IRIDEX CORP, 10-K405, 2000-03-31

IRIDEX CORP
10-K405, 2000-03-31
ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 1, 2000

[ ] 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)

<TABLE>
<S> <C>
DELAWARE 77-0210467
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR IDENTIFICATION NUMBER)
ORGANIZATION)
</TABLE>

1212 TERRA BELLA AVENUE, MOUNTAIN VIEW CA 94043-1824
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(650) 940-4700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

--------------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE

--------------------

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 [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 20, 2000, was approximately $32,461,125 based on the
closing price reported for such date on the NASDAQ National Market System. For
purposes of this disclosure, shares of Common Stock held by each executive
officer and director and by each holder of 5% or more of the outstanding shares
of Common Stock have been excluded from this calculation, because such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

As of March 20, 2000, Registrant had 6,624,308 shares of Common Stock
outstanding.

-------------------

DOCUMENTS INCORPORATED BY REFERENCE

Certain parts of the Proxy Statement for the Registrant's 2000 Annual
Meeting of Stockholders (the "Proxy Statement") are incorporated by reference
into Part III of this Annual Report on Form 10-K.

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<TABLE>
<CAPTION>
Table of Contents Page No.
<S> <C> <C> <C>
Part I
Item 1. Business.......................................................................1
Item 2. Properties....................................................................15
Item 3. Legal Proceedings.............................................................16
Item 4. Submission of Matters to a Vote of Security Holders...........................16

Part II
Item 5. Market for Registrants' Common Equity and Related Stockholder Matters.........17
Item 6. Selected Financial Data.......................................................17
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................19
Item 7A. Quantitative and Qualitative Disclosure about Market Risk.....................29
Item 8. Financial Statements and Supplementary Data...................................29
Item 9. Disagreements on Accounting and Financial Disclosure..........................47

Part III
Item 10. Directors and Executive Officers of the Registrant............................48
Item 11. Executive Compensation........................................................48
Item 12. Security Ownership of Certain Beneficial Owners and Management................48
Item 13. Certain Relationships and Related Transactions................................48

Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...............49

Signatures......................................................................................51
</TABLE>

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PART I

This Annual Report on Form 10-K (The "Form 10-K") contains certain
forward-looking statements within the meaning of section 21E of the Securities
Exchange Act of 1934, as amended, (The "Exchange Act"), including statements
that indicate what the Company "believes," "expects" and "anticipates" or
similar expressions. These statements involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements of the Company to differ materially from those expressed or implied
by such forward-looking statements. Such factors include, among others, the
information contained under the captions "Part I, Item 1, Business," and Part
II, Item 7" Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this Annual Report. 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 Form 10-K. The Company
undertakes no obligation to publicly release the results of any revision of
these forward-looking statements. The reader is strongly urged to read the
information set forth under the captions Part I, Item 1, "Business," and Part
II, Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a more detailed description of these significant
risks and uncertainties.

ITEM 1. BUSINESS

GENERAL

IRIDEX Corporation ("IRIDEX") is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. Our products are sold in the United States
predominantly through a direct sales force and internationally through 58
independent distributors into 74 countries. We market our products using three
brand names: IRIS Medical to the ophthalmology market, IRIDERM to the
dermatology market, and Light Solutions to the research market.

Our ophthalmology products treat eye diseases, including the three
leading causes of irreversible blindness. The current family of ophthalmology
laser systems includes the IRIS Medical OcuLight SL, OcuLight SLx, OcuLight GL
and OcuLight GLx Laser Photocoagulation systems (each an "OcuLight System"). Our
dermatology products treat skin diseases, primarily vascular and pigmented
lesions. Each ophthalmic and dermatologic system consists of a small, portable
laser console and interchangeable delivery devices, primarily for hospital and
office-based use by opthalmologists and dermatologists. We believe that our
semiconductor-based systems are more portable, economical, reliable and flexible
than competing systems which use traditional vacuum tube-based technology. Since
our first shipment in 1990, more than 3,200 IRIDEX medical laser systems have
been sold worldwide.

IRIDEX Corporation was incorporated in California in February 1989 as
IRIS Medical Instruments, Inc. In 1996, we changed our name to IRIDEX
Corporation and reincorporated in Delaware. Our executive offices are located at
1212 Terra Bella Avenue, Mountain View, California 94043-1824, and our telephone
number is (650) 940-4700. As used in this Form 10-K, the terms "Company,"
"IRIDEX," "we," "us" and "our" refer to IRIDEX Corporation, a Delaware
corporation, and, when the context so requires, our wholly owned subsidiaries,
IRIS Medical Instruments, Inc. and Light Solutions Corporation, both California
corporations, and IRIDEX Foreign Sales Corporation, a Barbados corporation, and
our dermatology division IRIDERM.

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THE IRIDEX STRATEGY

We are one of the worldwide leaders in developing, manufacturing,
marketing and selling innovative and cost-effective medical laser systems. The
key elements of our strategy are:

Broaden Product Lines by Leveraging Existing Technology. In 1996, we
introduced a new visible laser system, the OcuLight GL, for ophthalmology. In
1997, we introduced the DioLite 532, based on the same visible light technology
as the OcuLight GL, for the dermatology market. In 1998, we introduced the
OcuLight GLx, a new version of the OcuLight GL, with increased power and
delivery device capability. The characteristics of these new products are
similar to those which have made our previous products successful, such as low
cost ownership, reliability and portability.

