Hesham Shaaban – Maxim Group Stan Mann – Mann Family Investments Larry Haimovitch – HMTC

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the IRIDEX second quarter 2008 earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) This conference is being recorded today, Tuesday, August 12, 2008. At this time, I would like to turn the conference over to Mr. Ted Boutacoff. Please go ahead, sir.

Welcome to IRIDEX Corporation’s second quarter 2008 conference call. I’m Ted Boutacoff, President and CEO and with me is Jim Mackaness, our CFO. Before we get started, Susan Bruce, our Executive Administrator will read the required Safe Harbor Statement.

This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Act of 1934 as amended relating to the company’s financial strength, growth strategy and prospects, revenues, gross margins and earnings, expenses, the company’s ability to meet its obligations under the AMS settlement agreement, controlling and prioritizing expenses, managing cash and cash flows, and addressing our liquidity and capital resource needs. Actual results could differ materially and adversely from those projected in the forward-looking statements contained in this conference call. Additional information concerning factors that could cause results to materially differ from those in the forward-looking statements is contained in the risk factors discussed in part 1, item 1A of our annual report on Form 10-K for the fiscal year ended December 29, 2007 and in our quarterly report on Form 10-Q for the second quarter ended June 28, 2008, each filed with the Securities and Exchange Commission. Forward-looking statements contained in this conference call are made as of this date and will not be updated.

Thank you, Susan. During this call, after my initial comments, Jim will cover the finances in detail and then I will update you on our progress to date on the action plan for 2008 which remains to reestablish financial stability in the company, to focus on our ophthalmology business, and to the strength to aesthetics business. After which, we will open up the call to your questions. We continue to make progress in meeting our objectives. We are progressing towards financial stability. Compared to last year, we have reduced our operating expenses by $3.5 million which reduced our net operating loss from $2.6 million for the second quarter of 2007 to $0.3 million for the second quarter of 2008. And due to the receipt of the first of five annual $800,000 payments from Synergetics for the 2007 legal settlement, we reported a net income of $0.3 million or $0.03 of share. The primary reasons for the $3.5 million reduction in operating expenses were reduced headcount and related costs, reduced selling costs, and reduced marketing expenses. Cash flow from operations was modestly negative for the quarter which we anticipated, given that we repaid $1.6 million of our obligation to AMS leaving us with only $1.5 million to go. Our ophthalmology business continues to perform well even in these uncertain economic times and our aesthetics business remains our biggest challenge, particularly the negative impact of the economic downturn and the challenges we face with our U.S. distribution channel. However, we are encouraged by the sequential quarterly increase in aesthetics revenues over the first quarter of 2008 for both domestic and international. Now, I would like to turn the call over to Jim Mackaness.

I will start by reviewing our revenues for the second quarter. Revenues for the second quarter of 2008 were $12.9 million, 15.3% decrease compared to the $15.2 million in the corresponding quarter in 2007. Both were up 12.5% on a sequential basis from $11.5 million as reported for Q1 2008. The main cause of the year-over-year decrease is the ongoing challenge we face with our aesthetics business. Ophthalmology revenues for the quarter decreased 2.6% to $8.2 million compared with $8.4 million for the second quarter of 2007, but showed an increase of 8.4% on a sequential basis from the $7.5 million reported for Q1 2008. Looking at these revenues geographically, domestic ophthalmology revenues decreased 3.1% to $4.8 million compared with $5.0 million for the second quarter of 2007, and increased 8.5% on a sequential basis from the $4.4 million in Q1 2008. International ophthalmology revenues totaled $3.4 million, consistent with the corresponding quarter in 2007 and up 8.3% on a sequential basis from the $3.1 million in Q1 2008. The majority of our international sales for ophthalmology are denominated in U.S. dollars and therefore our exposure to foreign currency gains or losses on translation to U.S. dollars is minimal. However, the strengthening or weakening of the dollar will impact our price competitiveness in overseas markets. Focusing in on our recurring revenues which consist of disposables and service. Ophthalmology recurring revenues were $4.4 million which represented 54% of total ophthalmology revenues for the second quarter 2008, up 10.3% from $4.0 million in the second quarter 2007 and up 5.8% on a sequential basis from $4.2 million in Q1 2008. Our recurring revenues provide us with a predictable component to our ophthalmology revenue streams and the fact that we continue to see sequential growth is a very encouraging indicator of the strength…

