,116
Total unallocated indirect costs						(9,351	)						(6,472	)
Pre-tax income (loss)					$	(343	)					$	(356	)

	Six Months Ended June 30, 2007							Six Months Ended July 1, 2006
	Ophthalmology		Aesthetics					Ophthalmology		Aesthetics
	Medical		Medical					Medical		Medical
	Devices		Devices		Total			Devices		Devices		Total
Sales	$	15,578	$	12,237	$	27,815		$	15,221	$	2,426	$	17,647
Direct cost of goods sold		4,509		6,749		11,258			4,742		1,158		5,900
Direct gross margin		11,069		5,488		16,557			10,479		1,268		11,747
Total unallocated indirect costs						(21,820	)						(12,715	)
Pre-tax income (loss)					$	(5,263	)					$	(968	)

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     Indirect costs of manufacturing, research and development, and selling, general and administrative costs are not allocated to the segments.

     The Company’s assets and liabilities are not evaluated on a segment basis. Accordingly, no disclosure of segment assets and liabilities is provided.

9. Stock-based Compensation

Stand-Alone Options

     In February 2007, the Compensation Committee of the Company’s Board of Directors approved the grant of 235,000 non-qualified stock options, outside of the Company’s existing stock plans, to a total of 54 new employees, both domestic and international, hired in connection with the Company’s recently completed acquisition of the assets of the aesthetics business of Laserscope. These options were granted as of February 28, 2007 at an exercise price of $10.06 per share.

     The following table shows the pre-tax stock-based compensation expense recognized during the quarter and included in the Consolidated Statements of Operations for the three and six month periods ended June 30, 2007 and July 1, 2006:

	Three months ended				Six months ended
	June 30,		July 1,		June 30,		July 1,
(in thousands)	2007		2006		2007		2006
Cost of sales	$	44	$	31	$	70	$	67
Research and development		50		73		112		121
Sales, general and administrative		290		374		558		747
	$	384	$	478	$	740	$	935

10. Subsequent Events

     AMS Settlement

     On August 14, 2007, the Company AMS and Laserscope (collectively the “Parties”), entered into a Settlement Agreement (the “Settlement Agreement”). The Parties entered into the Settlement Agreement to document their full and final agreement as to the amount of the adjustment contemplated by Section 1.5 of the Asset Purchase Agreement, by and among AMS, Laserscope and the Company, dated November 30, 2006 (the “Purchase Agreement”); to amend the Product Supply Agreement, between Laserscope and the Company, dated January 16, 2007 (the “Product Supply Agreement”); and to set forth the Parties’ mutual understanding as to certain other matters.

     The Settlement Agreement provides that, pursuant to Section 1.5 of the Purchase Agreement, the Company will make an additional payment to AMS of approximately $1.2 million, which will be the sole and final adjustment

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to the purchase price and will be paid in equal weekly installments of $22,115 beginning August 16, 2007 over the course of the next year. This $1.2 million amount reflects the net amount owed by the Company to AMS after taking into account the $3.9 million in cash obtained through the Company’s acquisition of Laserscope’s foreign subsidiaries, which was not included in the original purchase price, net of $2.7 million owed to the Company by AMS pursuant to the purchase price adjustment provisions of the Purchase Agreement.

     In addition, the Settlement Agreement modifies and amends certain terms of the Product Supply Agreement, including among others: (a) agreement upon the current and future products to be built and delivered by Laserscope to the Company and the payment terms relating thereto; (b) allocation of and pricing and delivery terms relating to inventory parts to be sold by Laserscope to the Company and agreement on a payment plan for currently outstanding invoices, which includes two weekly payments of $100,000 each for the last two weeks of August, increasing to $150,000 per week for four weeks in September and (c) agreement upon certain payments to be made by the Company to AMS in the event that the Company increases its borrowing capacity to more than $12,000,000 under any credit facility that is senior to the Company’s payment obligations under the Settlement Agreement. Under the terms of the Settlement Agreement, the Company agreed to payments totaling $4,059,557 in respect of certain inventory and service parts to be purchased from AMS following termination of the Product Supply Agreement. This sum is to be paid in 39 weekly installments of $110,185 including an interest charge of 10% per annum beginning on January 3, 2008. This sum is in settlement of potential payments of up to $9 million for inventory from AMS following the scheduled termination of the Product Supply Agreement in October 2007.

     Under the Settlement Agreement, the Parties also agreed that the Company and AMS will evenly split AMS’s costs associated with the termination of one of Laserscope’s French employees who was originally scheduled to become an employee of the Company.

     The parties have also agreed subject to certain limitations, to release each other from any claims related to indemnification, purchase price and post-closing adjustments in the Purchase Agreement as well as any amounts due under the Product Supply Agreement. The Company also agreed to release AMS and Laserscope from any liability from claims related to the sections in the Purchase Agreement dealing with financial matters, undisclosed liabilities, receivables and preparation of historical financial statements. The Parties agreed that, other than with respect to fraud and certain specified representations and warranties, the representations and warranties contained in the Purchase Agreement terminated contemporaneously with the signing of the Settlement Agreement and the Parties could no longer make indemnification claims relating thereto.

     Upon execution of the Settlement Agreement, the Company also executed a Security Agreement, dated August 14, 2007 (the “Security Agreement”), granting AMS and Laserscope a subordinate security interest in all the Company’s assets to secure all of its current and future obligations to AMS or Laserscope.

     Any breach by the Company of any provision of any of its agreements with AMS or Laserscope shall constitute an immediate default and shall entitle AMS and Laserscope to any and all remedies available to them under the Security Agreement, the Product Supply Agreement, and the Settlement Agreement, including, but not limited to, the right to terminate the Product Supply Agreement immediately upon written notice to the Company with no additional notice period or opportunity to cure and the right to declare all amounts due from the Company to AMS to be immediately due and payable in full.

11. Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We do not believe that the adoption of the provisions of SFAS 159 will materially impact our consolidated financial position and results of operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Quarterly Report on Form 10-Q contains trend analysis and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, such as statements relating to levels of future sales and operating results; broadening our product line through product innovation;: market acceptance of our products; expectations for future sales growth, generally, including expectations of additional sales from our new products and new applications of our existing products; our ability to integrate the newly acquired aesthetics business into our core business successfully and in a timely manner; the potential for production cost decreases and higher gross margins; our ability to develop and introduce new products through strategic alliances; our ability to reduce spending, including a reduction in the use of contractors and consultants ; levels of interest income and expense; general economic conditions; levels of international sales and our current liquidity, ability to obtain additional financing and impact of concern regarding our ability to continue as a going concern; the potential to record an impairment charge to goodwill and intangible assets and effects of recent accounting pronouncements on our financial position. In some cases, forward-looking statements can be identified by terminology, such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the negative of such terms or other comparable terminology. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements, including as a result of the factors set forth under “Factors That May Affect Future Operating Results” and other risks detailed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2007 and detailed from time to time in our reports filed with the Securities and Exchange Commission. The reader is cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this quarterly report on Form 10-Q. We undertake no obligation to update such forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview

     IRIDEX Corporation is a leading worldwide provider of therapeutic based laser systems and delivery devices used to treat eye diseases in ophthalmology and skin conditions in aesthetics. Our products are sold in the United States predominantly through a direct sales force and internationally through 95 independent distributors into 107 countries.

     Our revenues arise from the sale of our IRIS Medical OcuLight Systems, IQ810 lasers, VariLite, DioLite 532 systems, delivery devices, disposables and revenues from service and support activities. Our current family of OcuLight systems includes the IRIS Medical OcuLight Symphony, OcuLight SL, OcuLight SLx, OcuLight TX, OcuLight GL and OcuLight GLx laser photocoagulation systems as well as the IQ810 laser. We also produce the Millennium Endolase module which is sold exclusively to Bausch & Lomb and incorporated into their Millennium Microsurgical System.

     In January 2007, the Company acquired Laserscope’s aesthetics business including its subsidiaries in France and the United Kingdom (UK) from American Medical Systems Holdings (AMS). Laserscope aesthetic treatments encompass minimally invasive surgical treatments for hair removal, leg vein treatments, wrinkle removal, acne damage, sun damage and skin rejuvenation. These procedures are usually not performed in an operating room and are therefore paid for by patients without the assistance of any insurance or Medicare reimbursement. Laserscope’s aesthetic products include the Gemini™ Laser System, Venus-i™ Laser Systems, Lyra-i™ Laser System, Aura-i™ Laser System featuring StarPulse™ and Solis IPL System.

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Lasersope’s delivery devices include VersaStat i SmartScan Plus, SmartScan™, CoolSpot™, Dermastats™ and MicronSpot™, Dermastats.

     We believe that our future growth in revenue will be based upon the successful implementation of our strategy in these areas: 1) leveraging our core business and increasing recurring revenues, 2) broadening our product lines through product innovation, and 3) successfully integrating the newly acquired aesthetics business into our core Iridex laser business.

Resignation of CFO

     On July 5, 2007, subsequent to the three month period covered by this Quarterly Report on Form 10-Q, Meryl A. Rains, who commenced service as the Company’s Chief Financial Officer on February 5, 2007, notified the Company that she was resigning as the Company’s Chief Financial Officer, effective as of July 20, 2007. The Company has hired an interim Chief Financial Officer to serve while the Company works to identify and hire a permanent Chief Financial Officer.

Results of Operations

     The following table sets forth certain operating data as a percentage of sales for the periods included.

	Three Months Ended						Six Months ended
	June 30,			July 1,			June 30,			July 1,
	2007			2006			2007			2006
Sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		56.8	%		47.1	%		57.6	%		49.4	%
Gross profit		43.2	%		52.9	%		42.4	%		50.6	%
Operating expenses:
Research and development		10.4	%		15.1	%		11.9	%		13.9	%
Sales, general and administrative		49.5	%		43.9	%		56.9	%		44.2	%
Total operating expenses		59.9	%		59.0	%		68.8	%		58.1	%
Loss from operations		(16.7	)%		(6.1	)%		(26.4	)%		(7.5	)%
Interest and other expense, net		14.4	%		2.0	%		7.5	%		2.0	%
Loss before income taxes		(2.3	)%		(4.1	)%		(18.9	)%		(5.5	)%
Benefit from income taxes		0.0	%		(2.0	)%		0.0	%		0.8	%
Net loss		(2.3	)%		(6.1	)%		(18.9	)%		(4.7	)%

     The following table sets forth for the periods indicated the amount of sales for our operating segments and sales as a percentage of total sales of medical devices for the ophthalmology and aesthetics segments.

	Three Months Ended										Six Months Ended
	June 30, 2007					July 1, 2006					June 30, 2007					July 1, 2006
			Percentage					Percentage					Percentage					Percentage
			of total					of total					of total					of total
(dollars in thousands)	Amount		sales			Amount		sales			Amount		sales			Amount		sales
Domestic	$	8,381		55.0	%	$	5,296		60.2	%	$	15,056		54.1	%	$	10,426		59.1	%
International		6,868		45.0	%		3,508		39.8	%		12,759		45.9	%		7,221		40.9	%
Total		15,249		100.0	%		8,804		100.0	%		27,815		100.0	%		17,647		100.0	%

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	Three Months Ended										Six Months Ended
	June 30, 2007					July 1, 2006					June 30, 2007					July 1, 2006
			Percentage					Percentage					Percentage					Percentage
			of total					of total					of total					of total
(dollars in thousands)	Amount		sales			Amount		sales			Amount		sales			Amount		sales
Ophthalmology:
Domestic		4,961		32.5	%		4,544		51.6	%		8,968		32.2	%		8,637		49.0	%
International		3,428		22.5	%		3,137		35.6	%		6,610		23.8	%		6,584		37.3	%
Total		8,389		55.0	%		7,681		87.2	%		15,578		56.0	%		15,221		86.3	%
Aesthetics:
Domestic		3,420		22.4	%		753		8.6	%		6,088		21.9	%		1,789		10.1	%
International		3,440		22.6	%		370		4.2	%		6,149		22.1	%		637		3.6	%
Total	$	6,860		45.0	%	$	1,123		12.8	%	$	12,237		44.0	%	$	2,246		13.7	%

Ophthalmology and Aesthetics Sales Overview:

     We manage and evaluate our business in two segments – ophthalmology medical devices and aesthetic medical devices. We further break down these segments by geography—Domestic (United States) and International (the rest of the world). In addition, within ophthalmology, we review trends by laser system sales (laser boxes and delivery devices) and recurring sales (single use disposable probes, EndoProbes.) The newly acquired Laserscope aesthetics business is included in the aesthetic segments.

     Total sales increased by 73.2% to $15.2 million for the three months ended June 30, 2007 from $8.8 million for the three months ended July 1, 2006. Domestic sales, which represented 55.0% of total sales, increased 58.3% to $8.4 million for the three month period ended June 30, 2007 from $5.3 million for the three months ended July 1, 2006. The increase in domestic sales was the result of a $1.7 million increase in domestic aesthetic revenue and a $1.0 million increase in domestic service revenue largely attributable to the newly acquired Laserscope business and a $0.4 million increase in domestic ophthalmology revenue largely related to an increase in disposable probe revenue. International sales, which represented 45.0% of total sales, increased 95.8% to $6.9 million for the three month period ended June 30, 2007 from $3.5 million for the three months ended July 1, 2006. The increase in international sales was the result of a $3.0 million increase in international aesthetic revenue and a $0.4 million increase in international service revenue largely attributable to the newly acquired Laserscope aesthetics business and a $0.3 million increase in international ophthalmology equipment revenue.

     Total sales increased by 57.6% to $27.8 million for the six months ended June 30, 2007 from $17.6 million for the six months ended July 1, 2006. Domestic sales, which accounted for 54.1% of total sales, increased 44.4% to $15.0 million for the six months ended June 30, 2007 from $10.4 million for the six months ended July 1, 2006. The increase in domestic sales resulted primarily from an increase of $2.3 million in domestic aesthetics revenue and an increase of $2.2 million in domestic service revenue both attributable to the Laserscope acquisition and a $0.1 million increase in domestic ophthalmology revenue. Increased domestic disposable revenue during the period was offset by decreases in other domestic ophthalmology revenue, primarily OEM revenue. International sales, which represented 45.9% of total sales increased 76.8% to $12.7 million for the six month period ended June 30, 2007 from $7.2 million for the six month period ended July 1, 2006. The increase in international sales resulted mainly from an increase of $5.4 million in international aesthetics revenue largely attributable to the newly acquired Laserscope aesthetics business and a $0.1 million increase in combined international ophthalmology and international service revenue.

Ophthalmology Sales

     Total ophthalmology sales increased 9.2% to $8.4 million for the three month period ended June 30, 2007 from $7.7 million for the three months ended July 1, 2006. For the three month period ended June 30, 2007, domestic ophthalmology sales increased 9.2% to $5.0 million from $4.5 million for the three months ended July 1, 2006. This increase was attributed to a 13% increase in disposable probe revenue and a 20%

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increase in ophthalmology service revenue. International ophthalmology equipment sales for the three month period ended June 30, 2007 increased 9.3% to $3.4 million, from $3.1 million for the three months ended July 1, 2006.

     For the six months ended June 30, 2007, total ophthalmology sales increased 2.3% to $15.6 million from $15.2 million for the six months ended July 1, 2006. During this period, domestic ophthalmology sales increased 3.8% to $9.0 million for the six month period ended June 30, 2007 from $8.6 million for the six month period ended July 1, 2006. The total increase in domestic ophthalmology revenue during this period was primarily due to an increase in domestic disposable revenue offset by decreased other ophthalmology revenue, primarily OEM sales. International ophthalmology sales remained constant at $6.6 million for both the six month periods ended June 30, 2007 and July 1, 2006.

Aesthetic Sales

     Total aesthetic sales increased $5.7 million from $1.1 million for the three month period ended July 1, 2006 to $6.9 million for the three month period ended June 30, 2007. Domestic aesthetic sales increased to $3.4 million for the three month period ended June 30, 2007 from $0.8 million for the three month period ended July 1, 2006. International aesthetic sales increased $3.0 million from $0.4 million for the three month period ended July 1, 2006 to $3.4 million for the three month period ended June 30, 2007. The increase in aesthetic revenue was due to the addition of the newly acquired Laserscope business. Approximately $1.2 million of the international aesthetics sales were generated from higher than normal expected sales to a single distributor partially caused by delays in shipment of orders placed in the first quarter of 2007.

     For the six months ended June 30, 2007 aesthetics sales increased to $12.2 million from $2.4 million for the six months ended July 1, 2006. Domestic aesthetics sales increased to $6.1 million for the six months ended June 30, 2007 from $1.8 million for the six months ended July 1, 2006. The increase in domestic aesthetics sales was driven mainly by the newly acquired Laserscope business. International aesthetics sales increased to $6.1 million for the six months ended June 30, 2007 from $0.6 million for the comparable period in 2006 largely due to the acquired Laserscope business.

Gross Margin

     Gross profit increased by $1.9 million to $6.6 million for the three months ended June 30, 2007 compared to $4.7 million for the three months ended July 1, 2006. Gross profit as a percentage of sales for the three months ended June 30, 2007 decreased to 43.2% from 52.9% for the comparable prior year three month period. The total 9.7% decrease in gross profit as a percentage of sales during this period resulted from a 78.3% increase in overhead spending combined with a 19.7% increase in direct costs which included $0.5 million of amortization expense of recently acquired intangible assets related to product technology which had a negative impact of 3.0% on overall gross margin. The overhead spending was primarily the result of increased expenses for the newly acquired field service organization, and increased spending related to manufacturing integration activities. Direct cost margin was 71.8% for ophthalmic products and 43.5% for aesthetics products for the three months ended June 30, 2007. This compares with 71.8% for ophthalmic products and 57.7% for aesthetics products for the three months ended July 1, 2006. Direct cost margins for aesthetics products in 2007 were unfavorably impacted by the higher mix of international aesthetic sales which typically generate lower average selling prices. Margins for our ophthalmic Iridex products were flat compared to prior year levels.

     For the six months ended June 30, 2007, gross profit increased by $2.9 million to $11.8 million from $8.9 million for the six months ended July 1, 2006. Gross profit as a percentage of sales for the six months ended June 30, 2007 decreased to 42.4% from 50.6% for the comparable prior year six month period. The total 8.2% decrease in gross profit as a percentage of sales during this period resulted from an 86.9% increase in overhead spending combined with a 15.6% increase in direct costs which included $0.9 million of

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amortization expense related to the recently acquired intangible assets. The overhead spending was primarily the result of increased expenses for the newly acquired field service organization, and increased spending related to manufacturing integration activities. Direct cost margins were unfavorably impacted by the higher mix of international aesthetic sales which typically generate lower average selling prices.