Develop and Validate New Applications. We seek to develop and validate
applications that are less costly, reduce complications and achieve better
clinical results than existing treatments. Our products are currently being used
in multiple studies in the United States and internationally to demonstrate the
clinical benefits of our technology in treatment. Examples of these studies
include several studies to treat the various stages of age-related macular
degeneration and international studies which are evaluating the use of our
G-Probe as a primary treatment for glaucoma. We announced in October 1999 that a
study on occult wet age-related macular degeneration (AMD) produced results
demonstrating that Transpupillary Thermotherapy (TTT) was effective in improving
or stabilizing vision in 75% of patients with a procedure using our OcuLight
infrared laser photocoagulator. New applications increase laser useage and may
ultimately increase the size of the market for laser photocoagulators.

Continue to Enhance Products. One of our core strengths has been our
regular introduction of new delivery devices and product upgrades to enhance the
benefits of our laser systems. In October 1999, we introduced the next
generation of OcuLight SLx, which offers added features, such as LongPulse(TM)
and MicroPulse(TM) operating modes. These features enable the OcuLight SLx to
perform the latest in clinical infrared applications. In September 1998, we
introduced our next generation of portable Slit Lamp Adapters, which offer
superior viewing ability. This superior viewing ability results from new
UltraView optics combined with precision laser beam steering using a new
self-centering micromanipulator. We intend to continue our investment in
research and development to improve the performance of our systems. We also
intend to develop additional technologies which can more cost effectively
address the needs of the ophthalmic and dermatologic markets. To enhance our
research and development efforts, we collaborate with an extensive network of
academic leaders who provide input and advice, as well as assist in validating
the efficacy of new products and applications.

Expand Medical Practice Versatility. We provide products that allow
ophthalmologists to expand their practice by increasing the offering of delivery
services available to physicians and adding to the clinical procedures that can
be performed in the ophthalmologist's office. In September 1998, we obtained
clearance from the FDA for a Dermatology Kit that allows our OcuLight GL laser
photocoagulator, which is currently used by ophthalmologists to treat a variety
of eye diseases, to also treat vascular and pigmented skin lesions.

Provide Total Disease Management. We intend to pursue both therapeutic
and adjunctive diagnostic systems. An adjunctive diagnostic system is used
either to screen and identify more patients who require therapy or objectively
assess the adequacy of therapy. We believe that a significant opportunity exists
to provide diagnostic equipment to the ophthalmic and optometric communities. We
intend to pursue our entrance into this diagnostic market through both internal
development and selected acquisitions. By pursuing therapeutic and diagnostic
systems, we intend to provide total disease management.

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Develop New Markets Through Strategic Alliances. We intend to establish
strategic alliances in order to expedite and lower the cost of developing and
bringing to market new products, both to the ophthalmology and dermatology
markets and to markets not currently addressed by our products. Through these
alliances, we will seek access to technologies that we do not currently possess.
In May 1996, we signed a Development and Distribution Agreement with Miravant
Medical Technologies, formerly known as PDT, Inc. ("Miravant"), a company
engaged in the development of photodynamic drugs and applications, to provide
lasers to activate certain photodynamic drugs developed by Miravant.

PRODUCTS

We utilize a systems approach to product design. Each system includes a
console, which generates the laser energy, and a number of interchangeable
peripheral delivery devices, including disposable delivery devices, for use in
specific clinical applications. This approach allows our customers to purchase a
basic system and add additional delivery devices as their needs expand or as we
develop new applications. This systems approach also brings economies-of-scale
to our product development and manufacturing efforts since each application does
not require the design and manufacture of complete stand-alone products. Our
primary non-disposable products range in price from $2,000 to $50,000.

Consoles. Our laser consoles incorporate the economic and technical
benefits of semiconductor laser technology, which is the basis of our
semiconductor-based laser systems.

Infrared Photocoagulator Consoles. These OcuLight photocoagulator
consoles are available in two infrared output power ranges: the OcuLight
SL at 2 Watts and the OcuLight SLx at 3 Watts. Each console weighs 14
pounds, has dimensions of 4"H x 12"W x 12"D, draws a maximum of 60 Watts
of wall power, and requires no external air or water cooling.

Veterinary Infrared Console. Introduced in 1994, the DioVet laser system
is used by veterinary ophthalmologists worldwide to treat glaucoma,
retinal disorders, and tumors in dogs, cats, horses and other animals.
The laser's 810 nm wavelength enables transscleral glaucoma and retinal
procedures that are less traumatic and painful than cryotherapy while
providing greater accuracy to the treatment area. The small size of the
DioVet allows easy transport to multiple clinics or remote locations.

Visible Photocoagulator Consoles. In September 1996, we introduced a new
semiconductor-based photocoagulator, the OcuLight GL, which delivers
visible laser light. In June 1997, we launched a dermatology product,
the DioLite 532, also based on visible semiconductor-based technology.
In January 1999, we shipped a new version of the OcuLight GL, the
OcuLight GLx, with increased power and delivery device capability. These
consoles weigh 15 pounds, have dimensions of 6"H x 12"W x 12"D, draw a
maximum of 300 Watts of wall power and require no external air or water
cooling.

Peripheral Delivery Devices. Our versatile family of consoles and
delivery devices has been designed to allow the addition of new capabilities
with a minimal incremental investment. A user adds capabilities by simply
purchasing a new interchangeable delivery device. We have developed both
disposable and nondisposable delivery devices and expect to continue to develop
additional devices.

Ophthalmic Delivery Devices:

TruFocus Laser Indirect Ophthalmoscope. The indirect ophthalmoscope is
worn on the physician's head and is used to treat peripheral retinal disorders,
particularly in infants or adults requiring treatment in the supine position.
This product can be used both for diagnosis and treatment at the point-of-care.

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Slit Lamp Adapter. These adapters allow the physician to utilize a
standard slit lamp for both diagnosis and treatment. A slit lamp adapter
can be installed by the doctor in several minutes, converting over 50
variations of a standard diagnostic slit lamp into a therapeutic
photocoagulator delivery system. Slit lamp adapters are used for
treatment of both retinal and glaucoma diseases.