Thank you, Jim. We remain focused on returning the company to a cash flow positive position and profitability in as shorter time as possible. We believe our ability to reduce our operating loss to $0.3 million for the quarter and the fact that we used only $0.7 million of cash in operations, including the $1.6 million repayment to AMS, demonstrates management’s commitment to these goals. Our ophthalmology business had another good quarter of performance especially given these uncertain economic times and the continued growth in our recurring revenues on a sequential quarterly basis highlights the value of this part of our business. We believe our ophthalmology business as a whole is performing solidly and is in line with the goal we set ourselves of enhancing its value. We are in process of releasing a new laser platform. The design concept of our new IQ platform will enable us to provide a family of IRIDEX IQ laser systems with different solid-state laser wavelengths on a common platform. We expect that using this platform concept will shorten the time and reduce the cost of introducing subsequent products, since the key elements such as electronics and used interface systems would be common. We have submitted a 510(k) for the entire family which is pending. The first product to be released using this platform will be the IQ577, which we demonstrated at our shareholders meeting in June. I had indicated in our last call that the IQ577 would be released during the second quarter and it is now targeted for release in the third quarter. The IQ577 will deliver 577-nanometer yellow light from a solid-state laser. With the IQ577, we will provide a wavelength and a technology that we currently do not offer which complements our product portfolio and is otherwise not commercially available…

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator instructions) Our first question comes from the line of Hesham Shaaban with Maxim Group. Please go ahead. Hesham Shaaban – Maxim Group: Hi, I have a few questions. I’d like to start up with the expenses. It seems like gross profit – or not gross profit, the gross margin continues to decline. I was wondering if you can give us a little bit more color on that and what we should expect on the back half of '08?

Well, we looked at it very closely. It is difficult to draw any clear conclusions when comparing 2008 to 2007 because during 2007 accounting for the year, acquisition created one-time entries that made identifying trends somewhat arbitrary and therefore we have stayed clear of doing this. We are waiting here to make sure we've got a good trend before we start to make any predictions. The one comment I would make though is if you look forward into 2009, you can use the amortization of the intangibles to determine the fact that we would expect to see some margin improvement as a result of those no longer being applicable. Basically, we are currently experiencing about $470,000 of quarterly expense for intangibles in the COGS and we would anticipate that that will drop to something like $50,000 when we get into – a quarterly basis in 2009. Hesham Shaaban – Maxim Group: Okay. So moving on, it seems that you guys are – you made a lot of progress in managing your cost structure, particularly within the research and development and SG&A lines. I mean is this the run rate that we can expect heading into the back half of ’08? I mean it seems there wasn’t much of a change between the first quarter and the second quarter SG&A, and I’m wondering if this is a run rate that we can expect going forward.

We certainly don’t see any significant items on the radar screen that would nudge it upwards. Obviously, we are looking for ways to try and increase efficiencies where we can. But at the same time and as I've commented before, we will take the opportunity to make prudent investments. So from a broad perspective, I would – the simple answer would be this is a fairly reasonable rate that we are at currently. Hesham Shaaban – Maxim Group: Okay. There were some headcount reductions that you had mentioned. I’m wondering what area is that from?

Basically, at the end of Q2 last year, we were at 179 employees and at the end Q2 this year, we were at about 154. A large part of that would be attributable to the sales force that came over during the acquisition and some associated headcount. That is the primary delta; this happened between last year and this year. Hesham Shaaban – Maxim Group: Okay. So the reference to the headcount reduction was in relation to a year-over-year comparison and not something that happen this quarter?

Correct. Q4 2008, we are about 153. So Q2 ’08, we are at 154. So we have been fairly stable so far during this year. Hesham Shaaban – Maxim Group: Okay. And just one final question, it seems that there is about $1.9 million remaining in total regarding the Laserscope acquisition. Just real quickly, how much progress have you made into the current quarter in paying this off? Is it possible that it would definitely be paid off this quarter? Is it a definite that it will be paid off this quarter?

Yes, it is a straight line amortization payment schedule. We pay weekly and the final payment is scheduled for September 25. Hesham Shaaban – Maxim Group: Perfect. Okay, that’s all my questions. Thank you.

Thank you. Our next question comes from the line of Larry Haimovitch with HMTC. Please go ahead. Larry Haimovitch – HMTC: Good afternoon, Jim. Good afternoon, Ted.

Good afternoon, Larry. Larry Haimovitch – HMTC: Hey, Jim, you did a great job on the numbers. I wanted to just dig in a little bit on a couple of things. You mentioned the selling of the UK business and the assets. What was the accounting for that? Did you receive some cash for that? Explain that, how that sort of flowed through the income statement or balance sheet.