     Our immediate margin improvement efforts are focused on achieving planned manufacturing cost efficiencies from integration of the Laserscope products within existing manufacturing capacity. Integration is expected to be completed by the end of the current fiscal year. In addition we are working to streamline the structure and efficiency of the newly acquired field service business. Overall, gross margins as a percentage of sales will continue to fluctuate due to the product mix of sales, costs associated with future product introductions, changes in the relative proportions of domestic and international sales, and a variety of other factors. See “—Factors That May Affect Future Results—Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year” in Item 1A of Part II, Section of this report.

Research and Development

     Research and development includes the cost of research and product innovation efforts. Research and product innovation expenses increased by 19.6% to $1.6 million, or 10.4% of net sales, in the second quarter of 2007 from $1.3 million, or 15.1% of net sales, in the second quarter of 2006. The increase in spending in the second quarter of 2007 in comparison to the second quarter of 2006 related to $0.2 million in increased salary expense associated with increased headcount and increased consultant and project spending of $0.1 million associated with increased development efforts. The decrease in R&D spending as a percentage of sales in the second quarter of 2007 was due to the increased sales levels in 2007 largely attributable to the Laserscope acquisition. R&D spending is targeted to approximate 9.0% of net sales in our planned business model.

     For the six months ended June 30, 2007 research and development expenses increased 35.4% to $3.3 million from $2.4 million for the six months ended July 1, 2006. As a percentage of sales, research and development expense decreased to 11.9% for the six months ended June 30, 2007 from 13.9% for the six months ended July 1, 2006. The increase in research and development expense in absolute dollars for the six month period ended June 30, 2007 was due primarily to $0.4 million in increased salaries, benefits and recruiting and relocation expenses and $0.5 million of increased consultant and project spending associated with development efforts.

Selling, General and Administrative

     Selling, general and administrative expense increased in the second quarter of 2007 by $3.7 million to $7.5 million or 49.5% of net sales from $3.9 million or 43.9% of net sales in the second quarter of 2006. The increase related primarily to higher salary and commission expense due to increased headcount and associated selling expenses of $1.2 million, $1.1 million for increased marketing headcount and aesthetics related marketing programs and $0.3 million for amortization of marketing intangibles. Additionally $1.0 million of selling, general and administrative expense was incurred in the two acquired Laserscope entities in France and the United Kingdom. General and administrative expense in the U.S. increased $0.3 million related to increased spending on consultants and contractors and higher accountant fees. We are planning to reduce the overall level of selling, general and administrative spending in future quarters through reduced spending programs and a reduction in the use of consultants and contractors.

     For the six months ended June 30, 2007 selling, general and administrative expense increased 102.9% to $15.8 million from $7.8 million for the six months ended July 1, 2006. This increase in selling, general and administrative expense for the six month period ended June 30, 2007 was due primarily to $1.9 million in

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increased selling expense associated with increased headcount including salaries, commissions and employee related expenses, $1.0 million for increased aesthetics related marketing programs, $0.6 million of increased salary and employee related costs associated with additional marketing headcount, amortization expense of $0.5 million associated with marketing intangibles, $0.4 million of increased accounting fees and $0.4 million associated with increased fees for consultants and contractors. In addition, the acquisition of the two Laserscope entities in France and the United Kingdom contributed $2.0 million to the 2007 selling, general and administrative spending increase.

Amortization of Purchased Intangibles

     In the first quarter of 2007, we completed the acquisition of the aesthetics business from Laserscope. We recorded in the second quarter of 2007, $0.8 million of amortization expense related to the acquisition of intangible assets acquired from Laserscope. $0.5 million of this total was allocated to cost of goods sold since it relates to product technology intangibles. The remaining $0.3 million of marketing amortization expense is recorded in selling, general and administrative expenses. We expect to record quarterly amortization expense at these levels for the remaining two quarters of 2007.

Goodwill and purchased intangible assets were initially recorded in the first three months of 2007 in conjunction with the acquisition of the aesthetics business of Laserscope (Note 3). We did not identify any events since the date of acquisition that would indicate that there has been an impairment in the carrying value of these assets. However, if there are changes in events or circumstances, such as an inability to achieve the cash flows originally expected from the acquisition, which indicate that the recorded value of the intangible assets will not be recovered through future cash flows, or if the fair value of the aesthetics business unit is determined to be less than its carrying value, the Company may be required to record an impairment charge for the intangible assets or goodwill or change the period of expected amortization for the intangible assets.

Interest and Other (Expense) Income, Net.

     For the three and six months ended June 30, 2007 net amounts included in Interest and Other Expense, consisted of $2.5 million of other income associated with a settlement of legal claims related to patent infringement with Synergetics offset by interest expense on newly acquired bank debt. For the three and six months ended July 1, 2006 other income was $0.2 million and $0.4 million respectively and consisted of interest income on available for sale securities. We do not expect to earn interest income in the near future and instead expect to incur interest expense related to our credit facility.

Income Taxes

     Significant components affecting the effective tax rate include pre-tax net income or loss, changes in valuation allowance, federal and state R&D tax credits, income from tax-exempt securities, the state composite tax rate and recognition of certain deferred tax assets subject to valuation allowance. The effective income tax rate for the three and six month period ending July 1, 2006 was 50.0% and 13.5% respectively. The change in the effective tax rate was driven primarily by the accounting for certain benefits associated with stock compensation expense commencing in 2006. In 2007 we do not anticipate recording a tax provision until we determine it is appropriate to revise the valuation allowance.

Liquidity and Capital Resources

     The Company expects that its current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will not be sufficient to meet the Company’s operating

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requirements, except for the near term and for a period substantially less than 12 months. Unless the Company is able to modify its planned operating requirements and raise additional capital, the Company’s current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will not be sufficient to meet the Company’s operating requirements, except for the near term and for a period substantially less than 12 months. In order to address these liquidity issues, the Company plans to, among other things: (i) work towards integrating the aesthetics business as quickly and efficiently as possible and maximizing the potential benefits that may be realized from the acquisition, (ii) modify its planned operations in order to increase our cash flows from operations, (iii) seek to further restructure or replace its current credit facilities, and (iv) raise additional capital through equity or debt financing in order to enhance its liquidity.

     Generally, the Company’s principal sources of liquidity are cash from operations and borrowings under our credit facility. As of June 30, 2007 we had $3.5 million of cash and cash equivalents and $3.8 million of restricted cash pursuant to our bank agreements. Under our credit facility, the restricted cash balances may not be used to fund our operating requirements. Our cash and cash equivalents decreased by $17.5 million during the six months ended June 30, 2007. This decrease is primarily due to acquisition related payments, partially offset by financing activities. In the first six months of 2007, cash provided by operations was $1.0 million. Significant changes in working capital accounts were:

• a $1.1 million decrease in accounts receivable;

• a $2.2 million increase in inventory;

• a $4.2 million increase in accounts payable, and

• a $0.8 million increase in accrued expenses.

     The Company generated positive cash flow from operations despite the $5.3 million loss for the six months ended June 30, 2007 due to non-cash charges of approximately $2.5 million and increases in accounts payable and accruals of $5.0 million. In future periods as accounts payable and accruals are reduced, cash flow from operations will be reduced.

     In the first six months of 2007, cash flow used in investing activities was $28.6 million primarily related to the acquisition of the aesthetics business of Laserscope. In the first six months of 2007, cash flows from financing activities included proceeds from the issuance of common stock under our equity based stock compensation plans of $0.8 million and $9.3 million of cash from the draw-down of our current credit facility. Included in our cash balance at June 30, 2007 is $3.9 million of cash owed to Laserscope for cash obtained through the acquisition of the foreign subsidiaries, but not included in the asset purchase agreement. This cash will be netted against payments owed to the Company upon settlement of the post close balance sheet adjustment.

     On August 14, 2007, the Company, AMS and Laserscope, (collectively the “Parties”), entered into a Settlement Agreement (the “Settlement Agreement”). The Parties entered into the Settlement Agreement to document their full and final agreement as to the amount of the adjustment contemplated by Section 1.5 of the Asset Purchase Agreement, by and among AMS, Laserscope and the Company, dated November 30, 2006 (the “Purchase Agreement”); to amend the Product Supply Agreement, between and between Laserscope and the Company, dated January 16, 2007 (the “Product Supply Agreement”); and to set forth the Parties’ mutual understanding as to certain other matters. The Settlement Agreement provides that, pursuant to Section 1.5 of the Purchase Agreement, the Company will make an additional payment to AMS of $1,150,000 which will be the sole and final adjustment to the purchase price and will be paid in equal weekly installments of $22,115 beginning August 16, 2007 over the course of the next year. The Settlement Agreement modifies and amends certain terms of the Product Supply Agreement, including, among others: (a) agreement upon the current and future products to be built and delivered by Laserscope to the Company and the payment terms relating thereto; (b) allocation of and pricing and delivery terms relating to inventory parts to be sold by Laserscope to the Company and agreement on a payment plan for currently outstanding invoices, which includes two weekly payments of $100,000 each for the last two weeks of August, increasing to $150,000 per week for four weeks in September; and (c) agreement upon certain payments to be made by the Company to AMS in the event that the Company increases its borrowing capacity to more than $12,000,000 under any credit facility that is senior to the Company’s payment obligations under the Settlement Agreement. Under the terms of the Settlement Agreement, the Company agreed to make payments to AMS totaling $4,059,557 in respect of

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certain inventory and service parts to be purchased from AMS following termination of the Product Supply Agreement. This sum is to be paid in 39 weekly installments of $110,185 including an interest charge of 10% per annum beginning on January 3, 2008 and is being paid as a settlement of potential payments required to be made by the Company to AMS of up to $9 million for inventory to be delivered to the Company by AMS following the scheduled termination of the Product Supply Agreement in October 2007. The Company believes that entering into the Settlement Agreement will (a) provide certainty with respect to its future payment obligations to Laserscope under the Purchase Agreement and Product Supply Agreement, (b) facilitate the Company’s restructuring of its planned operating requirements, and (c) allow the Company to enhance its liquidity and capital reserves relative to its future capital needs. (See Note 10 of the Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this report.)

     Any breach by the Company of any provision of any of its agreements with AMS or Laserscope shall constitute an immediate default and shall entitle AMS and Laserscope to any and all remedies available to them under the Security Agreement, the Product Supply Agreement, and the Settlement Agreement, including, but not limited to, the right to terminate the Product Supply Agreement immediately upon written notice to the Company with no additional notice period or opportunity to cure and the right to declare all amounts due from the Company to AMS to be immediately due and payable in full.

     In April 2007, we received $2.5 million from Synergetics in settlement of a patent infringement claim and expect to receive subsequent annual payments of $0.8 million per year for the next five years.

     As of June 30, 2007, the Company was not able to satisfy certain restrictive financial covenants contained in its credit facilities with Mid-Peninsula Bank and the Export-Import Bank (the “Lenders”) as well as an affirmative covenant regarding the preparation and delivery of quarterly financial statements within 45 days of quarter end (see Note 4). The Company has received a one-time waiver from Mid-Peninsula Bank with respect to its inability to satisfy the financial covenants contained in its loan agreements with the Lenders for the period ended June 30, 2007, but can provide no assurance that the Lenders will grant any additional future waivers if requested. The Company was also not in compliance with its debt covenants at the end of its first quarter but it was successful in obtaining a waiver of default for that period. In the event of noncompliance the Lenders would be entitled to exercise their remedies, under these facilities, which include declaring all obligations immediately due and payable and disposing of the collateral if obligations were not paid. The Company has modified planned operations in order to increase cash flows from operations, and intends to raise additional capital through equity or debt financing in order to enhance liquidity. However, there can be no assurances that the Company will be successful in these efforts or that any additional capital raised through debt or equity financings will be available on favorable terms or at all. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We do not believe that the adoption of the provisions of SFAS 157 will materially impact our consolidated financial position and results of operations.

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Item 3. Quantitative and Qualitative Disclosure about Market Risk

Quantitative Disclosures

     We are exposed to market risks inherent in our operations, primarily related to interest rate risk and currency risk. These risks arise from transactions and operations entered into in the normal course of business. We do not use derivatives to alter the interest characteristics of our marketable securities or our debt instruments. We have no holdings of derivative or commodity instruments.

Interest Rate Risk.

     We are subject to interest rate risks on cash and cash equivalents, our current credit facility and any future financing requirements.

Qualitative Disclosures

Interest Rate Risk.

     Our primary interest rate risk exposures for the periods covered by this report relate to the impact of interest rate movements on our ability to obtain adequate financing to fund future operations.

Currency Rate Risk.

     Historically, we have denominated our sales both domestically and internationally in US dollars. With the acquisition of the Laserscope aesthetics business we have acquired two foreign subsidiaries that make sales and incur the majority of their expenses in their local currencies. These subsidiaries operate in France and the United Kingston and their currencies are the Euro and Pounds Sterling respectively. Monthly income and expense from these operations are translated using average rates and balance sheets are translated using month end rates. Differences are recorded within stockholders’ equity as a component of accumulated other comprehensive income (loss) or to the statement of operations, as applicable. As our revenues denominated in currencies other than the dollar increase, we have an increased exposure to foreign currency rate risk. Based on our overall exposure for foreign currency at June 30, 2007, a hypothetical 10% change in foreign currency rates would not have a material impact on our net sales and operating expenses. We may elect to mitigate this rate risk, in part or in whole, through the purchase of forward currency contracts.

Item 4T. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

     Our management evaluated, with the participation of our Chief Executive Officer (CEO) who is currently our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13A-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 (the “‘34 Act”), as of the end of the period covered by this report. Based on that evaluation and as a result of the material weakness in our internal controls over financial reporting discussed below, the CEO in his capacity as both principal executive officer and principal financial officer concluded that as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective.

     Disclosure controls and procedures are designed with the objective of ensuring that (i) information required to be disclosed in our reports filed under the ‘34 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) information is accumulated

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and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal control procedures, which are designed with the objective of providing reasonable assurance that our transactions are properly authorized, our assets are safeguarded against unauthorized or improper use and its transactions are properly recorded and reported, are intended to permit the preparation of our financial statements in conformity with generally accepted accounting principles. To the extent that elements of our internal control over financial reporting are included within our disclosure controls and procedures, they are included in the scope of our quarterly controls evaluation.

     A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management determined that the following control deficiencies constitute a material weakness in our internal control over financial reporting as of June 30, 2007.

     In connection with the acquisition of two foreign subsidiaries it has been determined that these entities lack the necessary internal control and disclosure procedures such that there is more than a remote likelihood that a material misstatement of our financial statements will not be prevented or detected.

     Also, in connection with the annual audit of our financial statements as of December 30, 2006, our independent registered public accounting firm communicated to our management and the Audit Committee of the Board of Directors that they had identified a control deficiency that existed in the design or operation of our internal controls over financial reporting that they considered to be a material weakness, because the control deficiency resulted in more than a remote likelihood that a material misstatement could occur in our annual financial statements and not be prevented or detected. Specifically, the material weakness identified by our independent accountants relates to a failure to maintain adequate period-end review procedures to ensure the completeness and accuracy of certain journal entries impacting general ledger accounts. As a result, an error in a system generated custom inventory report and errors in two key spreadsheets related to warranty and deferred revenue resulted in incorrect entries being recorded to the financial statements which were not identified and corrected by management in a timely manner.

Plan for Remediation of Material Weaknesses

     To address the material weaknesses in our internal control over financial reporting identified above, management has designed a remediation plan which will supplement the existing controls of the Company.

     The remediation plan addresses the following corrective actions:

• implementation of additional controls over the preparation and review of key spreadsheets;

• implementation of automated general ledger reports to replace existing key spreadsheets where possible;

• implementation of additional review procedures;

• enhancement of the current capabilities of the finance function; and

• implementation of standard control and review procedures over our foreign subsidiaries.

     We continued the process of implementing certain corrective actions relating to our period-end review procedures during and subsequent to the three month period covered by this quarterly report on Form 10-Q. We believe that once all of these corrective actions are implemented, including the enhancement of the capabilities of the finance function, the material weaknesses that were identified will be mitigated.

     Even if we are to successfully remediate each of the material weaknesses described above, because of inherent limitations, our disclosure controls and procedures may not prevent or detect misstatements or

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material omissions. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

(b) Changes in Internal Controls

     There were no changes in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     Subsequent to the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Financial Officer who joined the Company in February 2007 resigned.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     Patent Litigation – On October 19, 2005, the Company filed a suit in the United States District Court for the Eastern District of Missouri against Synergetics, USA, Inc. for infringement of a patent. The Company later amended its complaint to assert infringement claims against Synergetics, Inc.; Synergetics USA, Inc. was dismissed from the suit. The Company alleged that Synergetics infringed the Company’s patent by making and selling infringing products, including its Quick Disconnect laser probes and its Quick Disconnect Laser Probe Adapter, and sought injunctive relief, monetary damages, treble damages, costs and attorneys’ fees. . On April 25, 2006, Synergetics added the Company as a defendant to a then existing lawsuit in the U.S. District Court for the Eastern District of Pennsylvania. In that litigation, Synergetics alleged that the Company infringed its patent on a disposable laser probe design.

     Trial in the Missouri litigation was scheduled to begin on April 16, 2007, however on April 6, 2007 the parties reached settlement on the claims. Under the terms of the settlement agreement, the parties agreed to terminate all legal proceedings between the parties and to a fully paid-up, royalty free, worldwide cross licensing of various patents between the two companies. In consideration of these licenses Synergetics agreed to pay the Company $6.5 million over a period of five years. The first payment of $2.5 million by Synergetics was paid on April 16, 2007, followed with annual payments of $0.8 million on each April 16th until 2012.

     Management believes that claims which are pending or known to be threatened, will not have a material adverse effect on the Company’s financial position or results of operations and are adequately covered by the Company’s liability insurance. However, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management’s attention and the incurrence of significant expenses.

Item 1A. Risk Factors

Factors That May Affect Future Results

     In addition to the other information contained in this Quarterly Report Form 10-Q, we have identified the following risks and uncertainties that may have a material adverse effect on our business, financial condition or results of operation. You should carefully consider the risks described below before making an investment decision.