Operating Microscope Adapter. These adapters allow the physician to
utilize a standard operating microscope for both diagnosis and laser
treatment. These devices are similar to slit lamp adapters, except they
are oriented horizontally and therefore can be used to deliver retinal
photocoagulation to a supine patient.

EndoProbe. The EndoProbe is used for endophotocoagulation, a retinal
treatment performed in the hospital operating room or surgery center.
These sterile disposable probes are available in tapered, angled,
fluted, active aspiration and illuminating styles.

G-Probe. The G-Probe is used to treat medically and surgically
uncontrolled glaucoma, in many instances replacing cyclocryotherapy, or
freezing of the eye. The G-Probe's non-invasive procedure takes about
ten minutes, is done to an anesthetized eye in the doctor's office and
results in less pain and fewer adverse side effects than
cyclocryotherapy. The G-Probe is a sterile disposable product.

DioPexy Probe. The DioPexy Probe is a hand-held instrument which is used
to treat retinal tears and breaks transsclerally, noninvasively through
the sclera as an alternative method of attaching the retina. Advantages
include increased precision, less pain and less inflammation than
traditional cryotherapy.

Dermatology Delivery Devices:

DioLite Handpiece. The DioLite Handpiece is a hand held instrument that
is used to treat vascular and pigmented lesions. These devices are
available in 200, 500, 700, 1000 and 1400 micron sizes.

ScanLite Scanner. The ScanLite is a computer pattern generator with
integrated controls designed to enhance the capabilities of the DioLite
532 laser system. It allows rapid and uniform treatment of large-area
vascular and pigmented lesions including port wine stains, matted
telangiectasia, and cafe au lait stains.

We have also developed a new laser system with Miravant. This system
emits a laser beam to activate a photodynamic drug being developed by Miravant
in order to achieve a therapeutic result in the treatment of age-related macular
degeneration. Clinical studies are currently underway to test the efficacy of
this procedure. Miravant has entered into a co-development agreement with
Pharmacia & Upjohn to more rapidly develop the photodynamic drug and validate
its use in clinical studies. We expect that, if successful, the development of
this product and the receipt of the appropriate regulatory approval thereof will
occur within 2 years. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors That May Affect Our
Future Results--We Depend on Development of New Products and New Applications
and--We Depend on Collaborative Relationships."

In March 1999, we announced a new laser system, the Apex(TM) 800 for
hair removal. We expect units to be available for shipment during the second
quarter of 2000 and are currently taking orders for these systems.

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The following chart lists the eye diseases that can be treated using our
photocoagulator systems, including the preferred delivery devices. The selection
of delivery device is often determined by the severity and location of the
disease. The chart also lists the skin diseases or conditions that can be
treated with the DioLite 532.

<TABLE>
<CAPTION>
Condition Procedure Console Delivery Devices
--------- --------- ------- ----------------
<S> <C> <C> <C>
Ophthalmology Treatments:

Age-related Macular Retinal Infrared & Slit Lamp Adapter
Degeneration Photocoagulation Visible

Diabetic Retinopathy

Macular Edema Grid Retinal Infrared & Slit Lamp Adapter &
Photocoagulation Visible Operating Microscope
Adapter
Focal Retinal Visible Slit Lamp Adapter
Photocoagulation

Proliferative Pan-Retinal Infrared & Slit Lamp Adapter,
Photocoagulation Visible Operating Microscope
Adapter, Laser Indirect
Ophthalmoscope,
EndoProbe

Glaucoma

Primary Open-Angle Trabeculoplasty Infrared & Slit Lamp Adapter
Visible

Angle-closure Iridotomy(1) Infrared & Slit Lamp Adapter
Visible

Uncontrolled Transscleral Infrared G-Probe
Cyclophotocoagulation

Retinal Detachment Retinopexy Retinal Infrared & Slit Lamp Adapter,
Photocoagulation Visible Laser Indirect
Ophthalmoscope,
Operating Microscope
Adapter, EndoProbe
Transscleral Retinal Infrared DioPexy Probe
Photocoagulation

Retinopathy of Prematurity Retinal Infrared Laser Indirect
Photocoagulation Ophthalmoscope

Ocular Tumors Retinal Infrared Slit Lamp Adapter,
Photocoagulation Operating Microscope
Adapter, Laser Indirect
Ophthalmoscope

Dermatology Treatments:

Vascular Lesions Selective Visible DioLite Handpiece
Photothermolysis

Pigmented Lesions Selective Visible DioLite Handpiece
Photothermolysis
</TABLE>

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(1) This indication is currently not cleared by the U.S. FDA.

RESEARCH AND DEVELOPMENT

Our research and development activities are performed internally by our
research and development staff comprised of 20 individuals and are supplemented
by consultants with specialized expertise. Research and development efforts are
directed toward both development of new products and development of new
applications using existing products. Our expenditures for research and
development totaled approximately $3,925,000, $3,099,000 and $1,716,000 in 1999,
1998 and 1997, respectively. In addition, we receive funds under grant from the

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United States government for research. We have close working relationships with
ophthalmic researchers, clinicians and dermatologists around the world who
provide new ideas, test the feasibility of these new ideas, and assist us in
validating new products and new applications before they are introduced.