Yes, it was more a transfer, I’d describe it as that, in the sense that it was – we signed a standard distributor agreement with an outfit in the UK and as part of that distribution agreement, we did transfer our employees in the UK and they did make a couple of small inventory purchases. But really, the purchases were not that much dissimilar than a regular distributor getting into the business. Larry Haimovitch – HMTC: So you didn’t sell the business in terms of getting cash or anything like that? So there was nothing that benefited the cash per se?

Correct. Larry Haimovitch – HMTC: Okay. So speaking about cash, if I understood your prepared remarks, I think you said you used $700,000 of cash all in, but that was after paying AMS back $2 million or $1.6 million?

$1.6 million in the quarter. Larry Haimovitch – HMTC: Okay. So effectively, you generated cash of what, $2.0 million [ph] – I'm just trying to do the math here – operating cash.

$0.9 million. Larry Haimovitch – HMTC: Yes, $0.9 million. Okay, so if you take AMS out, in fact operations did generate positive cash flow.

All other things remaining constant, yes. Larry Haimovitch – HMTC: Right. And then when we look at Q4, you don’t have the AMS, so then we’ll see a true operating cash number. It won’t be clouded by AMS.

That is certainly our target, yes. Larry Haimovitch – HMTC: Okay. Good. And then I was trying to understand the difference, Jim, between the loss, I think you said of $300,000 and net income of $600,000. Was this a tax credit?

No. We basically received – we had a legal settlement with Synergetics that was concluded in 2007. Larry Haimovitch – HMTC: Okay, so that’s where Synergetics comes in. It comes in below the operating loss line and before the net income line.

Exactly. Larry Haimovitch – HMTC: Okay. Got it. Ted, I better ask you a question. My favorite question is the yellow light laser; you were talking about releasing it this quarter. I know last quarter we talked on call about it and we were hoping it was coming, it was coming. You sound a little more optimistic like it really is going to come this quarter.

We did demonstrate it here at the shareholders meeting and we are making definite progress on it. Larry Haimovitch – HMTC: It is still at the FDA though.

Still there, yes. Larry Haimovitch – HMTC: And are there any difficult issues that are preventing it from getting approved because as you know, this thing was I think first applied for, if I am not mistaken, a couple of years ago.

I don’t think it was a couple of years ago but I am not familiar with exactly the first submission. But I think the complexity is that this is for a family of lasers, it is not just for one particular one and so a little different than what the FDA typically sees. So that is what it is, but we felt it would save time in the long run to do this one, and we embarked on the path and we are staying on the path and we are coming very close. Larry Haimovitch – HMTC: And what makes you feel that it is closer? Does dialog with the FDA suggests that they are asking the right questions or giving the right…

I think we have resolved many of their questions so… Larry Haimovitch – HMTC: Right, so this would be a 510(k) release hopefully this quarter?

That is our plan. Larry Haimovitch – HMTC: And then presumably it becomes an important part of your Trade Show for the American Academy of Ophthalmology in November.

Yes, that is correct. Larry Haimovitch – HMTC: And then Jim back to you, I think you said bank debt was at $6 million right now?

Correct. Larry Haimovitch – HMTC: And what is the full credit line you have on the bank debt?

The facility allows us to borrow at $8 million but it isn’t asset based line. I was like (inaudible) that we need to get a post-collateral to be able to use that facility, but it is a facility that would allow us to go to $8 million. Larry Haimovitch – HMTC: Okay. Let me jump back in queue, I have a couple of questions but I can ask them later.

Thank you. Our next question comes from the line of Stan Mann with Mann Family Investments. Please go ahead. Stan Mann – Mann Family Investments: Good job, gentlemen.

Thank you, Stan. Stan Mann – Mann Family Investments: I have a question for you on our sales and marketing program in each product line, could you kind of just give us a feel for where we are on ophthalmology and in aesthetics on sales and marketing personnel and program, and where you are trying to go to – are you trying to build anymore in either business segments?

In ophthalmology, domestically we have 13. Stan Mann – Mann Family Investments: Did that change from last year?

It has not really changed, no, and internationally, we have another three. Stan Mann – Mann Family Investments: Direct now?

Employees who are essentially direct. And we manage a number of distributors, about 60 [ph] seller distributors and we distribute in like hundred countries our products. In aesthetics, we have a similar model. The direct number of people though are smaller, essentially at five and that’s been brought down from last year as we have discussed in the past and we will increase that as soon as we can show and demonstrate that those five can produce to a certain level and then we plan to increase the number. Stan Mann – Mann Family Investments: Are the five new or up from the first quarter or the last quarter?