     We Do Not Believe that Our Current Liquidity and Capital Resources Will Be Sufficient to Meet Our Currently Planned Operating Requirements, Except for the Near Term and for a Period Substantially Less Than 12 Months, and We May Not Be Able to Comply with the Restrictive Covenants Contained in Our Loan Agreements with Mid-Peninsula Bank, Part of Greater Bay Bank N.A., and the Export-Import Bank, Despite Recent Amendments to Such Loan Agreements.

     We do not believe that our current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will be sufficient to meet the Company’s operating requirements, except for the near term and for a period substantially less than 12 months. Unless we are able to modify our planned operating requirements and raise additional capital, our current cash and cash equivalents, cash flow expected to be generated from operations and available credit facilities, if any, will not

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be sufficient to meet our planned operating requirements, except for the near term and for a period substantially less than 12 months. Our concerns about our ability to satisfy our liquidity requirements are primarily a result of our current operating performance relative to plan, as well as our continuing losses, negative cash flows and current liquidity in relation to future obligations, including our obligations to make payments to certain vendors and to Laserscope under the Settlement Agreement and Product Supply Agreement and our inability to satisfy certain covenants under our loan agreement with Mid-Peninsula Bank, part of Greater Bay Bank N.A., and the Export-Import Bank (the “Lenders”) as of June 30, 2007 and our potential inability to satisfy the covenants contained in these agreements, as amended, in the future.

     Our recent and current operating performance has not met our expectations, primarily as a result of our inability to realize the full benefits of the acquisition of the aesthetics business of Laserscope in our previously anticipated time frame, as well as recent negative cash flows from operations. In particular, revenues from the aesthetics business have been below our expectations. Our ability to realize the potential benefits of the acquisition will depend, in part, on our ability to integrate the aesthetics business. As expected, our efforts towards integrating the aesthetics business of Laserscope has and will continue to take a significant amount of time and place a significant strain on our managerial, operational and financial resources, and may continue to be more difficult and expensive than originally anticipated. This continued diversion of our management’s attention and any additional delays or difficulties encountered in connection with the integration of the aesthetics business could harm our operating results and increase the difficulty of our being able to satisfy our liquidity requirements.

     In addition, as of March 31, 2007, we were not able to satisfy certain restrictive covenants contained in our credit facilities with the Lenders. On April 19, 2007, we entered into amendments with the Lenders pursuant to which, (i) we agreed to deposit and maintain $3.8 million in cash in a segregated deposit account with the Lenders as collateral in support of our term loan and to restrict up to $2.2 million of the combined borrowing base from our line of credit in support of the term loan, and (ii) the parties agreed to eliminate the requirement that we maintain a minimum of $3.0 million in aggregate domestic unrestricted cash or marketable securities. The Lenders also agreed to increase the credit extended to the Company under the agreement with the Export-Import Bank from $3.0 to $5.0 million. In connection with these amendments, Mid-Peninsula Bank agreed to a one-time waiver of certain financial covenants contained in the loan agreements with the Mid-Peninsula Bank. As of June 30, 2007, we were again not able to satisfy certain restrictive covenants contained in our credit facilities with the Lenders, but Mid-Peninsula Bank agreed to a an additional one-time waiver of certain financial covenants contained in the loan agreements with the Mid-Peninsula Bank. These one-time waivers do not apply to any other potential future breaches of any of the financial covenants by the Company contained in the agreements with the Lenders. Compliance with the financial covenants for which such waiver was obtained is evaluated on a quarterly basis and the Lenders may not be willing to grant additional waivers if we fail to comply with restrictive covenants in the future.

     If we default on these credit facilities and the Lenders exercise their remedies, this will further contribute to the difficulties we expect to face in meeting our near- and long-term liquidity requirements. Our obligations under these credit facilities are secured by a lien on substantially all of the Company’s assets. We currently have drawn down $9.4 million under this credit facility which is the full amount currently available, and, given our current financial status, we currently do not expect to be able to satisfy the restrictive covenants relating to these facilities as of September 30, 2007. In the event of default by the Company with the covenants under these facilities, the Lenders would be entitled to exercise their remedies, which include declaring all obligations immediately due and payable and disposing of the collateral if obligations were not paid. Although we entered into amendments to the loan agreements with the Lenders in order to enhance our ability to comply with the restrictive covenants contained therein, we cannot assure you that will be able to comply with these covenants in the future and do not expect to be in compliance as of the end of the fiscal

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quarter ending September 30, 2007. See Note 4 of Notes to Consolidated Financial Statements in Item 1 of Part I of this report for more information regarding these credit facilities.

     In order to address our liquidity issues, we plan to, among other things: (i) work towards integrating the aesthetics business as quickly and efficiently as possible and maximizing the potential benefits that may be realized from the acquisition, (ii) modify our planned operations in order to increase our cash flows from operations, (iii) seek to further restructure or replace our current credit facilities, and (iv) raise additional capital through equity or debt financing in order to enhance our liquidity.

     We cannot assure you that we will be successful in these efforts or that any additional capital raised through debt or equity financings will be available on favorable terms or at all or that any additional capital raised will be sufficient to address our liquidity or capital resources needs. If we are unsuccessful in these efforts, we may have to suspend or cease operations or significantly dilute our stockholders’ equity holdings.

     We Have More Indebtedness and Fewer Liquid Resources After the Acquisition of the Aesthetics Business of Laserscope, Which Could Adversely Affect Our Cash Flows and Business.

     In order to complete the acquisition, we entered into financing arrangements that provide for a $6 million term loan and a revolving credit line of up to $6 million. We had no debt outstanding at December 30, 2006. We had $11.9 million outstanding on January 17, 2007 when the acquisition of the aesthetics business of Laserscope was consummated. We also used the majority of our liquid resources to finance the acquisition of the aesthetics business of Laserscope. As a result of the increase in debt, demands on our cash resources have increased following the completion of the acquisition. The increased levels of debt could, among other things:

• require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for working capital, capital expenditures, acquisitions and other purposes;

• making it more difficult for us to meet our payment and other obligations under our outstanding debt;

• increase our vulnerability to, and limit our flexibility in planning for, adverse economic and industry conditions;

• increase our sensitivity to interest rate increases on our indebtedness with variable interest rates;

• result in an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which event of default could result in all of our debt becoming immediately due and payable;

• affect our credit rating;

• limit our ability to obtain additional financing to fund future working capital, capital expenditures, additional acquisitions and other general corporate requirements;

• create competitive disadvantages compared to other companies with less indebtedness; and

• limit our ability to apply proceeds from an offering or asset sale to purposes other than the repayment of debt.

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     As a result of the above, we are currently unable to satisfy certain restrictive financial covenants contained in our loan agreements and may not be able to do so in the future. In the event of default by the Company with the covenants under these facilities, the Lenders would be entitled to exercise their remedies which would include declaring all obligations immediately due and payable and disposing of the collateral if obligations were not paid.

     Our Loan Agreements Contain Covenant Restrictions that May Limit Our Ability to Operate Our Business and To Service Our Indebtedness, We Will Require a Significant Amount of Cash. Our Ability to Generate Cash Flow Depends on Many Factors Beyond Our Control.

     Our ability to meet our payment and other obligations under our debt depends on our ability to generate significant cash flows in the future. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure holders that our business will generate cash flow from operations, or that future borrowings will be available to us under our credit facilities or otherwise, in an amount sufficient to enable us to meet our payment obligations under our debt and to fund other liquidity needs. Our loan agreements contain covenant restrictions that may limit our ability to operate our business. As discussed above, we are currently unable to satisfy certain restrictive financial covenants contained in our loan agreements and may not be able to do so in the future. In the event of default by the Company with the covenants under these facilities, the Lenders would be entitled to exercise their remedies which would include declaring all obligations immediately due and payable and disposing of the collateral if obligations were not paid.

     Although We Expect that Our Acquisition of the Aesthetics Business of Laserscope Will Result in Benefits to the Company, the Company May Not Realize Those Benefits Because of Integration and Other Challenges.

     On January 16, 2007, we completed our acquisition of the aesthetics business of Laserscope (the “Aesthetics Business”), a wholly-owned subsidiary of American Medical Systems Holdings, Inc. To date we have not realized the anticipated benefits of the acquisition and our ability to realize the anticipated benefits of the acquisition will depend, in part, on our ability to integrate the Aesthetics Business with our business. Integrating the Aesthetics Business may be expensive and time-consuming and we may not be able to successfully do so. These integration efforts have taken a significant amount of time, placed a significant strain on managerial, operational and financial resources and proven to be more difficult and more expensive than predicted. The diversion of our management’s attention and any delays and difficulties encountered in connection with integrating the Aesthetics Business could result in the disruption of our on-going business or inconsistencies in standards, controls, procedures and policies that could negatively affect our ability to maintain relationships with customers, suppliers, collaborators, employees and others with whom we have business dealings. These disruptions could harm our operating results. Further, the following specific factors may adversely affect our ability to integrate the Aesthetics Business:

• coordinating marketing functions;

• transferring of the manufacturing of the Laserscope products to the Company;

• unanticipated issues in integrating information, communications and other systems;

• unanticipated incompatibility of purchasing, logistics, marketing and administration methods;

• greater than anticipated liabilities;

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• retaining key employees, including members of our aesthetics sales force;

• consolidating corporate and administrative infrastructures;

• the diversion of management’s attention from ongoing business concerns;

• coordinating our current product and process development efforts with those of the Aesthetics Business in a way which permits us to bring future new products to the market in a timely and cost-effective manner; and

• coordinating geographically separate organizations.

     We cannot assure you that the combination of the Aesthetics Business with our business will result in the realization of the full benefits anticipated from the acquisition.

     In addition, as part of our acquisition, we entered into agreements with Laserscope to obtain certain manufacturing support, administrative services and future intellectual property rights. In the event that Laserscope fails to provide this support and service, or provides such support and service at a level of quality and timeliness inconsistent with the historical delivery of such support and service, or fails to grant us the intellectual property rights we expected, our ability to integrate the Aesthetics Business will be hampered and our operating results may be harmed.

     Failure to Remediate the Material Weaknesses in Our Disclosure Controls and Procedures in a Timely Manner, or at All, Could Harm Our Operating Results or Cause Us to Fail to Meet Our Regulatory or Reporting Obligations.

     We evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report and, based on this evaluation, management concluded that our disclosure controls and procedures were not effective because of the material weaknesses detailed in Item 4T of Part I of this Quarterly Report on Form 10-Q.

     In particular, the material weaknesses identified related to the Company’s period-end review procedures. We are taking a number of remedial actions designed to remedy the material weaknesses summarized above. However, if despite our remediation efforts, we fail to remediate our material weaknesses, we could be subject to regulatory scrutiny and a loss of public confidence in our disclosure controls and procedures. These remediation efforts will likely increase our general and administrative expenses and could, therefore, have an adverse effect on our reported net income.

     Even if we are to successfully remediate such material weaknesses, because of inherent limitations, our disclosure controls and procedures may not prevent or detect misstatements or material omissions. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     The Requirements of Complying with the Sarbanes-Oxley Act of 2002 Might Strain Our Resources, Which May Adversely Affect Our Business and Financial Condition.

     We are subject to a number of requirements, including the reporting requirements of the Securities Exchange Act of 1934, as amended, and the Sarbanes-Oxley Act of 2002. Beginning with our fiscal year ending December 29, 2007 we will be required to comply with the requirements of Section 404 of the

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Sarbanes-Oxley Act which will require management to perform an assessment of internal control over financial reporting. We are not currently in a position to comply with the requirements of Section 404 of the Sarbanes-Oxley Act and have not yet taken the necessary actions to prepare to be able to do so beginning with our fiscal year ending December 29, 2007. We expect that these requirements will be difficult to satisfy in a timely manner and that they will place a significant strain on our systems and resources, especially in light of the recent departure of our Chief Financial Officer and our need to find a permanent replacement Chief Financial Officer and to further enhance our finance function. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required. As a result, our management’s attention might be diverted from other business concerns, which could have a material adverse effect on our business, financial condition, and operating results. In addition, we might need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge, and we might not be able to do so in a timely fashion.

     We Rely on Continued Market Acceptance of Our Existing Products and Any Decline in Sales of Our Existing Products Would Adversely Affect Our Business and Results of Operations.

     We currently market visible and infrared light therapeutic-based photocoagulator medical laser systems and delivery devices to the ophthalmology and aesthetics markets. We believe that continued and increased sales, if any, of these medical laser systems is dependent upon a number of factors including the following:

• acceptance of product performance, features, ease of use, scalability and durability;

• acceptance of the company’s new marketing programs;

• recommendations and opinions by ophthalmologists, dermatologists, plastic surgeons, other clinicians and their associated opinion leaders;

• clinical study outcomes;

• price of our products and prices of competing products and technologies;

• availability of competing products, technologies and alternative treatments; and

• level of reimbursement for treatments administered with our products.

     In addition, we derive a meaningful portion of our sales from recurring revenues including disposable laser probes, EndoProbes and service. Our ability to increase recurring revenues from the sale of EndoProbes will depend primarily upon the features of our current products and product innovation, ease of use and prices of our products, including the relationship to prices of competing delivery devices. The level of service revenues will depend on our quality of care, responsiveness and the willingness of our customers to request and utilize our products and services rather than purchase competing products or services. Any significant decline in market acceptance of our products or our revenues derived from the sales of laser consoles, delivery devices or services may have a material adverse effect on our business, results of operations and financial condition.

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     If There is Not Sufficient Demand for the Procedures Performed with Our Products, Practitioner Demand for Our Products Could be Inhibited, Resulting in Unfavorable Operating Results and Reduced Growth Potential.

     Continued expansion of the global market for laser- and other light-based aesthetic procedures is a material assumption of our growth strategy. Most procedures performed using our products are elective procedures not reimbursable through government or private health insurance, and the costs of such procedures are borne by the patient. The decision to utilize our products may therefore be influenced by a number of factors, including:

• evolving customer needs;

• the introduction of new products and technologies;

• evolving surgical practices;

• evolving industry standards;

• the cost of procedures performed using our products;

• the cost, safety and effectiveness of alternative treatments, including treatments which are not based upon laser- or other light-based technologies and treatments which use pharmaceutical products;

• the success of our sales and marketing efforts; and

• consumer confidence, which may be impacted by economic and political conditions.

     If, as a result of these factors, there is not sufficient demand for the procedures performed with our products, practitioner demand for our products could be reduced, resulting in unfavorable operating results and lower growth potential.

     Our Future Success Depends on Our Ability to Develop and Successfully Introduce New Products and New Applications.

     Our future success is dependent upon, among other factors, our ability to develop, obtain regulatory approval or clearance of, manufacture and market new products. Successful commercialization of new products and new applications will require that we effectively transfer production processes from research and development to manufacturing and effectively coordinate with our suppliers. In addition, we must successfully sell and achieve market acceptance of new products and applications and enhanced versions of existing products. The extent of, and rate at which, market acceptance and penetration are achieved by future products is a function of many variables, which include, among other things, price, safety, efficacy, reliability, marketing and sales efforts, the development of new applications for these products, the availability of third-party reimbursement of procedures using our new products, the existence of competing products and general economic conditions affecting purchasing patterns. Our ability to market and sell new products may also be subject to government regulation, including approval or clearance by the United States Food and Drug Administration, or FDA, and foreign government agencies. Any failure in our ability to successfully develop and introduce new products or enhanced versions of existing products and achieve market acceptance of new products and new applications could have a material adverse effect on our operating results and would cause our net revenues to decline.

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     While We Devote Significant Resources to Research and Development, Our Research and Development May Not Lead to New Products that Achieve Commercial Success.

     Our research and development process is expensive, prolonged, and entails considerable uncertainty. Because of the complexities and uncertainties associated with ophthalmic and aesthetic research and development, products we are currently developing may not complete the development process or obtain the regulatory approvals required to market such products successfully. The products currently in our development pipeline may not be approved by regulatory entities and may not be commercially successful, and our current and planned products could be surpassed by more effective or advanced products of current or future competitors. Therefore, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.

     We Face Strong Competition in Our Markets and Expect the Level of Competition to Grow in the Foreseeable Future.

     Competition in the market for devices used for ophthalmic and aesthetic treatment procedures is intense and is expected to increase. Our competitive position depends on a number of factors including product performance, characteristics and functionality, ease of use, scalability, durability and cost. Our principal competitors in ophthalmology are Lumenis Ltd., Nidek, Carl Zeiss, Inc., Alcon, and Synergetics, Inc. Most of these companies currently offer a competitive semiconductor-based laser system in ophthalmology. Also within ophthalmology pharmaceutical alternative treatments for AMD such as Visudyne (Novartis), Macugen (OSI Pharmaceuticals) and Lucentis (Genentech) compete rigorously with traditional laser procedures. Our principal competitors in aesthetic are Palomar Technologies, Candela Corporation, Cutera Inc., Cynosure Inc. and Lumenis Ltd. Some competitors have substantially greater financial, engineering, product development, manufacturing, marketing and technical resources than we do. Some companies also have greater name recognition than we do and long-standing customer relationships. In addition to other companies that manufacture photocoagulators, we compete with pharmaceuticals, other technologies and other surgical techniques. Medical companies, academic and research institutions, or others, may develop new technologies or therapies that are more effective in treating conditions targeted by us or are less expensive than our current or future products. Any such developments could have a material adverse effect on our business, financial condition and results of operations.

     If We Cannot Increase Our Sales Volumes, Reduce Our Costs or Introduce Higher Margin Products to Offset Anticipated Reductions in the Average Unit Price of Our Products, Our Operating Results May Suffer.

     We have experienced some declines in the average unit price of our products and expect to continue to suffer from declines in the future. The average unit price of our products may decrease in the future in response to changes in product mix, competitive pricing pressures, new product introductions by our competitors or other factors. If we are unable to offset the anticipated decrease in our average selling prices by increasing our sales volumes or through new product introductions, our net revenues will decline. In addition, to maintain our gross margins we must continue to reduce the manufacturing cost of our products. If we cannot maintain our gross margins our business could be seriously harmed, particularly if the average selling price of our products decreases significantly without a corresponding increase in sales.

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     We Depend on Sales of Our Ophthalmology Products for a Significant Portion of Our Operating Results.

     We derive, and expect to continue to derive, a large portion of our revenue and profits from sales of our ophthalmology products. For the fiscal quarter ended June 30, 2007, our ophthalmology sales were $8.4 million or 55.0% of total sales. We anticipate that sales of our ophthalmology products will continue to account for a significant portion of our revenues in the foreseeable future.

     We Depend on International Sales for a Significant Portion of Our Operating Results.