We are supporting pre-clinical and clinical studies to develop new
photocoagulation treatments and applications. The objectives of developing new
applications are to expand the number of patients who can be treated, to more
effectively treat diseases, to treat patients earlier in the treatment regimen
and to reduce the side-effects of treatment. Examples of such studies include:

Ophthalmic Applications:

Age-Related Macular Degeneration - Dry Form. About 90% of AMD is the dry
form. We are pursuing two approaches to treat dry AMD: Therapeutic
Treatment and Prophylactic Treatment. The Therapeutic Treatment approach
uses the OcuLight infrared laser to restore vision by causing resorption
of dry AMD deposits which have accumulated in the macula and impacted
vision. For Prophylactic Treatment, we are supporting a multi-center
clinical trial which is testing a prophylactic treatment of age-related
macular degeneration (PTAMD trial). This trial treats patients with dry
AMD using our OcuLight infrared laser systems with the objective of
reducing the rate of progression of the disease from the dry form of AMD
to the wet form of AMD. We are also evaluating whether patient vision
improves as a result of this application.

Age-related Macular Degeneration (AMD) - Wet Form. The wet form of AMD
constitutes about 10% of all AMD but accounts for about 80% of all
severe vision loss associated with AMD. We are pursuing three approaches
to treat wet AMD by treating the disease at different stages:
Photodynamic Therapy (PDT), Transpupillary Thermotherapy (TTT) and
Feeder Vessel Treatment. All of these approaches close new vessels in
the macula caused by wet AMD with less damage than conventional laser
treatments. In the PDT approach an infused photodynamic drug is
stimulated by one of our lasers to close the new vessels. We are
collaborating with Miravent and Pharmacia & Upjohn in commercializing
this PDT approach to treat "classic" wet AMD. The Phase III clinical
trial was fully enrolled in December 1999. In the TTT approach a certain
form of wet AMD called "occult" is treated with the infrared laser
alone. Favorable results of a pilot study were published in October
1999. A multi-center randomized trial called the TTT4CNV Trial, which we
are sponsoring, is currently enrolling patients. For Feeder Vessel
Treatment two centers, one in Europe and one in the U.S., are using our
infrared laser in clinical studies to treat both "classic" and "occult"
wet AMD. Favorable results have been reported by both centers.

Glaucoma. Preliminary studies are underway to evaluate the use of the
G-Probe as a first-line treatment modality for various glaucomas.

Diabetic Retinopathy. Studies are underway to investigate the treatment
of diabetic retinopathy using MicroPulse (minimal impact sub-visible
threshold) infrared photocoagulation with the objective of causing
regression of the disease with less loss of vision than conventional
therapy.

Ocular Tumors. Clinical studies have reported successful treatment of
ocular tumors using OcuLight infrared lasers using an approach called
Transpupillary Thermotherapy (TTT).

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CUSTOMERS AND CUSTOMER SUPPORT

Our products are currently sold to ophthalmologists, including glaucoma
specialists, retinal specialists, pediatric ophthalmologists, and
dermatologists. Other customers include research and teaching hospitals,
government installations, surgi-centers and hospitals. No customer or
distributor accounted for 10% or more of total sales in 1999, 1998 or 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

We are continuing our efforts to broaden our customer base through the
development of new products and new applications. We currently estimate that
there are approximately 17,000 ophthalmologists in the United States and 45,000
internationally who are each potential customers. We believe there are
approximately 10,000 dermatologists in the U.S. Additionally, we estimate that
there are approximately 4,800 and 18,000 hospitals in the United States and
internationally, respectively, as well as approximately 2,200 ambulatory
surgical centers in the United States which potentially represent multiple unit
sales. Because independent ophthalmologists and dermatologists frequently
practice at their own offices as well as through affiliation with hospitals or
other medical centers, each independent ophthalmologist, dermatologist, hospital
and medical center is a potential customer for our products. We are seeking to
broaden our customer base by developing new diagnostic products directed at
addressing the needs of opthalmologists and dermatologists.

We seek to provide superior customer support and service. An
"around-the-clock" telephone service line is maintained to service customers. If
a problem with a product cannot be diagnosed and resolved by telephone, a
replacement unit is shipped overnight to any domestic customer, and the problem
unit is returned to us. The small size and rugged design of our products allows
for economical shipment and quick response to customers almost anywhere in the
world.

SALES AND MARKETING

To support our sales process, we conduct marketing programs which
include direct mail, trade shows, public relations, advertising in trade and
academic journals and newsletters. We annually participate in approximately 87
trade shows or meetings in the United States and 65 trade shows or meetings
internationally. These meetings allow us to present our products to existing and
prospective buyers. While the sales cycle varies from customer to customer, it
averages 12 months and typically ranges from two to 24 months. Our sales and
marketing organization is based at our corporate headquarters in Mountain View,
California with area sales managers located in California, Florida, Georgia,
Illinois, Maryland, Massachusetts, Ohio, Texas, and Virginia.

International product sales represented 38.6%, 36.6% and 51.8% of our
sales in 1999, 1998 and 1997, respectively. Our products are sold
internationally through our 58 independent distributors into 74 countries and in
the United States predominantly through our direct sales force. International
sales are administered through our corporate headquarters in Mountain View,
California, along with three area sales managers. Our distribution agreements
with our international distributors are generally exclusive and typically can be
terminated by either party without cause on 90 days notice. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Factors That May Affect Future Results--We Depend on International
Sales."

We believe that educating patients and physicians about the long-term
health benefits and cost-effectiveness of diagnosis and treatment of diseases
that cause blindness at an early stage is critical to market acceptance of our
ophthalmic products. We believe that the trend toward management of health care
costs in the United States will lead to increased awareness of and emphasis on
disease prevention and cost-effective treatments and, as a result, will increase
demand for our ophthalmic laser products as well as our prospective diagnostic
products.