They were hired in the first quarter. Stan Mann – Mann Family Investments: Okay. And they were experienced? Are any of them ex-Laserscope employee?

They are experienced but none were ex-Laserscope employees. Stan Mann – Mann Family Investments: Okay, even the marketing direction?

That’s correct. Stan Mann – Mann Family Investments: Okay. International?

International, we have an ex-Laserscope employee who is managing our international distribution and we have a large number of distributors there also. Stan Mann – Mann Family Investments: Okay.

Not quite as many as ophthalmology but a large number. Stan Mann – Mann Family Investments: Okay. So on the aesthetic side, these five people and one international, in your judgment, are not up to full speed yet? That's kind of the –

I think they are dealing (inaudible) with the economy at all. Stan Mann – Mann Family Investments: No, I understand.

And so what we’ve done is brought down or held the hiring and basing it upon what the performance is and as soon as we see the performance, then we will kind of let the reigns out and we will open up the hiring. Stan Mann – Mann Family Investments: You mean, one plus [ph] five, or six, start producing to target?

That’s correct. Stan Mann – Mann Family Investments: Okay. Where do sales and service in each segment fit with these individuals that you have identified, are they strictly sales or they also do sales and service? Is there a service business in each segment?

There is service business in each segment and they are different. They largely are all depot service. We do have our sales representatives do our installation of our units and training in ophthalmology and depot service means that equipment is shipped back here via UPS or FedEx for repair and oftentimes we provide a loaner instrument for the physician to use in the interim. Stan Mann – Mann Family Investments: And that's charged in profitable business?

Yes, it is. In the aesthetic business, the products are too big to be shipping around so we provide the service and we have a very good occasion [ph] like we’ve talked about in the past and a profit center for field service people and there are probably I think 13 or 14 on those in the U.S. Stan Mann – Mann Family Investments: And that's a profitable business?

That's a profitable business and internationally, the service is managed by the distributors. Stan Mann – Mann Family Investments: Okay. So if we look at each segment and your overall gross profitability is what it is right now. You said 41%, something like 41.3%. How does that breakout to ophthalmology and aesthetics and is that changing directionally from quarter to quarter? I’ve assumed that ophthalmology is in the 60s and aesthetic is still a negative contributor?

We really only split it out of the direct COGS level and you can see – I don’t have the numbers right in front of me, but – Stan Mann – Mann Family Investments: Approximately.

So we have it at the direct COGS level in the Q and that will give you an indication at that level of the business segments naturally as far we go. Stan Mann – Mann Family Investments: What I’m getting at is, is the aesthetics improving or flat or is it volume based? I assume it is not contributing at this point.

Well, it definitely took an improvement from Q1 to Q2. Stan Mann – Mann Family Investments: It did?

Yes. Stan Mann – Mann Family Investments: Okay. That is encouraging. And the product that we have accumulated in purchase from AMS in the aesthetic area, is that inventory going to last us for a year? In other words, will that deplete? How long will that last before we need to start manufacturing on our own and are we prepared for that?

Well we are manufacturing the key products on our own here already. We have transferred that into our facility in Mountain View. There are some other products which we receive from AMS now and we will make the evaluation later on next year. Stan Mann – Mann Family Investments: But, how long will the products that we bought – will they last, the products that they make or will that inventory deplete over the next several quarters? In other words, is there are year's worth of certain items that are selling?

It all depends, Stan, on the rate we sell it. At the current rate, we have adequate inventory. If it increases, it improves – accelerates – the rate accelerates, then the inventory will deplete faster. Stan Mann – Mann Family Investments: So we’re fine on inventory?

Yes. Right now, we are. Stan Mann – Mann Family Investments: And when the inventory on the items we don’t manufacture deplete, you’re going to make a judgment on whether to produce that product for…

That’s correct. Stan Mann – Mann Family Investments: Okay. Last question on the yellow laser, are you currently selling that even though you don’t have 510(k) clearance?

No. We’re not selling it. Stan Mann – Mann Family Investments: Okay. And what it is the overseas position for that product in Europe – is there any – in order to sell it to Europe?

We are not selling it overseas yet. Stan Mann – Mann Family Investments: I know that, but have you applied for the EC Mark?

Yes, we self-certify ourselves with CE. And so, once we have it released here in the U.S., we will have our CE Mark. Stan Mann – Mann Family Investments: Do you feel that that new laser offers much more potential on our existing product line from your judgment?

I think it’s complementary; it's additive. It's not necessarily a replacing product. Stan Mann – Mann Family Investments: No, but it is new to that.