     We derive, and expect to continue to derive, a large portion of our revenue from international sales. For the fiscal quarter ended June 30, 2007, our international sales were $6.9 million. We anticipate that international sales will continue to account for a significant portion of our revenues in the foreseeable future. None of our international revenues and costs has been denominated in foreign currencies. As a result, an increase in the value of the U.S. dollar relative to foreign currencies makes our products more expensive and thus less competitive in foreign markets. The factors stated above could have a material adverse effect on our business, financial condition or results of operations. Our international operations and sales are subject to a number of other risks and potential costs, including:

• differing local product preferences and product requirements;

• cultural differences;

• changes in foreign medical reimbursement and coverage policies and programs;

• political and economic instability;

• impact of recessions in economies outside of the United States;

• difficulty in staffing and managing foreign operations;

• performance of our international distribution channels;

• foreign certification requirements, including continued ability to use the “CE” mark in Europe;

• reduced or limited protections of intellectual property rights in jurisdictions outside the United States;

• longer accounts receivable collection periods;

• fluctuations in foreign currency exchange rates;

• potentially adverse tax consequences; and

• multiple protectionist, adverse and changing foreign governmental laws and regulations.

Any one or more of these factors stated above could have a material adverse effect on our business, financial condition or results of operations.

     As we expand our existing international operations, especially following our acquisition of the aesthetics business of Laserscope, we may encounter new risks. For example, as we focus on building our

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international sales and distribution networks in new geographic regions, we must continue to develop relationships with qualified local distributors and trading companies. If we are not successful in developing these relationships, we may not be able to grow sales in these geographic regions. These or other similar risks could adversely affect our revenue and profitability.

     We Are Exposed to Risks Associated With Worldwide Economic Slowdowns and Related Uncertainties.

     Concerns about consumer and investor confidence, volatile corporate profits and reduced capital spending, international conflicts, terrorist and military activity, civil unrest and pandemic illness could cause a slowdown in customer orders or cause customer order cancellations. In addition, political and social turmoil related to international conflicts and terrorist acts may put further pressure on economic conditions in the United States and abroad. Unstable political, social and economic conditions make it difficult for our customers, our suppliers and us to accurately forecast and plan future business activities. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, as well as effectively manage supply chain relationships. If such conditions persist, our business, financial condition and results of operations could suffer.

     We Rely on Our Direct Sales Force and Network of International Distributors to Sell Our Products and any Failure to Maintain Our Direct Sales Force and Distributor Relationships Could Harm Our Business.

     Our ability to sell our products and generate revenue depends upon our direct sales force within the United States and primarily through relationships with independent distributors outside the United States. Currently our direct sales force consists of 41 employees and we maintain relationships with 77 independent distributors internationally selling our products into 107 countries through four direct Area Sales Managers. We generally grant our distributors exclusive territories for the sale of our products in specified countries. The amount and timing of resources dedicated by our distributors to the sales of our products is not within our control. Our international sales are primarily dependent on the efforts of these third parties. If any distributor breaches terms of its distribution agreement or fails to generate sales of our products, we may be forced to replace the distributor and our ability to sell our products into that exclusive sales territory would be adversely affected.

     We do not have any long-term employment contracts with the members of our direct sales force. We may be unable to replace our direct sales force personnel with individuals of equivalent technical expertise and qualifications, which may limit our revenues and our ability to maintain market share. The loss of the services of these key personnel would harm our business. Similarly, our distributor agreements are generally terminable at will by either party and distributors may terminate their relationships with us, which would affect our international sales and results of operations.

     If We Lose Key Personnel or Fail to Integrate Replacement Personnel Successfully, Our Ability to Manage Our Business Could Be Impaired.

     Our future success depends upon the continued service of our key management, technical, sales, and other critical personnel. Our officers and other key personnel are employees-at-will, and we cannot assure you that we will be able to retain them. On July 5, 2007, subsequent to the three month period covered by this Quarterly Report on Form 10-Q, Meryl A. Rains, who commenced service as the Company’s Chief Financial Officer on February 5, 2007, notified the Company that she was resigning as the Company’s Chief Financial Officer, effective as of July 20, 2007. Although we have hired an interim Chief Financial Officer, we are continuing to work to identify and hire a new permanent Chief Financial Officer. Key personnel, including certain members of our aesthetics sales force who joined the company in connection with the acquisition of

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the aesthetics business of Laserscope, have left our company in the past and there likely will be additional departures of key personnel from time to time in the future. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, and the results of our operations. Competition for these individuals is intense, and we may not be able to attract, assimilate or retain highly qualified personnel. This competition for qualified personnel in our industry and the San Francisco Bay Area, as well as other geographic markets in which we recruit, contributes to increases in the salaries we are required to pay in order to attract and retain qualified personnel, which may increase our operating expenses and, if we are unable to pay competitive salaries, hinder our ability to recruit qualified candidates. In addition, the integration of replacement personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful.

     If We Fail to Accurately Forecast Demand For Our Product and Component Requirements For the Manufacture of Our Product, We Could Incur Additional Costs or Experience Manufacturing Delays and May Experience Lost Sales or Significant Inventory Carrying Costs.

     We use quarterly and annual forecasts based primarily on our anticipated product orders to plan our manufacturing efforts and determine our requirements for components and materials. It is very important that we accurately predict both the demand for our product and the lead times required to obtain the necessary components and materials. Lead times for components vary significantly and depend on numerous factors, including the specific supplier, the size of the order, contract terms and current market demand for such components. If we overestimate the demand for our product, we may have excess inventory, which would increase our costs. Over the past several quarters, we have placed a high priority on our asset management efforts to, among other things, reduce overall inventory levels and increase our cash position. If we underestimate demand for our product and, consequently, our component and materials requirements, we may have inadequate inventory, which could interrupt our manufacturing, delay delivery of our product to our customers and result in the loss of customer sales. We plan to assume responsibility for manufacturing the aesthetics product line that we acquired from Laserscope when the Product Supply Agreement we entered into with American Medical Systems Holdings in connection with the acquisition of the aesthetics business of Laserscope terminates. We expect this transition to occur on or before October 2007 and we may not have sufficient resources to assume these manufacturing obligations without increased costs or delays and disruptions in manufacturing. Any of these occurrences would negatively impact our business and operating results.

     We Depend on Sole Source or Limited Source Suppliers.

     We rely on third parties to manufacture substantially all of the components used in our products, including optics, laser diodes and crystals. We have some long term or volume purchase agreements with our suppliers and currently purchase components on a purchase order basis. Some of our suppliers and manufacturers are sole or limited sources. In addition, some of these suppliers are relatively small private companies that may discontinue their operations at any time. There are risks associated with the use of independent manufacturers, including the following:

• unavailability of, shortages or limitations on the ability to obtain supplies of components in the quantities that we require;

• delays in delivery or failure of suppliers to deliver critical components on the dates we require;

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• failure of suppliers to manufacture components to our specifications, and potentially reduced quality; and

• inability to obtain components at acceptable prices.

     Our business and operating results may suffer from the lack of alternative sources of supply for critical sole and limited source components. The process of qualifying suppliers is complex, requires extensive testing with our products, and may be lengthy, particularly as new products are introduced. New suppliers would have to be educated in our production processes. In addition, the use of alternate components may require design alterations to our products and additional product testing under FDA and relevant foreign regulatory agency guidelines, which may delay sales and increase product costs. In order to address our current liquidity issues, we have delayed the time period in which we have made payments to our vendors that are the sources of our component supply without the permission of such vendors. These delayed payments, if continued, may adversely affect these supply relationships and could jeopardize the timely and adequate supply of such components by such vendors. Until our current liquidity situation is remedied, such delays in payments to our vendors will persist. Any failures by our vendors to adequately and timely supply limited and sole source components may impair our ability to offer our existing products, delay the submission of new products for regulatory approval and market introduction, materially harm our business and financial condition and cause our stock price to decline. Establishing our own capabilities to manufacture these components would be expensive and could significantly decrease our profit margins, and is not practicable at the present time in any case. Our business, results of operations and financial condition would be adversely affected if we are unable to continue to timely obtain components in the quantity and quality desired and at the prices we have budgeted.

     We Face Risks Associated with our Collaborative and OEM Relationships.

     Our collaborators may not pursue further development and commercialization of products resulting from collaborations with us or may not devote sufficient resources to the marketing and sale of such products. For example, in 2005 we developed and sold a laser system on an OEM basis for a third party which positively impacted the revenues and gross margins during the second half of 2005. We cannot provide assurance that these types of relationships will continue over a longer period. Our reliance on others for clinical development, manufacturing and distribution of our products may result in unforeseen problems. Further, our collaborative partners may develop or pursue alternative technologies either on their own or in collaboration with others. If a collaborator elects to terminate its agreement with us, our ability to develop, introduce, market and sell the product may be significantly impaired and we may be forced to discontinue altogether the product resulting from the collaboration. We may not be able to negotiate alternative collaboration agreements on acceptable terms, if at all. The failure of any current or future collaboration efforts could have a material adverse effect on our ability to introduce new products or applications and therefore could have a material adverse effect on our business, results of operations and financial condition.

     We Face Manufacturing Risks.

     The manufacture of our infrared and visible light photocoagulators and the related delivery devices is a highly complex and precise process. We assemble critical subassemblies and all of our final products at our facility in Mountain View, California. We may experience manufacturing difficulties, quality control issues or assembly constraints, particularly with regard to new products that we may introduce. We may experience increased costs or delays and disruptions in manufacturing when we transition the production of the aesthetics product line that we acquired from Laserscope to our facilities upon the termination of the Product Supply Agreement we entered into with American Medical Systems Holdings in connection with the acquisition of the aesthetics business of Laserscope. We expect this transition to occur during the fourth quarter of 2007 and

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we may not have sufficient resources to assume these manufacturing obligations without increased costs or delays and disruptions in manufacturing. We may not be able to manufacture sufficient quantities of our products, which may require that we qualify other manufacturers for our products. Furthermore, we may experience delays, disruptions, capacity constraints or quality control problems in our manufacturing operations and, as a result, product shipments to our customers could be delayed, which would negatively impact our net revenues.

     We Depend on Collaborative Relationships to Produce, Develop, Introduce and Market New Products, Product Enhancements and New Applications.

     We depend on both clinical and commercial collaborative relationships. We entered into a Product Supply Agreement with American Medical Systems Holdings in connection with the acquisition of the aesthetics business of Laserscope, pursuant to which American Medical Systems Holdings currently manufactures a substantial portion of our aesthetics products. We expect to transition the manufacturing of these products to our facilities on or before October 2007, but we may not have sufficient resources to assume these manufacturing obligations without increased costs or delays and disruptions in manufacturing. We have also entered into collaborative relationships with academic medical centers and physicians in connection with the research and innovation and clinical testing of our products. Commercially, we currently collaborate with Bausch & Lomb to design and manufacture a solid-state green wavelength (532nm) laser photocoagulator module, called the Millennium Endolase module. The Millennium Endolase module is designed to be a component of Bausch & Lomb’s ophthalmic surgical suite product offering and is not expected to be sold as a stand-alone product. Sales of the Millennium Endolase module are dependent upon the actual order rate from and shipment rate to Bausch & Lomb, which depends on the efforts of our partner and is beyond our control. We cannot assure you that our relationship with Bausch & Lomb will result in further sales of our Millennium Endolase module. The failure to obtain any additional future clinical or commercial collaborations and the resulting failure or success of such arrangements of any current or future clinical or commercial collaboration relationships could have a material adverse effect on our ability to introduce new products or applications and therefore could have a material adverse effect on our business, results of operations and financial condition.

     If We Fail to Maintain Our Relationships With Health Care Providers, Customers May Not Buy Our Products and Our Revenue and Profitability May Decline.

     We market our products to numerous health care providers, including eye care professionals, hospitals, ambulatory surgical centers, corporate optometry chains and group purchasing organizations. We have developed and strive to maintain close relationships with members of each of these groups who assist in product research and development and advise us on how to satisfy the full range of surgeon and patient needs. We rely on these groups to recommend our products to their patients and to other members of their organizations. The failure of our existing products and any new products we may introduce to retain the support of these various groups could have a material adverse effect on our business, financial condition and results of operations.

     Our Operating Results May Fluctuate from Quarter to Quarter and Year to Year.

     Our sales and operating results may vary significantly from quarter to quarter and from year to year in the future. Our operating results are affected by a number of factors, many of which are beyond our control. Factors contributing to these fluctuations include the following:

• general economic uncertainties and political concerns;

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• the timing of the introduction and market acceptance of new products, product enhancements and new applications;

• changes in demand for our existing line of aesthetic and ophthalmic products;

• the cost and availability of components and subassemblies, including the willingness and ability of our sole or limited source suppliers to timely deliver components at the times and prices that we have planned;

• our ability to maintain sales volumes at a level sufficient to cover fixed manufacturing and operating costs;

• fluctuations in our product mix between aesthetic and ophthalmic products and foreign and domestic sales;

• our ability to address our current liquidity issues;

• the effect of regulatory approvals and changes in domestic and foreign regulatory requirements;

• introduction of new products, product enhancements and new applications by our competitors, entry of new competitors into our markets, pricing pressures and other competitive factors;

• our long and highly variable sales cycle;

• changes in the prices at which we can sell our products;

• changes in customers’ or potential customers’ budgets as a result of, among other things, reimbursement policies of government programs and private insurers for treatments that use our products; and

• increased product innovation costs.

     In addition to these factors, our quarterly results have been, and are expected to continue to be, affected by seasonal factors.

     Our expense levels are based, in part, on expected future sales. If sales levels in a particular quarter do not meet expectations, we may be unable to adjust operating expenses quickly enough to compensate for the shortfall of sales, and our results of operations may be adversely affected. We encountered this adverse effect on our operating results in each of the quarters ended March 31, 2007 and June 30, 2007. In addition, we have historically made a significant portion of each quarter’s product shipments near the end of the quarter. If that pattern continues, any delays in shipment of products could have a material adverse effect on results of operations for such quarter. Due to these and other factors, we believe that quarter to quarter and year to year comparisons of our past operating results may not be meaningful. You should not rely on our results for any quarter or year as an indication of our future performance. Our operating results in future quarters and years may be below expectations, which would likely cause the price of our common stock to fall.

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     Our Stock Price Has Been and May Continue to be Volatile and an Investment in Our Common Stock Could Suffer a Decline in Value.

     The trading price of our common stock has been subject to wide fluctuations in response to a variety of factors, some of which are beyond our control, including quarterly variations in our operating results, announcements by us or our competitors of new products or of significant clinical achievements, changes in market valuations of other similar companies in our industry and general market conditions. In the current calendar year, the trading price of our common stock has fluctuated from a high of $10.70 per share to a low of $2.32 per share, and there can be no assurance our common stock trading price will not suffer additional declines, especially in light of our current liquidity issues. In addition, from time to time, we meet with investors and potential investors. In addition, we receive attention by securities analysts and present at analyst meetings when invited. Our common stock may experience an imbalance between supply and demand resulting from low trading volumes. These broad market fluctuations could have a significant impact on the market price of our common stock regardless of our performance.

     Material Increases in Interest Rates May Harm Our Sales.

     We currently sell our products primarily to health care providers in general practice. These health care providers often purchase our products with funds they secure through various financing arrangements with third party financial institutions, including credit facilities and short-term loans. If interest rates continue to increase, these financing arrangements will be more expensive to our customers, which would effectively increase the overall cost of owning our products for our customers and, thereby, may decrease demand for our products. Any reduction in the sales of our products would cause our business to suffer.

     We Are Subject To Government Regulation Which May Cause Us to Delay or Withdraw the Introduction of New Products or New Applications for Our Products.

     The medical devices that we market and manufacture are subject to extensive regulation by the FDA and by foreign and state governments. Under the Federal Food, Drug and Cosmetic Act and the related regulations, the FDA regulates the design, development, clinical testing, manufacture, labeling, sale, distribution and promotion of medical devices. Before a new device can be introduced into the market, the product must undergo rigorous testing and an extensive regulatory review process implemented by the FDA under federal law. Unless otherwise exempt, a device manufacturer must obtain market clearance through either the 510(k) pre-market notification process or the lengthier pre-market approval application (PMA) process. Depending upon the type, complexity and novelty of the device and the nature of the disease or disorder to be treated, the FDA process can take several years, require extensive clinical testing and result in significant expenditures. Even if regulatory approval is obtained, later discovery of previously unknown safety issues may result in restrictions on the product, including withdrawal of the product from the market. Other countries also have extensive regulations regarding clinical trials and testing prior to new product introductions. Our failure to obtain government approvals or any delays in receipt of such approvals would have a material adverse effect on our business, results of operations and financial condition.

     The FDA imposes additional regulations on manufacturers of approved medical devices. We are required to comply with the applicable Quality System regulations and our manufacturing facilities are subject to ongoing periodic inspections by the FDA and corresponding state agencies, including unannounced inspections, and must be licensed as part of the product approval process before being utilized for commercial manufacturing. Noncompliance with the applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, withdrawal of marketing approvals, and criminal prosecution. The FDA also has the authority to request repair, replacement or refund of the cost of any device we manufacture or distribute. Any of these actions by the

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FDA would materially and adversely affect our ability to continue operating our business and the results of our operations.

     In addition, we are also subject to varying product standards, packaging requirements, labeling requirements, tariff regulations, duties and tax requirements. As a result of our sales in Europe, we are required to have all products “CE” marked, an international symbol affixed to all products demonstrating compliance with the European Medical Device Directive and all applicable standards. While currently all of our released products are CE marked, continued certification is based on the successful review of our quality system by our European Registrar during their annual audit. Any loss of certification would have a material adverse effect on our business, results of operations and financial condition.

     If We Fail to Comply With the FDA’s Quality System Regulation and Laser Performance Standards, Our Manufacturing Operations Could Be Halted, and Our Business Would Suffer.

     We are currently required to demonstrate and maintain compliance with the FDA’s Quality System Regulation, or QSR. The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. Because our products involve the use of lasers, our products also are covered by a performance standard for lasers set forth in FDA regulations. The laser performance standard imposes specific record-keeping, reporting, product testing and product labeling requirements. These requirements include affixing warning labels to laser products, as well as incorporating certain safety features in the design of laser products. The FDA enforces the QSR and laser performance standards through periodic unannounced inspections. We have been, and anticipate in the future being, subject to such inspections. Our failure to take satisfactory corrective action in response to an adverse QSR inspection or our failure to comply with applicable laser performance standards could result in enforcement actions, including a public warning letter, a shutdown of our manufacturing operations, a recall of our products, civil or criminal penalties, or other sanctions, such as those described in the preceding paragraph, which would cause our sales and business to suffer.