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We work with our customers to enhance our ability to identify new
applications for our products, validate new procedures using our products,
respond more effectively to new procedures and expedite regulatory approvals of
new products and applications. Customers include key opinion leaders who are
often the heads of the departments or professors at universities. These
luminaries in the field of ophthalmology and dermatology are key to the
successful introduction of new technologies and their subsequent acceptance by
the general market. Acceptance of our products by these early adopters is key to
our strategy in the validation of our technology. In addition, we believe that
widespread adoption of our laser platforms will require education about our
products as compared to competing systems.

OPERATIONS

The manufacture of ophthalmic and dermatologic laser systems is a
complex process involving precision components, intricate procedures, and
environmental controls. Completed systems must pass quality control and
reliability tests before shipment. We purchase substantially all of our
components that are either standard or built to proprietary specifications and
subassemblies from various independent suppliers and sub-contractors. We
assemble critical subassemblies and the final product at our Mountain View,
California facility. Most of the sub-contractors are located within 10 miles of
our Mountain View facility. There are risks associated with the use of
independent suppliers and sub-contractors, including unavailability of or delays
in obtaining adequate supplies of components and potentially reduced control of
quality, production costs and the timing of delivery. Any failures by such third
parties to adequately perform may delay the submission of products for
regulatory approval, impair our ability to deliver products on a timely basis,
or otherwise impair our competitive position. Establishing our own capabilities
to manufacture these components would require significant scale-up expenses and
additions to facilities and personnel and could adversely affect our earnings.

We have qualified two or more sources for most of the components used in
our products. As an example, in the past, we have experienced delays in the
manufacturing of our Oculight GL due to the inability of a supplier to deliver
certain diode components in volume and on a timely basis. We continue to work
with our suppliers to ensure that such difficulties do not recur. Additionally,
we qualified a second source for this diode. The process of qualifying suppliers
is ongoing and may be lengthy, particularly as new products are introduced. We
do not have long-term or volume purchase agreements with any of our suppliers
and currently purchase components on a purchase order basis. Our business,
financial condition and results of operations would be adversely affected if we
are unable to obtain components in the quantities required at a reasonable cost
and on a timely basis, or if we could not expand manufacturing capacity to meet
demand or if operations at our single facility were disrupted. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors That May Affect Future Results--We Face Risks of
Manufacturing."

In April 1998, we received certification for ISO 9001/EN 46001. ISO
9001/EN 46001 is a documented international quality system demonstrating
compliance to the European Medical Device Directive.

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With Annex II CE registration, IRIDEX Corporation has demonstrated its ability
to both understand and comply with all applicable European standards. This
allows us to register any product upon our internal verification of compliance
to all applicable European Standards. Currently, all released products are CE
registered. Continued registration is based on successful review of the process
by our European Registrar during its annual audit. Any loss of registration
would have a material adverse effect on our business, results of operations and
financial condition.

COMPETITION

Competition in the market for devices used for ophthalmic and
dermatologic treatments is intense and is expected to increase. This market is
also characterized by rapid technological innovation and change and our products
could become obsolete as a result of future innovations. Our competitive
position depends on a number of factors including product performance,
characteristics and functionality, ease of use, scalability, durability and
cost. In addition to other companies that manufacture photocoagulators, we
compete with pharmaceuticals, other technologies and other surgical techniques.
Our principal competitors in ophthalmology are Coherent, Inc., Nidek, Inc.
("Nidek"), Carl Zeiss, Inc. ("Zeiss"), Alcon International, Keeler Instruments,
Inc. ("Keeler") and HGM Medical Laser Systems, Inc. ("HGM"). Of these companies,
all currently offer a competitive, semiconductor-based laser system in
ophthalmology and other competitors may introduce semiconductor-based laser
systems. Our principal competitors in dermatology are Laserscope and HGM. The
Apex 800 Laser Hair Removal System will compete primarily with products from
Coherent, Inc., Candela Corporation, ESC Medical Systems, Ltd. and Cynosure,
Inc. Some competitors have substantially greater financial, engineering, product
development, manufacturing, marketing and technical resources than we do. Such
companies also have greater name recognition than us and long-standing customer
relationships. In addition, other medical companies, academic and research
institutions or others may develop new technologies or therapies, including
medical devices, surgical procedures or pharmacological treatments and obtain
regulatory approval for products utilizing such techniques that are more
effective in treating the conditions targeted by us or are less expensive than
our current or future products. Our technologies and products could be rendered
obsolete by such developments. Any such developments could have a material
adverse effect on our business, financial condition and results of operations.
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Factors That May Affect Future Results--Our Market is
Competitive."

PATENTS AND PROPRIETARY RIGHTS

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 eight United
States patents on the technologies related to our products and processes. There
can be no assurance that any of our patent applications will issue as patents,
that any patents now or hereafter held by us will offer any degree of protection
or that our patents or patent applications will not be challenged, invalidated
or circumvented in the future. 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 March 2000, we entered into a patent license agreement with Palomar
Medical Technologies, Inc. (PMTI). This agreement gives us a non-exclusive 7.5%
royalty bearing sublicense to skin cooling patents for use in laser hair
removal. The license provides the Apex 800 hair removal system with additional
cooling features.

9
<PAGE> 12
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. 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. Because patent applications are
maintained in secrecy in the United States until patents are issued and are
maintained in secrecy for a period of time outside the United States, we have
not conducted any searches to determine whether our technology infringes any
patents or patent applications. 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. This may adversely impact
our operating results.

Any claims, with or without merit, could be time-consuming, result in
costly litigation and diversion of technical and management personnel, cause
shipment delays, require us to develop noninfringing technology or require us to
enter into royalty or licensing agreements. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. An adverse determination in
a judicial or administrative proceeding or failure to obtain necessary licenses
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. Conversely, litigation may be necessary to enforce patents issued to
us, to protect trade secrets or know-how owned by us or to determine the
enforceability, scope and validity of the proprietary rights of others. Both the
defense and prosecution of intellectual property suits or interference
proceedings are costly and time consuming.