It’s new and it’s different and it was a very profitable [ph] wavelength in the past, and then that particular wavelength was not accessible anymore because of the technology that was used which was too complicated and unreliable. And now, we are coming out with a good, dependable, reliable solid-state laser that delivers it. Stan Mann – Mann Family Investments: So, it could be a significant addition to your product line?

Yes. Stan Mann – Mann Family Investments: Okay, thank you.

You’re welcome.

Thank you. (Operator instructions) And our next question is a follow-up question from the line of Larry Haimovitch with HMTC. Please, go ahead. Larry Haimovitch – HMTC: Jim, can you just review one more time the ophthalmology and the aesthetic numbers, ophthalmology for Q2 ’08 was what?

On the revenue basis? Larry Haimovitch – HMTC: Yes.

Let me just go back here. Larry Haimovitch – HMTC: It is probably in the press release, which unfortunately I’m not in front of right now.

That’s okay. Ophthalmology revenues for the quarter were $8.2 million. Larry Haimovitch – HMTC: And then first quarter?

And aesthetics for the quarter were $4.8 million. Larry Haimovitch – HMTC: Okay. And ophthalmology compared to last year's second quarter was?

Last year’s second quarter for ophthalmology was $8.4 million, so there’s a slight difference of $0.2 million. Larry Haimovitch – HMTC: And what’s the explanation for the ophthalmology business being down versus last year, was it competitive issues or what do you think it was?

The numbers that Jim showed you on the recurring revenue, those were up, though we saw a dip in the system sales, the equipment sales. Larry Haimovitch – HMTC: Okay.

This was up from year to year. And we think it has probably affected a bit on delays of capital purchases by customers because of the economy. And we have not really seen that in the past, but we are starting to see it we think in ophthalmology. So it should be that. Larry Haimovitch – HMTC: You don’t think there is any competitive issues here, Ted?

There is always competitive issues but I think it is, with fewer numbers of sites buying, then the competition becomes a little more intense. Larry Haimovitch – HMTC: And then going back to you, Jim, aesthetics was $4.8 million and what was the second quarter of last year?

Second quarter of 2007 was $6.9 million. Larry Haimovitch – HMTC: But I think you said international was actually up year-over-year, is that correct?

No, sequential quarter, international revenues was $2.8 million down from $3.5 million. Larry Haimovitch – HMTC: Okay.

2007 Q2 was really a first full quarter after the acquisition. Larry Haimovitch – HMTC: And that was $3.5 million?

Yes. Larry Haimovitch – HMTC: Okay. Good. I think overall you've made some good progress, certainly on the cash management, and getting the expenses down and if you can get the revenues going a little bit better, we should be in pretty good shape for the second half.

Definitely what we’re aiming for. Larry Haimovitch – HMTC: Yes.

Thank you.

Our next question is also a follow-up from the line of Stan Mann with Mann Family Investments. Please go ahead. Stan Mann – Mann Family Investments: Just for developing cash flow, could you give for 2008 and looking in 2009, your D&A, depreciation and amortization, and also your non-tangible for both years? I didn’t get that.

Let me just give you right now – Stan Mann – Mann Family Investments: Annualized.

Okay. Well, here’s what I’m going to do. Depreciation and amortization for the six months of 2008 is $1.6 million, so I would anticipate just multiplying that by 2. Stan Mann – Mann Family Investments: Right, $3.2 million, got you. Non-tangible?

Intangibles was basically running at a rate of just under $600,000 a quarter. Stan Mann – Mann Family Investments: So it’s $2.4 million?

2008, and then – Stan Mann – Mann Family Investments: In 2009?

In 2009 on an annual basis, I have here that it would aggregate $700,000. Part of that intangible expenses goes to COGS and part of that intangible expense goes to marketing. Stan Mann – Mann Family Investments: Okay. What about D&A, do you expect that would stay constant, $3.2 million, or come down?

It’s been pretty stable. Stan Mann – Mann Family Investments: Okay. Basically then, if you go forward for ’09 with our existing numbers, we would be very cash flow positive and probably profitable.

That’s what we’re driving for, yes. Stan Mann – Mann Family Investments: Okay. Good job, gentlemen. Thank you.

Thank you, Stan.

Thank you. And at this time, if there are no additional questions. I’d like to turn it back to Mr. Boutacoff for any closing remarks.

Thank you and I just want to thank everybody for participating in this call and for your interest in IRIDEX and we look forward to sharing our progress with you at our next earning call.

Thank you, sir. Ladies and gentleman, that does conclude our conference for today. If you'd like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000, using the access code of 11118106 followed by the pound key. ACT would like to thank you for your participation. You may now disconnect.