     If We Modify One of Our FDA Approved Devices, We May Need to Seek Reapproval, Which, if Not Granted, Would Prevent Us from Selling Our Modified Products or Cause Us to Redesign Our Products.

     Any modifications to an FDA-cleared device that would significantly affect its safety or effectiveness or that would constitute a major change in its intended use would require a new 510(k) clearance or possibly a pre-market approval. We may not be able to obtain additional 510(k) clearance or pre-market approvals for new products or for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearance would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenue and future profitability. We have made modifications to our devices in the past and may make additional modifications in the future that we believe do not or will not require additional clearance or approvals. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified devices, which could harm our operating results and require us to redesign our products.

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

     Our success and ability to compete is dependent in part upon our proprietary information. We rely on a combination of patents, trade secrets, copyright and trademark laws, nondisclosure and other contractual agreements and technical measures to protect our intellectual property rights. We file patent applications to protect technology, inventions and improvements that are significant to the development of our business. We have been issued fifteen United States patents and five foreign patents on the technologies related to our

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products and processes. We have approximately five pending patent applications in the United States and six foreign pending patent applications that have been filed. Our patent applications may not be approved. Any patents granted now or in the future may offer only limited protection against potential infringement and development by our competitors of competing products. Moreover, our competitors, many of which have substantial resources and have made substantial investments in competing technologies, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets.

     In addition to patents, we rely on trade secrets and proprietary know-how which we seek to protect, in part, through proprietary information agreements with employees, consultants and other parties. Our proprietary information agreements with our employees and consultants contain industry standard provisions requiring such individuals to assign to us without additional consideration any inventions conceived or reduced to practice by them while employed or retained by us, subject to customary exceptions. Proprietary information agreements with employees, consultants and others may be breached, and we may not have adequate remedies for any breach. Also, our trade secrets may become known to or independently developed by competitors.

     The laser and medical device industry is characterized by frequent litigation regarding patent and other intellectual property rights. Companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. Numerous patents are held by others, including academic institutions and our competitors. Until recently patent applications were maintained in secrecy in the United States until the patents issued. Patent applications filed in the United States after November 2000 generally will be published eighteen months after the filing date. However, since patent applications continue to be maintained in secrecy for at least some period of time, both within the United States and with regards to international patent applications, we cannot assure you that our technology does not infringe any patents or patent applications held by third parties. We have, from time to time, been notified of, or have otherwise been made aware of, claims that we may be infringing upon patents or other proprietary intellectual property owned by others. If it appears necessary or desirable, we may seek licenses under such patents or proprietary intellectual property. Although patent holders commonly offer such licenses, licenses under such patents or intellectual property may not be offered or the terms of any offered licenses may not be reasonable.

     Any claims, with or without merit, and regardless of whether we are successful on the merits, would be time-consuming, result in costly litigation and diversion of technical and management personnel, cause shipment delays or require us to develop noninfringing technology or to enter into royalty or licensing agreements. An adverse determination in a judicial or administrative proceeding and failure to obtain necessary licenses or develop alternate technologies could prevent us from manufacturing and selling our products, which would have a material adverse effect on our business, results of operations and financial condition. Management believes that liabilities resulting from the matters described in Part II, Item 1, or other claims which are pending or known to be threatened, will not have a material adverse effect on the Company’s financial position or results of operations. However, it is possible that cash flows or results or operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management’s attention and the incurrence of significant expenses.

     Because We Do Not Require Training for Users of Our Products, and Sell Our Products to Non-physicians, There Exists an Increased Potential for Misuse of Our Products, Which Could Harm Our Reputation and Our Business.

     Federal regulations allow us to sell our products to or on the order of “licensed practitioners.” The definition of “licensed practitioners” varies from state to state. As a result, our products may be purchased or

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operated by physicians with varying levels of training, and in many states by non-physicians, including nurse practitioners and technicians. Outside the United States, many jurisdictions do not require specific qualifications or training for purchasers or operators of our products. We do not supervise the procedures performed with our products, nor do we require that direct medical supervision occur. We, and our distributors, generally offer but do not require purchasers or operators of our products to attend training sessions. In addition, we sometimes sell our systems to companies that rent our systems to third parties and that provide a technician to perform the procedure. The lack of training and the purchase and use of our products by non-physicians may result in product misuse and adverse treatment outcomes, which could harm our reputation and expose us to costly product liability litigation.

     Some of Our Laser Systems Are Complex in Design and May Contain Defects That Are Not Detected Until Deployed By Our Customers, Which Could Increase Our Costs and Reduce Our Revenues.

     Laser systems are inherently complex in design and require ongoing regular maintenance. The manufacture of our lasers, laser products and systems involves a highly complex and precise process. As a result of the technical complexity of our products, changes in our or our suppliers’ manufacturing processes or the inadvertent use of defective materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve such yields or product reliability, our business, operating results, financial condition and customer relationships would be adversely affected. We provide warranties on certain of our product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of failure rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

     Our customers may discover defects in our products after the products have been fully deployed and operated under peak stress conditions. In addition, some of our products are combined with products from other vendors, which may contain defects. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to identify and fix defects or other problems, we could experience, among other things:

• loss of customers;

• increased costs of product returns and warranty expenses;

• damage to our brand reputation;

• failure to attract new customers or achieve market acceptance;

• diversion of development and engineering resources; and

• legal actions by our customers.

     The occurrence of any one or more of the foregoing factors could seriously harm our business, financial condition and results of operations.

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     Our Products Could Be Subject to Recalls Even After Receiving FDA Approval or Clearance. A Recall Would Harm Our Reputation and Adversely Affect Our Operating Results.

     The FDA and similar governmental authorities in other countries in which we market and sell our products have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government mandated recall, or a voluntary recall by us, could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. A recall could divert management’s attention, cause us to incur significant expenses, harm our reputation with customers and negatively affect our future sales.

     If We Fail to Manage Growth Effectively, Our Business Could Be Disrupted Which Could Harm Our Operating Results.

     We have experienced and may in the future experience growth in our business, both organically and through the acquisition of business and products. We have made and expect to continue to make significant investments to enable our future growth through, among other things, new product innovation and clinical trials for new applications and products. We must also be prepared to expand our work force and to train, motivate and manage additional employees as the need for additional personnel arises. Our personnel, systems, procedures and controls may not be adequate to support our future operations. Any failure to effectively manage future growth could have a material adverse effect on our business, results of operations and financial condition.

     Our Manufacturing Capacity May Not Be Adequate to Meet the Demands of Our Business.

     If our sales increase substantially, including increases in the sales of our aesthetic products, we may need to increase our production capacity and may not be able to do so in a timely, effective, or cost efficient manner. Any prolonged disruption in the operation of our manufacturing facilities could materially harm our business. We cannot assure you that if we choose to scale-up our manufacturing operations, we will have the resources necessary to do so, or that we will be able to obtain regulatory approvals in a timely fashion, which could affect our ability to meet product demand or result in additional costs.

     If Product Liability Claims are Successfully Asserted Against Us, We may Incur Substantial Liabilities That May Adversely Affect Our Business or Results of Operations.

     We may be subject to product liability claims from time to time. Our products are highly complex and some are used to treat extremely delicate eye tissue and skin conditions on and near a patient’s face. Although we maintain product liability insurance with coverage limits of $10.0 million per occurrence and an annual aggregate maximum of $10.0 million, our coverage from our insurance policies may not be adequate. Product liability insurance is expensive. We might not be able to obtain product liability insurance in the future on acceptable terms or in sufficient amounts to protect us, if at all. A successful claim brought against us in excess of our insurance coverage could have a material adverse effect on our business, results of operations and financial condition.

     Our Operating Results May be Adversely Affected by Changes in Third Party Coverage and Reimbursement Policies and any Uncertainty Regarding Healthcare Reform Measures.

     Our ophthalmology products are typically purchased by doctors, clinics, hospitals and other users, which bill various third-party payers, such as governmental programs and private insurance plans, for the health care services provided to their patients. Third-party payers are increasingly scrutinizing and challenging the coverage of new products and the level of reimbursement for covered products. Doctors,

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clinics, hospitals and other users of our products may not obtain adequate reimbursement for use of our products from third-party payers. While we believe that the laser procedures using our products have generally been reimbursed, payers may deny coverage and reimbursement for our products if they determine that the device was not reasonable and necessary for the purpose used, was investigational or was not cost-effective.

     Changes in government legislation or regulation or in private third-party payers’ policies toward reimbursement for procedures employing our products may prohibit adequate reimbursement. There have been a number of legislative and regulatory proposals to change the healthcare system, reduce the costs of healthcare and change medical reimbursement policies. Doctors, clinics, hospitals and other users of our products may decline to purchase our products to the extent there is uncertainty regarding reimbursement of medical procedures using our products and any healthcare reform measures. Further proposed legislation, regulation and policy changes affecting third party reimbursement are likely. We are unable to predict what legislation or regulation, if any, relating to the health care industry or third-party coverage and reimbursement may be enacted in the future, or what effect such legislation or regulation may have on us. However, denial of coverage and reimbursement of our products would have a material adverse effect on our business, results of operations and financial condition.

     The Successful Outcome of Clinical Trials and the Development of New Applications Using Certain of Our Products will Accelerate Future Revenue Growth Rates.

     The Company’s ability to generate incremental revenue growth will depend, in part, on the successful outcome of clinical trials that lead to the development of new applications using our products. Clinical trials are long, expensive and uncertain processes. If the future results of any of our clinical trials fail to demonstrate improved patient outcomes and/or the development of new product applications, our ability to generate incremental revenue growth would be adversely affected.

     If Our Facilities Were To Experience Catastrophic Loss, Our Operations Would Be Seriously Harmed.

     Our facilities could be subject to catastrophic loss such as fire, flood or earthquake. All of our research and product innovation activities, manufacturing, our corporate headquarters and other critical business operations are located near major earthquake faults in Mountain View, California. Any such loss at any of our facilities could disrupt our operations, delay production, shipments and revenue and result in large expense to repair and replace our facilities.

     Our Business is Subject to Environmental Regulations.

     Our facilities and operations are subject to federal, state and local environmental and occupational health and safety requirements of the United States and foreign countries, including those relating to discharges of substances to the air, water and land, the handling, storage and disposal of hazardous materials and wastes and the cleanup of properties affected by pollutants. Failure to maintain compliance with these regulations could have a material adverse effect on our business or financial condition.

     In the future, federal, state or local governments in the United States or foreign countries could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker health and safety matters that could affect our operations. Also, in the future, contamination may be found to exist at our current or former facilities or off-site locations where we have sent wastes. We could be held liable for such newly discovered contamination which could have a material adverse effect on our business or

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financial condition. In addition, changes in environmental and worker health and safety requirements could have a material adverse effect on our business or financial condition.

     Our Export Controls May Not be Adequate to Ensure Compliance With United States Export Laws, Especially When We Sell Our Products to Distributors Over Which We Have Limited Control.

     The United States government has declared an embargo that restricts the export of products and services to a number of countries, including Iran, Syria, Sudan and Cuba, for a variety of reasons, including the support by these countries of terrorism. We sell our products through distributors in Europe, Asia and the Middle East, and in such circumstances, the distributor is responsible for interacting with the end user of our products, including assisting in the set up of any products purchased by such end user. In order to comply with United States export laws, we have instituted export controls including training for our personnel in export restrictions and requirements, appointing an export control officer to oversee our export procedures, executing agreements with our distributors that include defining their territory for sale and requirements pertaining to United States export laws, obtaining end user information from our distributors and screening it to restricted party lists maintained by the United States government. While we believe that these procedures are adequate to prevent the export or re-export of our products into countries under embargo by the United States government, we cannot assure you that our products will not be exported or re-exported by our distributors into such restricted countries. In particular, our control over what our distributors do with our products is necessarily limited, and we cannot assure you that they will not sell our products to an end user in a country in violation of United States export laws. Any violation of United States export regulations could result in substantial legal, consulting and accounting costs, and significant fines and/or criminal penalties. In the event that our products are exported to countries under a United States trade embargo in violation of applicable United States export laws and regulations, such violations, costs and penalties or other actions that could be taken against us could adversely affect our reputation and/or have an adverse effect on our business, financial condition, prospects or results of operations.

     We have sold and may continue to sell, with a license, our products into countries that are under embargo by the United States and as a result have incurred and may continue to incur significant legal, consulting and accounting fees and may place our Company’s reputation at risk.

     United States export laws permit the sale of medical products to certain countries under embargo by the United States government if the seller of such products obtains a license to do so, which requirements are in place because the United States has designated such countries as state sponsors of terrorism. Certain of our products have been sold in Sudan and Syria under license through a distribution agreement with an independent distributor. In addition, certain of our products were distributed in Iran without United States governmental authorization. The aggregate revenue generated by sales of our products into Iran, Sudan and Syria have been immaterial to our business and results of operations

     We may continue to supply medical devices to Iran, Sudan and Syria and other countries that are under embargo by the United States government upon obtaining all necessary licenses. We do not believe, however, that our sales into such countries will be material to our business or results of operations. There are risks we face in selling to countries under United States embargo, including, but not limited to, possible damage to our reputation for sales to countries that are deemed to support terrorism and failure of our export controls to limit sales strictly to the terms of the relevant license, which failure may result in civil and criminal penalties. In addition, we may incur significant legal, consulting and accounting costs in ensuring compliance with our export licenses to countries under embargo. Any damage to our reputation from such sales, failure to comply with the terms of our export licenses or the additional costs we incur in making such sales could have a material adverse impact on our business, financial condition, prospects or results of operations.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None.

Item 3. Defaults Upon Senior Securities

     None.

Item 4. Submission of Matters to a Vote of Security Holders

     At our Annual Meeting of Stockholders held on June 7, 2007, with an adjournment until June 19, 2007, 7,267,501 shares of Common Stock, or 88.7% of the total outstanding shares, were voted. The table below presents the voting results with respect to the proposal to elect seven directors of the Company to serve for the ensuing year until their successors are elected and qualified, all of whom were elected.

	FOR		WITHHELD
Theodore Boutacoff		6,706,710		560,791
Barry Caldwell		5,419,563		1,847,938
James Donovan		6,490,260		777,241
Donald Hammond		5,415,284		1,852,217
Garrett Garrettson		6,154,814		1,112,687
Robert Anderson		6,624,043		643,458
Sanford Fitch		6,481,563		786,326

     The table below presents the voting results with respect to the proposal to amend our amended and restated 1998 Stock Plan to increase the number of shares of common stock of the Company reserved for issuance thereunder, which proposal was adopted by the stockholders:

ABSTAIN	FOR		AGAINST		NO-VOTE
244,562		3,392,813		1,982,482		1,647,698

     The table below presents the voting results with respect to the proposal to ratify the appointment of PricewaterhouseCoopers LLP as independent registered public accountants of the Company for the fiscal year ending December 29, 2007, which proposal was adopted by the stockholders:

ABSTAIN	FOR		AGAINST
4,000		7,210,454		53,047

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Item 5. Other Information

     None.

Item 6. Exhibits

10.1	Settlement Agreement dated as of April 6, 2007 by and between the Company and Synergetics, Inc. and Synergetics USA, Inc.
10.2	First Amendment dated as of April 19, 2007, to the Business Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A. (which is incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.3	Amendment dated as of April 19, 2007, to the Export-Import Bank Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A. (which is incorporated herein by reference to Exhibit 10.2 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.4	Business Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A., dated January 16, 2007 (which is incorporated herein by reference to Exhibit 99.1 to the Current Report on Form 8-K filed with the Commission on January 22, 2007).
10.5	Export-Import Bank Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A., dated January 16, 2007 (which is incorporated herein by reference to Exhibit 99.2 to the Current Report on Form 8-K filed with the Commission on January 22, 2007).
10.6	Letter from Mid-Peninsula Bank, part of Greater Bay Bank N.A., to the Company, dated April 23, 2007 (which is incorporated herein by reference to Exhibit 10.6 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.7	IRIDEX Corporation 1998 Stock Plan, amended and restated as of June 19, 2007.
10.8	Letter Agreement, dated as of June 27, 2007 by and between the Company and Laserscope, a California corporation and wholly-owned subsidiary of American Medical Systems, Inc.
31.1	Certification of Chief Executive Officer (Principal Executive and Principal Financial Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer (Principal Executive and Principal Financial Officer) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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Trademark Acknowledgments

     IRIDEX, the IRIDEX logo, IRIS Medical, OcuLight, SmartKey, EndoProbe and Apex are our registered trademarks. IRIDERM, G-Probe, DioPexy, DioVet, TruFocus, TrueCW, UltraView, DioLite 532, Long Pulse, MicroPulse, ScanLite, ColdTip (Handpiece), VariSpot (Handpiece), TruView and EasyFit product names are our trademarks. All other trademarks or trade names appearing in the Form 10-Q are the property of their respective owners.

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	IRIDEX Corporation (Registrant)
Date: August 14, 2007	By:	/s/ BARRY G. CALDWELL
		Name:	Barry G. Caldwell
		Title:	President and Chief Executive Officer (Principal Executive and Principal Financial Officer)

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Index

10.1	Settlement Agreement dated as of April 6, 2007 by and between the Company and Synergetics, Inc. and Synergetics USA, Inc.
10.2	First Amendment dated as of April 19, 2007, to the Business Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A. (which is incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.3	Amendment dated as of April 19, 2007, to the Export-Import Bank Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A. (which is incorporated herein by reference to Exhibit 10.2 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.4	Business Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A., dated January 16, 2007 (which is incorporated herein by reference to Exhibit 99.1 to the Current Report on Form 8-K filed with the Commission on January 22, 2007).
10.5	Export-Import Bank Loan and Security Agreement by and between the Company and Mid-Peninsula Bank, part of Greater Bay Bank N.A., dated January 16, 2007 (which is incorporated herein by reference to Exhibit 99.2 to the Current Report on Form 8-K filed with the Commission on January 22, 2007).
10.6	Letter from Mid-Peninsula Bank, part of Greater Bay Bank N.A., to the Company, dated April 23, 2007 (which is incorporated herein by reference to Exhibit 10.6 to the Current Report on Form 8-K filed with the Commission on April 24, 2007).
10.7	IRIDEX Corporation 1998 Stock Plan, amended and restated as of June 19, 2007.
10.8	Letter Agreement, dated as of June 27, 2007 by and between the Company and Laserscope, a California corporation and wholly-owned subsidiary of American Medical Systems, Inc.
31.1	Certification of Chief Executive Officer (Principal Executive and Principal Financial Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer (Principal Executive and Principal Financial Officer) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

EX-10.1

Exhibit 10.1

SETTLEMENT AGREEMENT

     This Settlement Agreement (“Settlement Agreement”) is made and entered into as of the last date of signature below (the “Effective Date”), by and between IRIDEX Corporation, a Delaware corporation, having offices at 1212 Terra Bella Avenue, Mountain View, California 94043 USA (“IRIDEX”), Synergetics, Inc., a Missouri corporation, having offices at 3845 Corporate Centre Drive, O’Fallon, Missouri 63368, and Synergetics USA, Inc. a Delaware corporation, having offices at 3845 Corporate Centre Drive, O’Fallon, Missouri 63368 (collectively, “Synergetics”) (IRIDEX and Synergetics are individually referred to herein as a “Party,” and collectively as the “Parties”).