GOVERNMENT REGULATION

The medical devices to be marketed and manufactured by us are subject to
extensive regulation by numerous governmental authorities, including federal,
state, and foreign governmental agencies. Pursuant to the Federal Food, Drug,
and Cosmetic Act, as amended, and the regulations promulgated thereunder (the
"FDA Act"), the Food and Drug Administration (the "FDA") serves as the principal
federal agency with authority over medical devices and regulates the research,
clinical testing, manufacture, labeling, distribution, sale, marketing and
promotion of such devices. Noncompliance with applicable requirements can result
in, among other things, fines, injunctions, civil penalties, recall or seizures
of products, total or partial suspension of production, failure of the
government to grant premarket clearance or approval for devices, 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 manufactured or
distributed by us.

In the United States, medical devices are classified into one of three
classes (Class I, II or III), on the basis of the controls deemed necessary by
the FDA to reasonably assure their safety and effectiveness. Under FDA
regulations, Class I devices are subject to general controls (for example,
labeling, premarket notification and adherence to Quality System Regulations
("QSRs") requirements). Class II devices are subject to general and special
controls (for example, performance standards, postmarket surveillance, patient

10
<PAGE> 13

registries, and FDA guidelines). Generally, Class III devices are those which
must receive premarket approval (or "PMA") by the FDA to ensure their safety and
effectiveness.

Before a new device can be introduced into the market, the manufacturer
must generally obtain marketing clearance through either a 510(k) premarket
notification or a PMA. A 510(k) clearance will be granted if the submitted
information establishes that the proposed device is "substantially equivalent"
to a legally marketed Class I or II medical device, or to a Class III medical
device for which the FDA has not called for a PMA. The FDA may determine that a
proposed device is not substantially equivalent to a legally marketed device, or
that additional information or data are needed before a substantial equivalence
determination can be made. A request for additional data may require that
clinical studies of the device's safety and efficacy be performed.

Commercial distribution of a device for which a 510(k) notification is
required can begin only after the FDA issues an order finding the device to be
"substantially equivalent" to a predicate device. The FDA has recently been
requiring a more rigorous demonstration of substantial equivalence than in the
past. Even in cases where the FDA grants a 510(k) clearance, it can take the FDA
from four to twelve months from the date of submission to grant a 510(k)
clearance, but it may take longer. In December 1999, the FDA granted a 510(k)
clearance for the Company's new Apex 800 hair removal laser.

A "not substantially equivalent" determination, or a request for
additional information, could delay the market introduction of new products that
fall into this category and could have a materially adverse effect on our
business, financial condition and results of operations. For any of our products
that are cleared through the 510(k) process, modifications or enhancements that
could significantly affect the safety or efficacy of the device or that
constitute a major change to the intended use of the device will require new
510(k) submissions.

A PMA application must be filed if a proposed device is not
substantially equivalent to a legally marketed Class I or Class II device, or if
it is a Class III device for which the FDA has called for PMAs. A PMA
application must be supported by valid scientific evidence which typically
includes extensive data, including human clinical trial data, to demonstrate the
safety and effectiveness of the device. The PMA application must also contain
the results of all relevant bench tests, laboratory and animal studies, a
complete description of the device and its components, and a detailed
description of the methods, facilities and controls used to manufacture the
device. In addition, the submission may require the applicant to detail the
proposed labeling, advertising literature and training methods.

Upon receipt of a PMA application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit a
substantive review. If the FDA determines that the PMA application is
sufficiently complete to permit a substantive review, the FDA will accept the
application for filing. Once the submission is accepted for filing, the FDA
begins an in-depth review of the PMA. An FDA review of a PMA application
generally takes one to two years from the date the PMA application is accepted
for filing, but may take significantly longer. The review time is often
significantly extended by the FDA asking for more information or clarification
of information already provided in the submission. During the review period, an
advisory committee, typically a panel of clinicians, will likely be convened to
review and evaluate the application and provide recommendations to the FDA as to
whether the device should be approved. The FDA is not bound by the
recommendations of the advisory panel. Toward the end of the PMA review process,
the FDA generally will conduct an inspection of the manufacturer's facilities to
ensure that the facilities are in compliance with applicable QSR requirements,
which include good manufacturing practices.

11
<PAGE> 14

If the FDA's evaluations of both the PMA application and the
manufacturing facilities are favorable, the FDA will either issue an approval
letter or an approvable letter, which may contain a number of conditions which
must be met in order to secure final approval of the PMA. When and if those
conditions have been fulfilled to the satisfaction of the FDA, the agency will
issue a PMA approval letter, authorizing commercial marketing of the device for
certain indications. The FDA may also determine that additional clinical trials
are necessary or other deficiencies exist in the PMA, in which case PMA approval
may be delayed. The PMA process can be expensive, uncertain and lengthy and a
number of devices for which the FDA approval has been sought by other companies
have never been approved for marketing.

If human clinical trials of a device are required in connection with
either a 510(k) notification or a PMA, and the device presents a "significant
risk," the sponsor of the trial (usually the manufacturer or the distributor of
the device) is required to file an investigational device exemption ("IDE")
application prior to commencing human clinical trials. The IDE application must
be supported by data, typically including the results of animal and laboratory
testing. If the IDE application is reviewed and approved by the FDA and one or
more appropriate institutional review boards ("IRBs"), human clinical trials may
begin at a specific number of investigational sites with a specific number of
patients, as approved by the FDA. If the device presents a "nonsignificant risk"
to the patient, a sponsor may begin the clinical trial after obtaining approval
for the study by one or more appropriate IRBs.

All of our products have obtained either an independent 510(k) clearance
or are modifications of previously cleared 510(k) devices, which do not require
the submission of a new 510(k) notification. However, the FDA may not agree with
our determination that a 510(k) notification is not required for the modified
devices and require us to submit a new 510(k) notification for the modification.
If the FDA requires us to submit a new 510(k) notification for the modified
devices, we may be prohibited from marketing the modified device until the
510(k) notification is cleared by the FDA.

We have also established a strategic alliance with Miravant to
manufacture a device designed to photoactivate an ophthalmic drug currently
under development by Miravant. Miravant is responsible for obtaining the
required regulatory approvals. Under the FDA's combination products policy, the
ophthalmic drug and photoactivating device may be considered a drug-device
combination product and, therefore, be required to undergo the new drug approval
process. The steps required before a new drug can be commercially distributed in
the United States include (1) conducting appropriate pre-clinical laboratory and
animal tests, (2) submitting to the FDA an application for an investigational
new drug ("IND"), which must become effective before clinical trials may
commence, (3) conducting well-controlled human clinical trials that establish
the safety and effectiveness of the drug, (4) filing a new drug application
("NDA") with the FDA, and (5) obtaining FDA approval of the NDA prior to any
commercial distribution of the drug. The new drug approval process is expensive,
lengthy and uncertain, and many new drug products have never been approved for
marketing. An approved NDA may be required for the ophthalmic drug and
photoactivating device as a combination product. If required, we may not be able
to obtain such approval. In addition, the FDA may require separate premarket
clearance for the photoactivating device through either a 510(k) notification or
a PMA. If required, we may not be able to obtain such premarket clearance or
approval.

Any products manufactured or distributed by us pursuant to FDA
clearances or approvals are subject to pervasive and continuing regulation by
the FDA, including recordkeeping requirements and reporting of adverse
experiences with the use of the device. Device manufacturers are required to
register their establishments and list their devices with the FDA and certain
state agencies, and are subject to periodic inspections by the FDA and certain
state agencies. The FDA Act requires devices to be manufactured to comply with
applicable QSR regulations which impose certain procedural and documentation
requirements upon us with respect to manufacturing, design, development and
quality assurance activities.

12
<PAGE> 15

Labeling and promotion activities are subject to scrutiny by the FDA
and, in certain instances, by the Federal Trade Commission. The FDA actively
enforces regulations prohibiting marketing of products for unapproved uses. We
and our products are also subject to a variety of state laws and regulations in
those states or localities where our products are or will be marketed. Any
applicable state or local regulations may hinder our ability to market our
products in those states or localities. Manufacturers are also subject to
numerous federal, state and local laws relating to such matters as safe working
conditions, manufacturing practices, environmental protection, fire hazard
control and disposal of hazardous or potentially hazardous substances. We may be
required to incur significant costs to comply with such laws and regulations now
or in the future. Such laws or regulations may have a material adverse effect
upon our ability to do business.

Exports of our products are regulated by the FDA and are covered by the
Export Amendment of 1996, which greatly expanded the export of approved and
unapproved United States medical devices. However, some foreign countries
require manufacturers to provide an FDA certificate for products for export
("CPE") which requires the device manufacturer to certify to the FDA that the
product has been granted premarket clearance in the United States and that the
manufacturing facilities appeared to be in compliance with QSR at the time of
the last QSR inspection. The FDA will refuse to issue a CPE if significant
outstanding QSR violations exist.

The introduction of our products in foreign markets will also subject us
to foreign regulatory clearances which may impose additional substantial costs
and burdens. International sales of medical devices are subject to the
regulatory requirements of each country. The regulatory review process varies
from country to country. Many countries also impose product standards,
packaging, requirements, labeling requirements and import restrictions on
devices. In addition, each country has its own tariff regulations, duties and
tax requirements. The approval by the FDA and foreign government authorities is
unpredictable and uncertain. The necessary approvals or clearances may not be
granted on a timely basis, if at all. Delays in receipt of, or a failure to
receive, such approvals or clearances, or the loss of any previously received
approvals or clearances, could have a material adverse effect on our business,
financial condition and results of operations.

Changes in existing requirements or adoption of new requirements or
policies by the FDA or other foreign and domestic regulatory authorities could
adversely affect our ability to comply with regulatory requirements. Failure to
comply with regulatory requirements could have a material adverse effect on our
business, financial condition and results of operations. We may be required to
incur significant costs to comply with laws and regulations in the future. These
laws or regulations may have a material adverse effect upon our business,
financial condition or results of operations.

REIMBURSEMENT

Our 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 carefully review and are increasingly
challenging the prices charged for medical products and services. Reimbursement
rates from private companies vary depending on the procedure performed, the
third-party payor, the insurance plan and other factors. Medicare reimburses
hospitals on a prospectively-determined fixed amount for the costs associated
with an in-patient hospitalization based on the patient's discharge diagnosis.
Medicare reimburses physicians a prospectively-determined fixed amount based on
the procedure performed, regardless of the actual costs incurred by the hospital
or physician in furnishing the care and regardless of the specific devices used
in that procedure. Third-party payers are increasingly scrutinizing whether to
cover new products and the level of reimbursement for covered products.

13
<PAGE> 16

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. Additionally,
Miravant may not be able to obtain coverage for its use of drugs with our
OcuLight Systems, or the reimbursement may not be adequate to cover the
treatment procedure. Doctors, clinics, hospitals and other users of our products
may not obtain adequate reimbursement for use of our products from third-party
payers. Changes in government legislation or regulation or in private
third-party payers' policies toward reimbursement for procedures employing our
products may prohibit adequate reimbursement. Such occurrences could have a
material adverse effect on our business, results of operations and financial
condition. Moreover, 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. Most of the treatment procedures for our DioLite 532
dermatology systems are billed to private-pay customers.