     WHEREAS, IRIDEX and Synergetics have asserted claims against each other in the Actions;

     WHEREAS, IRIDEX and Synergetics desire to settle all claims that were ever asserted in the Actions on the terms and conditions recited below;

     NOW, THEREFORE, in consideration of the above recitals and the terms and conditions hereinafter contained, the Parties agree as follows:

ARTICLE 1 — DEFINITIONS

     As used in this Settlement Agreement, the following terms shall have the following meanings:

1.1 “Actions” means the following legal proceedings:

1.1.1	IRIDEX Corporation v. Synergetics USA, Inc. and Synergetics, Inc., United States District Court for the Eastern District of Missouri, Case No. 4:05-cv-01916-CDP (“the First Missouri Case”);
1.1.2	Synergetics, Inc. v. IRIDEX Corporation, United States District Court for the Eastern District of Missouri, Case No. 4:07-cv-358-MLM (“the Second Missouri Case”); and
1.1.3	Synergetics, Inc. v. Peregrine Surgical, Ltd., Innovatech Surgical, Inc., and IRIDEX Corporation, United States District Court for the Eastern District of Pennsylvania, Case No. 2:06-cv-00107-TMG (“the Pennsylvania Case”).

1.2 “Intuitive Patent Applications” means U.S. Patent Applications 60/444,060,10/765,350, and 11/035,694, any patent issuing therefrom and all reissues, reexaminations and extensions of any of such patents, and any other patents issuing from continuations, continuations-in-part and divisions of these applications, and all patent applications and issued patents (both foreign and domestic) that claim priority from them.

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1.3	“IRIDEX Patent” means U.S. Patent No. 5,085,492 (the ‘“492” Patent), all reissues, reexaminations and extensions of any of such patent, and any other patents issuing from continuations, continuations-in-part and divisions of the application on which such patent is based, and all patent applications and issued patents (both foreign and domestic) that claim priority from the 492 Patent.
1.4	“Person” shall mean an individual, trust, corporation, partnership, joint venture, limited liability company, association, unincorporated organization or other legal or governmental entity.
1.5	“Synergetics Patent” means U.S. Patent No. 6,984,230 (the “230” Patent), all reissues, reexaminations and extensions of any of such patents, and any other patents issuing from continuations, continuations-in-part and divisions of the application on which such patent is based, and all patent applications and issued patents (both foreign and domestic) that claim priority from the’230 Patent. The definition of “Synergetics Patent” does not include U.S. Patent No. 6,572,608.

ARTICLE 2 — DISMISSALS, RELEASES, LICENSES AND MANUFACTURING AGREEMENT

2.1

Dismissal. Within five (5) business days of the Effective Date of this Settlement Agreement, the Parties shall jointly execute and file dismissals with prejudice of the Actions, with each Party bearing its own attorney’s fees and costs. With respect to the Pennsylvania Case, Synergetics will dismiss with prejudice its claims against IRIDEX. Synergetics will dismiss without prejudice as to Peregrine Surgical Ltd. but hereby waives and releases its claim for past damages as alleged in the Pennsylvania Case against Peregrine Surgical Ltd. through the Effective Date of this Settlement Agreement. Except as explicitly waived or released herein, Synergetics specifically reserves all claims, causes of action, demands, damages, losses or other right to sue Peregrine Surgical Ltd., including but not limited to patent infringement for future damages and injunctive relief if Peregrine continues to make, use, sell, offer to sell or otherwise infringe Synergetics patents beyond the Effective Date of this Settlement Agreement, provided, however, that Peregrine may continue to make laser probes for IRIDEX pursuant to IRIDEX’s license under Section 2.5.1 until one-hundred, twenty-five (125) days after the Effective Date or until Synergetics provides IRIDEX a Notice of Ready pursuant to the “Supply Agreement” attached hereto as Exhibit B, whichever is later. This Settlement Agreement shall have no effect with regards to Innovatech Surgical, Inc. and does not require Synergetics to dismiss its claim against Innovatech Surgical, Inc.

2.2

Synergetics Release. Synergetics, and Synergetics’ successors, predecessors, parents, subsidiaries, affiliates, officers, directors, shareholders, employees and agents, hereby release, relinquish and discharge IRIDEX, and all of IRIDEX’s successors, predecessors, parents, subsidiaries, affiliates, officers, directors, shareholders, employees, customers,

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	and agents from any and all claims, causes of action, demands, damages, liabilities and losses of any nature, as of the Effective Date of this Settlement Agreement.
2.3	IRIDEX Release. IRIDEX, and IRIDEX’s successors, predecessors, parents, subsidiaries, affiliates, officers, directors, shareholders, employees and agents, hereby release, relinquish and discharge Synergetics, and all of Synergetics’ successors, predecessors, parents, subsidiaries, affiliates, officers, directors, shareholders, employees, customers, and agents from any and all claims, causes of action, demands, damages, liabilities and losses of any nature, as of the Effective Date of this Settlement Agreement.
2.4	IRIDEX License.

2.4.1	IRIDEX hereby grants to Synergetics a perpetual, fully paid-up, royalty free, worldwide, non-exclusive, non-transferable, non-sublicensable license under the IRIDEX Patent to make, have made, use, sell, offer to sell, and import Synergetics Licensed Products. No license is granted to Synergetics to practice any IRIDEX Patent except in the form of a Synergetics Licensed Product.
2.4.2	“Synergetics Licensed Product(s)” means any existing product, any product in development, or any product developed and released in the future that is a disposable laser delivery device that uses a connector comprising an RCA plug and SMA connector (what the Parties have referred to as the “new connector” in the First Missouri Case), in substantially the form shown in Exhibit A, to connect to an IRIDEX laser. The definition of “Synergetics Licensed Product(s)” excludes products using the adapter-based Quick Disconnect connector system that was also accused of infringement in the First Missouri Case.
2.4.3	IRIDEX hereby grants to Synergetics a perpetual, fully paid-up, royalty free, worldwide, non-exclusive, non-transferable, non-sublicensable license under the Intuitive Patent Applications to make, have made, use, sell, offer to sell, and import any product and use any method.
2.4.4	Both parties agree to mark their products in compliance with the patent laws with the licensed patent numbers of the other party. If a party identifies that the other party is not properly marking its products, the party owning the patent shall send notice and the non-marking party shall thereafter take diligent steps to properly mark products sold under license of the patent and provide written assurance to the other party that it has done so.

2.5 Synergetics License.

2.5.1 Synergetics hereby grants to IRIDEX a perpetual, fully paid-up, royalty free, worldwide, non-exclusive, non-transferable, non-sublicensable license under the Synergetics Patent to make, have made, use, sell, offer to sell, and import any product and use any method.

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2.5.2 Section 2.4.4 is incorporated herein by reference with respect to Index’s marking obligations for products that it sells under license of the Synergetics Patent.

2.6	Representation and Warranty. Each Party represents and warrants that it holds the full right, title, and interest necessary to grant the licenses herein granted.
2.7	No Admission. The Parties agree that the settlement of the Actions is intended solely as a compromise of disputed claims, counterclaims and defenses, all as more particularly described in this Settlement Agreement. Neither the fact of a Party’s entry into this Settlement Agreement nor the terms hereof nor any acts undertaken, pursuant hereto shall constitute an admission or concession by any Party relating to any Action regarding liability or the validity of any claim, counterclaim, or defense in the Actions.
2.8	The Parties each acknowledge that they are familiar with Section 1542 of the Civil Code of the State of California, which provides as follows:
	A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR.

The Parties hereby waive any right or benefit that each has or may have under Section 1542 of the Civil Code of the State of California. In connection with such waiver, the Parties acknowledge that they or their attorneys or other agents, may hereafter discover claims or facts in addition to or different from those which they now know or believe to exist with respect to the subject matter of this Settlement Agreement. Nevertheless, it is their intention to fully, finally and forever settle and release all of the released matters.

2.9 Iridex agrees to exclusively engage Synergetics to manufacture directional laser probes pursuant to the license granted by Synergetics under Section 2.5 and pursuant to the “Supply Agreement” attached hereto as Exhibit B. Any material breach or default under the Supply Agreement shall constitute a material breach under this Settlement Agreement, provided that the obligation to pay the amounts specified in Section 4.1 is absolute and unconditional, and shall not be subject to any set-off, claim or defense for any reason, including any breach of the Supply Agreement, except that if IRIDEX enters any proceeding under Chapter 7 of the Bankruptcy Code, any then-executory payments will be excused, and that Synergetics may set-off any uncontested amount due Synergetics under the Supply Agreement that is past due by thirty days or more and is confirmed to be uncontested in writing by IRIDEX, which confirmation shall not unreasonably be withheld.

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ARTICLE 3 — COOPERATION

3.1

The Parties agree to use commercially reasonable efforts to ensure the present and continuing validity and enforceability of the Synergetics Patent and the Intuitive Patent Applications and to cooperate in good faith to the extent lawfully permissible with respect to the Synergetics Patent and the Intuitive Patent Applications to promote their mutual interests, including their interests in maintaining the Synergetics Patent and the Intuitive Patent Applications valid and enforceable.

3.2

The Parties agree to jointly prepare a mutually acceptable press release to announce the settlement of their litigation, such press release to be issued after the Effective Date, and no further press releases regarding this Settlement Agreement shall be made by any Party, its employees, agents or representatives, except for purposes of reporting on this Settlement Agreement to shareholders or otherwise complying with tax and securities laws.

ARTICLE 4 — PAYMENT

4.1 In consideration of the licenses granted hereunder, Synergetics shall pay to IRIDEX the following sums, due and payable according to the following schedule:

Amount	Due and payable
2.5 million dollars (US $2,500,000)	April 16, 2007
Eight hundred thousand dollars (US $800,000)	April 16, 2008
Eight hundred thousand dollars (US $800,000)	April 16, 2009
Eight hundred thousand dollars (US $800,000)	April 16, 2010
Eight hundred thousand dollars (US $800,000)	April 16, 2011
Eight hundred thousand dollars (US $800,000)	April 16, 2012

4.2 Payments by Synergetics to IRIDEX shall be made by wire transfer of funds to the following account or such other account as Iridex may reasonably direct:

Mid Peninsula Bank
420 Cowper Street
Palo Alto, CA 94301
ABA# 121 141 534
Beneficiary: IRIDEX Corporation
Account Number: 10 79 95 601

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4.3 In the event that Synergetics fails to pay any amount due under Section 4.1, each of the as-yet unpaid amounts listed in Section 4.1 shall become immediately due and payable, subject to Section 6.1, which requires written notice of a breach and the ability to cure.

ARTICLE 5 — DISCLAIMERS

5.1 Disclaimers. Nothing in this Settlement Agreement shall be construed as:

     (a) a warranty or representation by any Party as to the validity or scope of any of its patents or patent applications;

     (b) a warranty or representation by any Party that any manufacture, sale, use or other disposition of products by the other Party has been or will be free from infringement of any third party patents;

     (c) an agreement by any Party to bring or prosecute actions or suits against any third party for infringement, or conferring any right to any other Party to bring or prosecute actions or suits against any third party for infringement;

     (d) conferring upon any Party any right to include in advertising, packaging or other commercial activities related to any product, any reference to another Part, its trade names, trademarks or service marks in a manner which would be likely to cause confusion or to indicate that such product is in any way certified by any other Party;

     (e) conferring by implication, estoppel or otherwise, upon any Party, any right or license not expressly set forth herein under any patent or other intellectual property right; or

     (f) an obligation to furnish any technical information, copyrights, mask works or know- how, or any tangible embodiments thereof.

ARTICLE 6 — MISCELLANEOUS PROVISIONS

6.1

Remedies for Breach. In the event of a breach of this Settlement Agreement, the non-defaulting Party shall have all rights and remedies available to it at law or equity, in addition to the rights and remedies provided for in this Settlement Agreement. The non-defaulting Party shall provide written notice describing the nature of the breach to the Party in breach of this Settlement Agreement, and the non-defaulting Party shall provide the defaulting Party five (5) business days from the date of the notice to cure its breach before taking or instituting any legal action or otherwise withholding performance under this Settlement Agreement, provided, however, that Synergetics shall have thirty (30) days from notice of breach of a payment obligation under Section 4.1 to cure that breach if IRIDEX did not give notice of the upcoming payment obligation thirty days in advance of the due date specified in Section 4.1.

6.2

Representation. Each Party hereby declares and represents that it is executing this Settlement Agreement after consultation with its own independent legal counsel.

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6.3	Further Acts. Each Party agrees to perform any further acts, and to execute and deliver any further documents that may be reasonably necessary to carry out the provisions of this Settlement Agreement.
6.4	Notices. All notices required or permitted to be given hereunder shall be in writing and shall be made by depositing the writing with Federal Express or other similar express letter carrier, expenses prepaid for overnight delivery with receipt signature required. Notices shall be deemed effective upon execution of the receipt signature. Notices shall be addressed as follows:

If to Synergetics:	Synergetics USA, Inc.
	Attention: Chief Executive Officer
	3845 Corporate Centre Drive
	O’Fallon, MO 63368
If to IRIDEX:	IRIDEX Corporation
	Attention: Chief Executive Officer
	1212 Terra Bella Avenue
	Mountain View, CA 94043

6.5	Severability. If any provision of this Settlement Agreement is held to be illegal or unenforceable, such provision shall be limited or eliminated to the minimum extent necessary so that the remainder of this Settlement Agreement will continue in full force and effect and be enforceable. The Parties agree to negotiate in good faith an enforceable substitute provision for any invalid or unenforceable provision that most nearly achieves the intent and effect of such provision.
6.6	Entire Agreement. This Settlement Agreement, with Exhibit A, embodies the entire understanding of the Parties with respect to the subject matter hereof, and merges all prior discussions and agreements (written or oral) between them, and none of the Parties shall be bound by any conditions, definitions, warranties, understandings, or representations with respect to the subject matter hereof other than as expressly provided herein. No oral explanation or oral information by any Party hereto shall alter the meaning or interpretation of this Settlement Agreement.
6.7	Modification. No modification or amendment to this Settlement Agreement will be effective unless it is in writing and executed by authorized representatives of the Parties, nor will any waiver of any rights be effective unless assented to in writing by the Party to be charged. The waiver of any breach or default will not constitute a waiver of any subsequent breach or default.
6.8	Construction. Any rule of construction to the effect that ambiguities are to be resolved against the drafting Party will not be applied in the construction or interpretation of this

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	Settlement Agreement. As used in this Settlement Agreement, the words “include” and “including,” “for example”, “such as” and variations thereof, will not be deemed to be terms of limitation, but rather will be deemed to be followed by the words “without limitation.” The headings in this Settlement Agreement will not be referred to in connection with the construction or interpretation of this Settlement Agreement.
6.9	Counterparts. This Settlement Agreement may be executed in identical counterparts or duplicate originals, both of which shall be regarded as one and the same instrument, and which shall be the official arid governing version in the interpretation of this Settlement Agreement. This Settlement Agreement may be executed by facsimile signatures and such signatures shall be deemed to bind each Party as if they were original signatures.
6.10	Assignability. This Settlement Agreement shall not be assignable by either Party to any Person without the prior written consent of the other Party. Consent may be withheld for any reason.

          IN WITNESS WHEREOF, the Parties hereto have caused this Settlement Agreement to be signed below by their respective duly authorized officers.

Synergetics, Inc.	IRIDEX Corporation
By: /s/ Gregg Scheller	By:	/s/ Barry Caldwell
Name: Gregg Scheller	Name: Barry Caldwell
Title: President & CEO	Title: President & CEO
Date: 4/6/07	Date: 4/6/07
Synergetics USA, Inc.
By: /s/ Gregg Scheller
Name: Gregg Scheller
Title: President & CEO
Date: 4/6/07

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Exhibit A

Synergetics’ New Connector

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Exhibit B

Supply Agreement

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EX-10.7

Exhibit 10.7

IRIDEX CORPORATION

1998 STOCK PLAN

(As amended June 19, 2007)

     1. Purposes of the Plan. The purposes of this Stock Plan are:

• to attract and retain the best available personnel for positions of substantial responsibility,

• to provide additional incentive to Employees, Directors and Consultants, and

• to promote the success of the Company’s business.

     The Plan permits the grant of Incentive Stock Options, Nonstatutory Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Shares and Performance Units, as the Administrator may determine.

     2. Definitions. As used herein, the following definitions shall apply:

          (a) “Administrator” means the Board or any of its Committees as shall be administering the Plan, in accordance with Section 4 of the Plan.

          (b) “Affiliate” means any corporation or any other entity (including, but not limited to, partnerships and joint ventures) controlling, controlled by, or under common control with the Company.

          (c) “Applicable Laws” means the requirements relating to the administration of equity-based awards under U.S. state corporate laws, U.S. federal and state securities laws, the Code, any stock exchange or quotation system on which the Common Stock is listed or quoted and the applicable laws of any foreign country or jurisdiction where Awards are, or will be, granted under the Plan.

          (d) “Award” means, individually or collectively, a grant under the Plan of Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Units and Performance Shares as the Administrator may determine.

          (e) “Award Agreement” means the written or electronic agreement setting forth the terms and provisions applicable to each Award granted under the Plan, which shall include an Option Agreement. The Award Agreement is subject to the terms and conditions of the Plan.

          (f) “Board” means the Board of Directors of the Company.

          (g) “Cash Position” means as to any Performance Period, the Company’s level of cash, cash equivalents, available-for-sales securities, and the long term portion of available-for-sales securities.

          (h) “Code” means the Internal Revenue Code of 1986, as amended. Any reference to a section of the Code herein will be a reference to any successor or amended section of the Code.

          (i) “Committee” means a committee of Directors or of other individuals satisfying Applicable Laws appointed by the Board in accordance with Section 4 hereof.

          (j) “Common Stock” means the common stock of the Company.

          (k) “Company” means IRIDEX Corporation, a Delaware corporation, or any successor thereto.

          (l) “Consultant” means any person, including an advisor, engaged by the Company or its Affiliate to render services to such entity.

          (m) “Determination Date” means the latest possible date that will not jeopardize the qualification of an Award granted under the Plan as “performance-based compensation” under Section 162(m) of the Code.

          (n) “Director” means a member of the Board.

          (o) “Disability” means total and permanent disability as defined in Section 22(e)(3) of the Code, provided that in the case of Awards other than Incentive Stock Options, the Administrator in its discretion may determine whether a permanent and total disability exists in accordance with uniform and non-discriminatory standards adopted by the Administrator from time to time.

          (p) “Earnings Per Share” means as to any Performance Period, the Company’s or a business unit’s Net Income, divided by a weighted average number of Common Stock outstanding and dilutive common equivalent Shares deemed outstanding.

          (q) “Employee” means any person, including Officers and Directors, employed by the Company or its Affiliates. Neither service as a Director nor payment of a director’s fee by the Company will be sufficient to constitute “employment” by the Company.

          (r) “Exchange Act” means the Securities Exchange Act of 1934, as amended.

          (s) “Fair Market Value” means, as of any date, the value of Common Stock as the Administrator may determine in good faith by reference to the price of such stock on any established stock exchange or a national market system on the day of determination if the Common Stock is so listed on any established stock exchange or a national market system. If the Common Stock is not listed on any established stock exchange or a national market system, the value of the Common Stock as the Administrator may determine in good faith.

          (t) “Fiscal Year” means the fiscal year of the Company.

          (u) “Incentive Stock Option” means an Option that by its terms qualifies and is otherwise intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder.

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          (v) “Individual Objectives” means as to a Participant for any Performance Period, the objective and measurable goals set by a “management by objectives” process and approved by the Administrator (in its discretion).

          (w) “Net Income” means as to any Performance Period, the Company’s or a business unit’s income after taxes.

          (x) “Nonstatutory Stock Option” means an Option that by its terms does not qualify or is not intended to qualify as an Incentive Stock Option.

          (y) “Officer” means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder.

          (z) “Operating Cash Flow” means as to any Performance Period, the Company’s or a business unit’s sum of Net Income plus depreciation and amortization plus changes in working capital comprised of accounts receivable, inventories, other current assets, trade accounts payable, accrued expenses, product warranty, advance payments from customers and long-term accrued expenses.

          (aa) “Operating Income” means as to any Performance Period, the Company’s or a business unit’s income from operations but excluding any unusual items or non-operating or non-cash related expenses.

          (bb) “Option” means a stock option granted pursuant to the Plan.

          (cc) “Option Agreement” means an agreement between the Company and a Participant evidencing the terms and conditions of an individual Option grant. The Option Agreement is subject to the terms and conditions of the Plan.

          (dd) “Optioned Stock” means the Common Stock subject to an Award

          (ee) “Parent” means a “parent corporation,” whether now or hereafter existing, as defined in Section 424(e) of the Code.

          (ff) “Participant” means the holder of an outstanding Award, which shall include an Optionee.

          (gg) “Performance Goals” means the goal(s) (or combined goal(s)) determined by the Administrator (in its discretion) to be applicable to a Participant with respect to an Award. As determined by the Administrator, the Performance Goals applicable to an Award may provide for a targeted level or levels of achievement using one or more of the following measures: (a) Cash Position, (b) Earnings Per Share, (c) Individual Objectives, (d) Net Income, (e) Operating Cash Flow, (f) Operating Income, (g) Return on Assets, (h) Return on Equity, (i) Return on Sales, (j) Revenue, and (k) Total Stockholder Return. The Performance Goals may differ from Participant to Participant and from Award to Award. Prior to the Determination Date, the Administrator shall determine whether any significant element(s) shall be included in or excluded from the calculation of any Performance Goal with respect to any Participant. For example (but not by way of limitation), the Administrator may determine that the measures for one or more Performance Goals shall be based upon the Company’s pro-forma results and/or results in accordance with generally accepted accounting principles.

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          (hh) “Performance Period” means any Fiscal Year or such other period as determined by the Administrator in its sole discretion.

          (ii) “Performance Share” means an Award denominated in Shares which may be earned in whole or in part upon attainment of Performance Goals or other vesting criteria as the Administrator may determine pursuant to Section 10.

          (jj) “Performance Unit” means an Award which may be earned in whole or in part upon attainment of Performance Goals or other vesting criteria as the Administrator may determine and which may be settled for cash, Shares or other securities or a combination of the foregoing pursuant to Section 10.

          (kk) “Plan” means this 1998 Stock Plan, as amended and restated.

          (ll) “Restricted Stock” means Shares issued pursuant to a Restricted Stock award under Section 8 of the Plan, or issued pursuant to the early exercise of an Option.

          (mm) “Restricted Stock Unit” means a bookkeeping entry representing an amount equal to the Fair Market Value of one Share, granted pursuant to Section 9. Each Restricted Stock Unit represents an unfunded and unsecured obligation of the Company.

          (nn) “Return on Assets” means as to any Performance Period, the percentage equal to the Company’s or a business unit’s Operating Income, divided by average net Company or business unit, as applicable, assets.

          (oo) “Return on Equity” means as to any Performance Period, the percentage equal to the Company’s Net Income divided by average stockholder’s equity.

          (pp) “Return on Sales” means as to any Performance Period, the percentage equal to the Company’s or a business unit’s Operating Income, divided by the Company’s or the business unit’s, as applicable, revenue.

          (qq) “Revenue” means as to any Performance Period, the Company’s or business unit’s net sales.

          (rr) “Rule 16b-3” means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan.

          (ss) “Section 16(b)” means Section 16(b) of the Exchange Act.

          (tt) “Service Provider” means an Employee, Director or Consultant.

          (uu) “Share” means a share of the Common Stock, as adjusted in accordance with Section 13 of the Plan.

          (vv) “Stock Appreciation Right” means an Award, granted alone or in connection with an Option, that pursuant to Section 7 is designated as a Stock Appreciation Right.

          (ww) “Subsidiary” means a “subsidiary corporation”, whether now or hereafter existing, as defined in Section 424(f) of the Code.

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          (xx) “Total Stockholder Return” means as to any Performance Period, the total return (change in Share price plus reinvestment of any dividends) of a Share.

     3. Stock Subject to the Plan.

          (a) Stock Subject to the Plan. Subject to the provisions of Section 13 of the Plan, the maximum aggregate number of Shares which may be optioned and sold under the Plan is two million one hundred and fifty thousand (2,150,000) Shares. The Shares may be authorized, but unissued, or reacquired Common Stock.

          (b) Full Value Awards. Any Shares subject to Options or Stock Appreciation Rights will be counted against the numerical limits of this Section 3 as one Share for every Share subject thereto. Any Shares subject to Awards of Restricted Stock, Restricted Stock Units, Performance Shares or Performance Units with a per share or unit purchase price lower than 100% of Fair Market Value on the date of grant will be counted against the numerical limits of this Section 3 as two (2) Shares for every one Share subject thereto. To the extent that a Share that was subject to an Award that counted as two (2) Shares against the Plan reserve pursuant to the preceding sentence is recycled back into the Plan under the next paragraph of this Section 3, the Plan will be credited with two (2) Shares.

          (c) Lapsed Awards. If an Award expires or becomes unexercisable without having been exercised in full, or, with respect to Restricted Stock, Restricted Stock Units, Performance Shares or Performance Units, is forfeited to or repurchased by the Company, the unpurchased Shares (or for Awards other than Options and Stock Appreciation Rights, the forfeited or repurchased shares) which were subject thereto will become available for future grant or sale under the Plan (unless the Plan has terminated). With respect to Stock Appreciation Rights, Shares actually issued pursuant to a Stock Appreciation Right as well as the Shares that represent payment of the exercise price will cease to be available under the Plan. Shares that have actually been issued under the Plan under any Award will not be returned to the Plan and will not become available for future distribution under the Plan; provided, however, that if Shares subject to Awards of Restricted Stock, Restricted Stock Units, Performance Shares or Performance Units are repurchased by the Company or are forfeited to the Company, such Shares will become available for future grant under the Plan. Shares used to pay the exercise price of an Option will not become available for future grant or sale under the Plan. Shares used to satisfy tax withholding obligations will not become available for future grant or sale under the Plan. To the extent an Award under the Plan is paid out in cash rather than Shares, such cash payment will not reduce the number of Shares available for issuance under the Plan. Notwithstanding the foregoing and, subject to adjustment provided in Section 13, the maximum number of Shares that may be issued upon the exercise of Incentive Stock Options will equal the aggregate Share number stated in Section 3(a), plus, to the extent allowable under Section 422 of the Code, any Shares that become available for issuance under the Plan under this Section 3(c).

          (d) Share Reserve. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as will be sufficient to satisfy the requirements of the Plan.

     4. Administration of the Plan.

          (a) Procedure.

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               (i) Multiple Administrative Bodies. The Plan may be administered by different Committees with respect to different groups of Service Providers.

               (ii) Section 162(m). To the extent that the Administrator determines it to be desirable to qualify Options granted hereunder as “performance-based compensation” within the meaning of Section 162(m) of the Code, the Plan shall be administered by a Committee of two or more “outside directors” within the meaning of Section 162(m) of the Code.

               (iii) Rule 16b-3. To the extent desirable to qualify transactions hereunder as exempt under Rule 16b-3, the transactions contemplated hereunder shall be structured to satisfy the requirements for exemption under Rule 16b-3.

               (iv) Other Administration. Other than as provided above, the Plan shall be administered by (A) the Board or (B) a Committee, which committee shall be constituted to satisfy Applicable Laws.

          (b) Powers of the Administrator. Subject to the provisions of the Plan, and in the case of a Committee, subject to the specific duties delegated by the Board to such Committee, the Administrator shall have the authority, in its discretion:

               (i) to select the Service Providers to whom Awards may be granted hereunder;

               (ii) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any Award granted hereunder;

               (iii) to construe and interpret the terms of the Plan and Awards granted pursuant to the Plan;

               (iv) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations relating to sub-plans established for the purpose of satisfying applicable foreign laws;

               (v) to modify or amend each Award (subject to Section 21(c) of the Plan) including, without limitation, the discretionary authority to extend the post-termination exercisability period of Awards longer than is otherwise provided for in the Plan. Notwithstanding the previous sentence, the Administrator may not modify or amend an Option or Stock Appreciation Right to reduce the exercise price of such Option or Stock Appreciation Right after it has been granted (except for adjustments made pursuant to Section 16) nor may the Administrator cancel any outstanding Option or Stock Appreciation Right and replace it with a new Option or Stock Appreciation Right with a lower exercise price, unless, in either case, such action is approved by the Company’s stockholders;

               (vi) to authorize any person to execute on behalf of the Company any instrument required to effect the grant of an Award previously granted by the Administrator;

               (vii) to allow a Participant to defer the receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Participant under an Award pursuant to such procedures as the Administrator may determine; and

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               (viii) to make all other determinations deemed necessary or advisable for administering the Plan.

          (c) Effect of Administrator’s Decision. The Administrator’s decisions, determinations and interpretations shall be final and binding on all Participants and any other holders of Awards.

     5. Eligibility. Nonstatutory Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Shares and Performance Units as the Administrator determines may be granted to Service Providers. Incentive Stock Options may be granted only to Employees of the Company or any Parent or Subsidiary of the Company.

     6. Options.

          (a) Limitations.

               (i) Each Option shall be designated in the Award Agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designation, to the extent that the aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Participant during any calendar year (under all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 6(a), Incentive Stock Options shall be taken into account in the order in which they were granted. The Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted.

               (ii) The following limitations shall apply to grants of Options:

                    (1) No Service Provider shall be granted, in any Fiscal Year, Options to purchase more than 200,000 Shares.

                    (2) In connection with his or her initial service, a Service Provider may be granted Options to purchase up to an additional 400,000 Shares which shall not count against the limit set forth in subsection (1) above.

                    (3) The foregoing limitations shall be adjusted proportionately in connection with any change in the Company’s capitalization as described in Section 13.

                    (4) If an Option is cancelled in the same fiscal year of the Company in which it was granted (other than in connection with a transaction described in Section 13), the cancelled Option will be counted against the limits set forth in subsections (1) and (2) above. For this purpose, if the exercise price of an Option is reduced, the transaction will be treated as a cancellation of the Option and the grant of a new Option.

          (b) Term of Option. The term of each Option shall be stated in the Award Agreement and shall be seven (7) years from the date of grant or such shorter term as may be provided by the Administrator; provided, however, that in the case of an Incentive Stock Option granted to a Participant who, at the time the Incentive Stock Option is granted, owns stock representing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Incentive Stock Option shall be five (5) years from the date of grant or such shorter term as may be provided by the Administrator.

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          (c) Option Exercise Price and Consideration.

               (i) Exercise Price. The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be determined by the Administrator, subject to the following:

                    (1) In the case of an Incentive Stock Option

                         a) granted to an Employee who, at the time the Incentive Stock Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant.

                         b) granted to any Employee other than an Employee described in paragraph (A) immediately above, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant.

                    (2) In the case of a Nonstatutory Stock Option, the per Share exercise price will be determined by the Administrator, but will be no less than 100% of the Fair Market Value per Share on the date of grant.

                    (3) Notwithstanding the foregoing, Options may be granted with a per Share exercise price of less than 100% of the Fair Market Value per Share on the date of grant pursuant to a transaction described in, and in a manner consistent with, Section 424(a) of the Code.

               (ii) Waiting Period and Exercise Dates. At the time an Option is granted, the Administrator shall fix the period within which the Option may be exercised and shall determine any conditions which must be satisfied before the Option may be exercised.

               (iii) Form of Consideration. The Administrator will determine the acceptable form(s) of consideration for exercising an Option, including the method of payment, to the extent permitted by Applicable Laws.

          (d) Exercise of Option.

               (i) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable according to the terms of the Plan and at such times and under such conditions as determined by the Administrator and set forth in the Award Agreement. An Option may not be exercised for a fraction of a Share.

               An Option shall be deemed exercised when the Company receives: (i) written or electronic notice of exercise (in accordance with the Award Agreement) from the person entitled to exercise the Option, and (ii) full payment for the Shares with respect to which the Option is exercised together with any applicable withholding taxes. Full payment may consist of any consideration and method of payment authorized by the Administrator and permitted by the Award Agreement and the Plan. Shares issued upon exercise of an Option shall be issued in the name of the Participant or, if requested by the Participant, in the name of the Participant and his or her spouse. Until the Shares are issued (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company), no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such Shares promptly after the Option

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is exercised. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Shares are issued, except as provided in Section 13 of the Plan.

               Exercising an Option in any manner shall decrease the number of Shares thereafter available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised.

               (ii) Termination of Relationship as a Service Provider. If an Participant ceases to be a Service Provider, other than upon the Participant’s death or Disability, the Participant may exercise his or her Option within such period of time as is specified in the Award Agreement to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for three (3) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If, after termination, the Participant does not exercise his or her Option within the time specified by the Administrator, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

               (iii) Disability of Participant. If an Participant ceases to be a Service Provider as a result of the Participant’s Disability, the Participant may exercise his or her Option within such period of time as is specified in the Award Agreement to the extent the Option is vested on the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for twelve (12) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If, after termination, the Participant does not exercise his or her Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

               (iv) Death of Participant. If an Participant dies while a Service Provider, the Option may be exercised within such period of time as is specified in the Award Agreement (but in no event later than the expiration of the term of such Option as set forth in the Award Agreement), by the Participant’s estate or by a person who acquires the right to exercise the Option by bequest or inheritance, but only to the extent that the Option is vested on the date of death. In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for twelve (12) months following the Participant’s termination. If, at the time of death, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of the Option shall immediately revert to the Plan. The Option may be exercised by the executor or administrator of the Participant’s estate or, if none, by the person(s) entitled to exercise the Option under the Participant’s will or the laws of descent or distribution. If the Option is not so exercised within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

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     7. Stock Appreciation Rights.

          (a) Grant of Stock Appreciation Rights. Subject to the terms and conditions of the Plan, a Stock Appreciation Right may be granted to Service Providers at any time and from time to time as will be determined by the Administrator, in its sole discretion.

          (b) Number of Shares. The Administrator will have complete discretion to determine the number of Stock Appreciation Rights granted to any Participant, provided that during any Fiscal Year, no Participant will be granted Stock Appreciation Rights covering more than 200,000 Shares. Notwithstanding the foregoing limitation, in connection with a Participant’s initial service as an Employee, an Employee may be granted Stock Appreciation Rights covering up to an additional 400,000 Shares.

          (c) Exercise Price and Other Terms. The Administrator, subject to the provisions of the Plan, will have complete discretion to determine the terms and conditions of Stock Appreciation Rights granted under the Plan, provided, however, that the exercise price will be not less than one hundred percent (100%) of the Fair Market Value of a Share on the date of grant.

          (d) Stock Appreciation Right Agreement. Each Stock Appreciation Right grant will be evidenced by an Award Agreement that will specify the exercise price, the term of the Stock Appreciation Right, the conditions of exercise, and such other terms and conditions as the Administrator, in its sole discretion, will determine.

          (e) Expiration of Stock Appreciation Rights. A Stock Appreciation Right granted under the Plan will expire upon the date determined by the Administrator, in its sole discretion, and set forth in the Award Agreement. Notwithstanding the foregoing, the rules of Section 6(d) also will apply to Stock Appreciation Rights.

          (f) Payment of Stock Appreciation Right Amount. Upon exercise of a Stock Appreciation Right, a Participant will be entitled to receive payment from the Company in an amount determined by multiplying:

               (i) The difference between the Fair Market Value of a Share on the date of exercise over the exercise price; times

               (ii) The number of Shares with respect to which the Stock Appreciation Right is exercised.

At the discretion of the Administrator, the payment upon Stock Appreciation Right exercise may be in cash, in Shares of equivalent value, or in some combination thereof.

     8. Restricted Stock.

          (a) Grant of Restricted Stock. Subject to the terms and provisions of the Plan, the Administrator, at any time and from time to time, may grant Shares of Restricted Stock to Service Providers in such amounts as the Administrator, in its sole discretion, will determine.

          (b) Restricted Stock Agreement. Each Award of Restricted Stock will be evidenced by an Award Agreement that will specify the number of Shares granted, and such other

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terms and conditions as the Administrator, in its sole discretion, will determine. Notwithstanding the foregoing, during any Fiscal Year no Participant will receive more than an aggregate of 150,000 Shares of Restricted Stock; provided, however, that in connection with a Participant’s initial service as an Employee, an Employee may be granted an aggregate of up to an additional 150,000 Shares of Restricted Stock. Unless the Administrator determines otherwise, Shares of Restricted Stock will be held by the Company as escrow agent until the restrictions on such Shares have lapsed.

          (c) Transferability. Except as provided in this Section 8, Shares of Restricted Stock may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the Shares have vested and are no longer subject to a substantial risk of forfeiture.

          (d) Other Restrictions. The Administrator, in its sole discretion, may impose such other restrictions on Shares of Restricted Stock as it may deem advisable or appropriate.

          (e) Removal of Restrictions. Except as otherwise provided in this Section 8, Shares of Restricted Stock covered by each Restricted Stock grant made under the Plan will be released from escrow as soon as practicable after the last day the Shares have vested and are no longer subject to a substantial risk of forfeiture. The restrictions will lapse at a rate determined by the Administrator. The Administrator, in its discretion, may accelerate the time at which any restrictions will lapse or be removed.

          (f) Voting Rights. During the period during which Shares of Restricted Stock are unvested and subject to a substantial risk of forfeiture, Service Providers holding such Shares may exercise full voting rights with respect to those Shares, unless the Administrator determines otherwise.

          (g) Dividends and Other Distributions. During the period during which Shares of Restricted Stock are unvested and subject to substantial risk of forfeiture, Service Providers holding such Shares will be entitled to receive all dividends and other distributions paid with respect to such Shares unless otherwise Administrator provides otherwise. If any such dividends or distributions are paid in Shares, the Shares will be subject to the same restrictions on transferability and forfeitability as the Shares of Restricted Stock with respect to which they were paid.

          (h) Return of Restricted Stock to Company. On the date set forth in the Award Agreement, the Restricted Stock for which restrictions have not lapsed will revert to the Company and again will become available for grant under the Plan.

     9. Restricted Stock Units.

          (a) Grant. Restricted Stock Units may be granted at any time and from time to time as determined by the Administrator. Each Restricted Stock Unit grant shall be evidenced by an Award Agreement that shall specify such other terms and conditions as the Administrator, in its sole discretion, shall determine, including all terms, conditions, and restrictions related to the grant, the number of Restricted Stock Units and the form of payout, which, subject to Section 9(d), may be left to the discretion of the Administrator. Notwithstanding the anything to the contrary in this subsection (a), during any Fiscal Year, no Participant will receive more than an aggregate of 150,000 Restricted Stock Units; provided, however, that in connection with a Participant’s initial service as an Employee, an Employee may be granted an aggregate of up to an additional 150,000 Restricted Stock Units.

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          (b) Vesting Criteria and Other Terms. The Administrator shall set vesting criteria in its discretion, which, depending on the extent to which the criteria are met, will determine the number of Restricted Stock Units that will be paid out to the Participant. The Administrator may set vesting criteria based upon the achievement of Company-wide, business unit, or individual goals (including, but not limited to, continued employment or service), or any other basis determined by the Administrator in its discretion.

          (c) Earning Restricted Stock Units. Upon meeting the applicable vesting criteria, the Participant shall be entitled to receive a payout as specified in the Restricted Stock Unit Award Agreement. Notwithstanding the foregoing, at any time after the grant of Restricted Stock Units, the Administrator, in its sole discretion, may reduce or waive any vesting criteria that must be met to receive a payout.

          (d) Form and Timing of Payment. Payment of earned Restricted Stock Units shall be made as soon as practicable after the date(s) set forth in the Award Agreement. The Administrator, in its sole discretion, may pay earned Restricted Stock Units in cash, Shares, or a combination thereof. Shares represented by Restricted Stock Units that are fully paid in cash again shall be available for grant under the Plan.

          (e) Cancellation. On the date set forth in the Award Agreement, all unearned Restricted Stock Units shall be forfeited to the Company.

     10. Performance Units and Performance Shares.

          (a) Grant of Performance Units/Shares. Performance Units and Performance Shares may be granted to Service Providers at any time and from time to time, as will be determined by the Administrator, in its sole discretion. The Administrator will have complete discretion in determining the number of Performance Units/Shares granted to each Participant provided that during any Fiscal Year, (a) no Participant will receive Performance Units having an initial value greater than $1,000,000, and (b) no Participant will receive more than 150,000 Performance Shares. Notwithstanding the foregoing limitation, in connection with a Participant’s initial service as an Employee, an Employee may be granted up to an additional 150,000 Performance Shares.

          (b) Value of Performance Units/Shares. Each Performance Unit will have an initial value that is established by the Administrator on or before the date of grant. Each Performance Share will have an initial value equal to the Fair Market Value of a Share on the date of grant.

          (c) Performance Objectives and Other Terms. The Administrator will set performance objectives or other vesting provisions (including, without limitation, continued status as a Service Provider) in its discretion which, depending on the extent to which they are met, will determine the number or value of Performance Units/Shares that will be paid out to the Participant         . Each Award of Performance Units/Shares will be evidenced by an Award Agreement that will specify the Performance Period, and such other terms and conditions as the Administrator, in its sole discretion, will determine.

          (d) Earning of Performance Units/Shares. After the applicable Performance Period has ended, the holder of Performance Units/Shares will be entitled to receive a payout of the number of Performance Units/Shares earned by the Participant over the Performance Period, to be

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determined as a function of the extent to which the corresponding performance objectives or other vesting provisions have been achieved. After the grant of a Performance Unit/Share, the Administrator, in its sole discretion, may reduce or waive any performance objectives or other vesting provisions for such Performance Unit/Share.

          (e) Form and Timing of Payment of Performance Units/Shares. Payment of earned Performance Units/Shares will be made as soon as practicable after the expiration of the applicable Performance Period. The Administrator, in its sole discretion, may pay earned Performance Units/Shares in the form of cash, in Shares (which have an aggregate Fair Market Value equal to the value of the earned Performance Units/Shares at the close of the applicable Performance Period) or in a combination thereof.

          (f) Cancellation of Performance Units/Shares. On the date set forth in the Award Agreement, all unearned or unvested Performance Units/Shares will be forfeited to the Company, and again will be available for grant under the Plan.

     11. Leaves of Absence. Unless the Administrator provides otherwise, vesting of Awards granted hereunder will be suspended during any unpaid leave of absence. A Service Provider will not cease to be an Employee in the case of (i) any leave of absence approved by the Company or (ii) transfers between locations of the Company or between the Company, its Parent, or any Subsidiary. For purposes of Incentive Stock Options, no such leave may exceed ninety (90) days, unless reemployment upon expiration of such leave is guaranteed by statute or contract. If reemployment upon expiration of a leave of absence approved by the Company is not so guaranteed, then three (3) months following the 91st day of such leave any Incentive Stock Option held by the Participant will cease to be treated as an Incentive Stock Option and will be treated for tax purposes as a Nonstatutory Stock Option.

     12. Transferability of Awards. Unless determined otherwise by the Administrator, an Award may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Participant, only by the Participant. If the Administrator makes an Award transferable, such Award will contain such additional terms and conditions as the Administrator deems appropriate.

     13. Adjustments Upon Changes in Capitalization, Dissolution, Merger or Asset Sale.

          (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock that have been authorized for issuance under the Plan but as to which no Awards have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Award, the number of shares of Common Stock as well as the price per share of Common Stock covered by each such outstanding Award, and the numerical Share limits in Sections 6, 7, 8, 9 and 10, shall be proportionately adjusted for any change in, or increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, spin-off, combination or reclassification of the Common Stock, or any other change in, or increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any

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class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Award.

          (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify each Participant as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for a Participant to have the right to exercise his or her Award until ten (10) days prior to such transaction as to all of the Optioned Stock covered thereby, including Shares as to which the Award would not otherwise be exercisable. In addition, the Administrator may provide that any Company repurchase option or reacquisition right applicable to any Restricted Stock shall lapse as to all such Shares, provided the proposed dissolution or liquidation takes place at the time and in the manner contemplated. To the extent it has not been previously exercised, an Award will terminate immediately prior to the consummation of such proposed action.

          (c) Merger or Asset Sale. In the event of a merger of the Company with or into another corporation or the sale of all or substantially all of the Company’s assets, each outstanding Award will be assumed or an equivalent award substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the Award, the Participant will fully vest in and have the right to exercise all of his or her outstanding Options and Stock Appreciation Rights, including Shares as to which such Awards would not otherwise be vested or exercisable, all restrictions on Restricted Stock and Restricted Stock Units will lapse, and, with respect to Performance Shares and Performance Units, all Performance Goals or other vesting criteria will be deemed achieved at target levels and all other terms and conditions met. In addition, if an Option or Stock Appreciation Right becomes fully vested and exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Administrator will notify the Participant in writing or electronically that the Option or Stock Appreciation Right will be fully vested and exercisable for a period of time determined by the Administrator in its sole discretion, and the Option or Stock Appreciation Right will terminate upon the expiration of such period.

          For the purposes of this subsection (c), an Award will be considered assumed if, following the merger or sale of assets, the Award confers the right to purchase or receive, for each Share subject to the Award immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) or, in the case of a Stock Appreciation Right upon the exercise of which the Administrator determines to pay cash or a Restricted Stock Unit, Performance Share or Performance Unit which the Administrator can determine to pay in cash, the fair market value of the consideration received in the merger or merger or sale of assets by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale of assets is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of an Option or Stock Appreciation Right or upon the payout of a Restricted Stock Unit, Performance Share or Performance Unit, for each Share subject to such Award (or in the case of Restricted Stock Units or Performance Units, the number of implied shares determined by dividing the value of the Restricted Stock Units or Performance Units, as applicable, by the per share consideration received by holders of Common Stock in the merger or sale of assets), to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or sale of assets.

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          Notwithstanding anything in this Section 13(c) to the contrary, an Award that vests, is earned or paid-out upon the satisfaction of one or more Performance Goals will not be considered assumed if the Company or its successor modifies any of such Performance Goals without the Participant’s consent; provided, however, a modification to such Performance Goals only to reflect the successor corporation’s post-transaction corporate structure will not be deemed to invalidate an otherwise valid Award assumption.

14. Tax Withholding

          (a) Withholding Requirements. Prior to the delivery of any Shares or cash pursuant to an Award (or exercise thereof), the Company will have the power and the right to deduct or withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy federal, state, local, foreign or other taxes (including the Participant’s FICA obligation) required to be withheld with respect to such Award (or exercise thereof).

          (b) Withholding Arrangements. The Administrator, in its sole discretion and pursuant to such procedures as it may specify from time to time, may permit a Participant to satisfy such tax withholding obligation, in whole or in part by (without limitation) (a) paying cash, (b) electing to have the Company withhold otherwise deliverable cash or Shares having a Fair Market Value equal to the amount required to be withheld, (c) delivering to the Company already-owned Shares having a Fair Market Value equal to the amount required to be withheld, or (d) selling a sufficient number of Shares otherwise deliverable to the Participant through such means as the Administrator may determine in its sole discretion (whether through a broker or otherwise) equal to the amount required to be withheld. The amount of the withholding requirement will be deemed to include any amount which the Administrator agrees may be withheld at the time the election is made, not to exceed the amount determined by using the maximum federal, state or local marginal income tax rates applicable to the Participant with respect to the Award on the date that the amount of tax to be withheld is to be determined. The Fair Market Value of the Shares to be withheld or delivered will be determined as of the date that the taxes are required to be withheld.

     15. No Effect on Employment or Service. Neither the Plan nor any Award will confer upon a Participant any right with respect to continuing the Participant’s relationship as a Service Provider with the Company, nor will they interfere in any way with the Participant’s right or the Company’s right to terminate such relationship at any time, with or without cause, to the extent permitted by Applicable Laws.

     16. Date of Grant. The date of grant of an Award will be, for all purposes, the date on which the Administrator makes the determination granting such Award, or such other later date as is determined by the Administrator. Notice of the determination will be provided to each Participant within a reasonable time after the date of such grant.

     17. Term of Plan. Subject to Section 21 of the Plan, the Plan shall become effective upon its original adoption by the Board. It shall continue in effect for a term of ten (10) years unless terminated earlier under Section 18 of the Plan.

     18. Amendment and Termination of the Plan.

          (a) Amendment and Termination. The Administrator may at any time amend, alter, suspend or terminate the Plan.

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          (b) Stockholder Approval. The Company will obtain stockholder approval of any Plan amendment to the extent necessary and desirable to comply with Applicable Laws.

          (c) Effect of Amendment or Termination. No amendment, alteration, suspension or termination of the Plan will impair the rights of any Participant, unless mutually agreed otherwise between the Participant and the Administrator, which agreement must be in writing and signed by the Participant and the Company. Termination of the Plan will not affect the Administrator’s ability to exercise the powers granted to it hereunder with respect to Awards granted under the Plan prior to the date of such termination.

     19. Conditions Upon Issuance of Shares.

          (a) Legal Compliance. Shares will not be issued pursuant to the exercise of an Award unless the exercise of such Award and the issuance and delivery of such Shares will comply with Applicable Laws and will be further subject to the approval of counsel for the Company with respect to such compliance.

          (b) Investment Representations. As a condition to the exercise of an Award, the Company may require the person exercising such Award to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required.

     20. Inability to Obtain Authority. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained.

     21. Stockholder Approval. The Plan shall be subject to approval by the stockholders of the Company within twelve (12) months after the date the Plan is adopted. Such stockholder approval shall be obtained in the manner and to the degree required under Applicable Laws.

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EX-10.8

Exhibit 10.8

10700 Bren Road West
Minnetonka, MN 55343 USA Phone: 952-933-4666
Fax:      952-930-6157

June 27, 2007

Barry Caldwell
Chief Executive Officer
Iridex Corporation
1212 Terra Bella Avenue
Mountain View, CA 94043

Dear Barry:

This letter sets forth our mutual agreement with regard to: (a) the Product Supply Agreement, dated January 16, 2007, between Laserscope and Iridex Corporation (the “Supply Agreement”); (b) Iridex’s material, uncured breach of the Supply Agreement; and (c) the conditions under which Laserscope would agree not to exercise its right to terminate the Supply Agreement immediately.

Iridex acknowledges and agrees that: (a) as of the date hereof Iridex owes Laserscope an aggregate of $3,487,141.96 for products and service parts previously shipped to Iridex, consisting of $3,440,689.15 due under outstanding invoices and $46,452.81 in interest at the rate of 1.5% per month; (b) on May 23, 2007, Laserscope delivered to Iridex a letter (the “May 23, 2007 Letter”) in which it validly notified Iridex of its material breach of the Supply Agreement pursuant to Section 7.2 thereof; (c) Iridex’s opportunity to cure its material breach of the Supply Agreement expired on June 22, 2007 and it did not timely cure its material breach; and (d) Laserscope has the right to terminate the Supply Agreement immediately upon written notice to Iridex with no additional notice period or opportunity to cure.

Beginning with the week of July 2, 2007, Iridex will pay $400,000 per week to Laserscope, by wire transfer in immediately available funds, against outstanding invoices, plus accrued interest. Laserscope will apply these payments first to invoices (both invoiced amount and accrued interest) that have been outstanding the longest. Iridex will pay all outstanding invoices in full, plus accrued interest, upon the earlier of (a) two (2) business days following the closing of its contemplated equity financing of approximately $5 million or (b) July 31, 2007. Upon payment in full of all outstanding invoices, plus accrued interest, in accordance with this letter, Iridex will be deemed to have cured its material breach of the Supply Agreement described in the May 23, 2007 Letter, and the Supply Agreement shall remain in full force and effect, as amended by this letter.

As long as Iridex complies with its obligation to make payments to Laserscope in accordance with this letter, Laserscope will ship service parts and products to Iridex under the Supply

Iridex Corporation
June 27, 2007
Page 2

Agreement only on a cash in advance or confirmed letter of credit basis. Iridex further acknowledges and agrees that after Iridex has paid in full all outstanding invoices, plus accrued interest, in accordance with this letter, Laserscope will ship service parts and products to Iridex under the Supply Agreement only on a cash in advance or confirmed letter of credit basis for the remaining term of the Supply Agreement. This paragraph shall constitute an amendment to Section 3.2 of the Supply Agreement.

Laserscope agrees that for so long as Iridex complies with its obligation to make payments to Laserscope in accordance with this letter, Laserscope will not exercise its right to terminate the Supply Agreement as a result of the material breach described in the May 23, 2007 Letter. If Iridex fails to comply in any respect with its obligation to make timely payments to Laserscope in accordance with this letter, Iridex agrees that Laserscope has the right to terminate the Supply Agreement immediately upon written notice to Iridex with no additional notice period or opportunity to cure.

Except as specifically provided herein, this letter shall not be deemed or construed to release Iridex from its obligations under the Supply Agreement or any other agreement between the parties or constitute an agreement or waiver of any other disputes between the parties.

Please acknowledge your agreement to the terms and conditions set forth in this letter by signing a copy of this letter and returning it to me.

Very truly yours,

LASERSCOPE

John F. Nealon
Senior Vice President, Business Development

Acknowledged and Agreed to as of
June [27], 2007

IRIDEX CORPORATION

By:	/s/ Barry Caldwell Barry Caldwell
	Chief Executive Officer

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE AND PRINCIPAL FINANCIAL OFFICER)
PURSUANT TO SECTION 13(a) OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF

I, Barry G. Caldwell, certify that:

1. I have reviewed this quarterly report on Form 10-Q of IRIDEX Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

     a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

     b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

     c) Disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting; and

     5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

     a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

     b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 14, 2007

By:	/s/ BARRY G. CALDWELL
	Name:	Barry G. Caldwell
	Title:	President and Chief Executive Officer (Principal Executive and Principal Financial Officer)

EX-32.1

EXHIBIT 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE AND PRINCIPAL FINANCIAL OFFICER)
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Quarterly Report of IRIDEX Corporation (the “Company”) on Form 10-Q for the quarter ending March 31, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Barry G. Caldwell, Chief Executive Officer of the Company, certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 14, 2007

By:	/s/ BARRY G. CALDWELL
	Name:	Barry G. Caldwell
	Title:	President and Chief Executive Officer (Principal Executive and Principal Financial Officer)