PRODUCT LIABILITY AND INSURANCE

We may be subject to product liability claims in the future. Our
products are highly complex and are used to treat extremely delicate eye tissue
and skin conditions on and near a patient's face. Our products are often used in
situations where there is a high risk of serious injury or adverse side effects.
In addition, although we recommend that our disposable products only be used
once and prominently label these disposables, we believe that certain customers
may nevertheless reuse these disposable products. If a disposable product is not
adequately sterilized by the customer between such uses, a patient could suffer
serious consequences, possibly resulting in a suit against us for damages.
Accordingly, the manufacture and sale of medical products entails significant
risk of product liability claims. Although we maintain product liability
insurance with coverage limits of $11.0 million per occurrence and an annual
aggregate maximum of $12.0 million, the coverage of our insurance policies may
not be adequate. Such insurance is expensive and in the future may not be
available on acceptable terms, 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. To date, we have not
experienced any product liability claims which would result in payments in
excess of our policy limits.

BACKLOG

We generally ship our products within a few days after acceptance of a
customer's purchase order. Accordingly, we do not believe that our backlog at
any particular time is indicative of future sales levels.

EMPLOYEES

At January 1, 2000, we had a total of 102 full-time employees, including
39 in operations, 32 in sales and marketing, 20 in research and development and
11 in finance and administration. We also employ, from time to time, a number of
temporary and part-time employees as well as consultants on a contract basis. At
January 1, 2000, we employed 4 such persons. We intend to hire additional
personnel during the next twelve months in each of these areas. Our future
success will depend in part on our ability to attract, train, retain and
motivate highly qualified employees, who are in great demand. We may not be
successful in attracting and retaining such personnel. Our employees are not
represented by a collective bargaining organization, and we have never
experienced a work stoppage or strike. We consider our employee relations to be
good.

EXECUTIVE OFFICERS OF THE COMPANY

Our executive officers and their ages as of January 1, 2000 were as
follows:

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<PAGE> 17

<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Theodore A. Boutacoff 52 President, Chief Executive Officer and Director
Robert Kamenski 45 Chief Financial Officer and Vice President, Administration
Eduardo Arias 55 Senior Vice President, Worldwide Sales
Timothy Powers 38 Vice President, Operations
James L. Donovan 62 Vice President, Corporate Business Development and Director
</TABLE>

Mr. Boutacoff co-founded IRIDEX and since February 1989 has served as
its President, Chief Executive Officer and a member of its Board of Directors.
Prior to co-founding the Company, Mr. Boutacoff held various positions,
including Director of New Business and Clinical Development, Director of
Marketing and Director of Regulatory Affairs, with the Medical Division of
Coherent, Inc., a manufacturer of laser systems for science, medicine and
industry. Mr. Boutacoff holds a B.S. degree in civil engineering from Stanford
University.

Mr. Kamenski joined IRIDEX in March 1997 as Vice President, Finance and
Administration and was appointed Chief Financial Officer in October 1997. Prior
to joining us, from July 1992 to March 1997, Mr. Kamenski held various
positions, including Chief Financial Officer and Vice President of Finance and
Administration, with TeleSensory Corporation. Mr. Kamenski holds a B.B.A. degree
in accounting from the University of Wisconsin-Milwaukee and is a member of the
American Institute of CPAs.

Mr. Arias co-founded IRIDEX and served as Vice President, Sales &
Marketing from April 1989 until September 1991 when he was promoted to the
position of Senior Vice President, Worldwide Sales. Prior to co-founding the
Company, Mr. Arias held various positions, including Director of Marketing and
Sales, Medical Group and Director of International Operations, at Coherent, Inc.

Mr. Powers joined IRIDEX in July 1997 as Vice President, Operations.
Prior to joining us, from November 1988 to July 1997, Mr. Powers held various
positions, including Vice President of Operations, at Strato/Infusaid, Inc., a
Pfizer subsidiary. Mr. Powers holds a Masters of Management Science degree in
manufacturing engineering and a Bachelors of Science degree in industrial
technology, both from the University of Lowell in Massachusetts.

Mr. Donovan co-founded IRIDEX and, since February 1989, has served as a
member of our Board of Directors. From February 1989 to October 1997, Mr.
Donovan served as our Chief Financial Officer, except in the period June to
November 1996, and is currently serving as our Vice President, Corporate
Business Development. Prior to co-founding the Company, Mr. Donovan served as
General Manager of the Medical Division and Chief Financial Officer of Coherent,
Inc. Mr. Donovan holds a B.S. degree in business administration from Southern
Oregon State College.

ITEM 2. PROPERTIES

We relocated our operating facilities in September 1997 to 37,000 square
feet of space in Mountain View, California. The new building houses
manufacturing, research and development and serves as our headquarter offices.
The lease term expires in 2002 and contains a renewal option.

Management believes that our new facility will be adequate for our
current needs and that suitable additional space or alternative space will be
available as needed in the future on commercially reasonable terms.

15
<PAGE> 18

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.

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<PAGE> 19

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION FOR COMMON EQUITY

Our Common Stock has been traded on the NASDAQ National Market System
under the symbol "IRIX" since our initial public offering on February 15, 1996.
The following table sets forth for the periods indicated the high and low
closing prices for our Common Stock.

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
FISCAL 2000
First Quarter (through March 20, 2000).................... $18.500 $ 7.938

FISCAL 1999
First Quarter............................................. $ 5.750 $ 3.875
Second Quarter............................................ 5.125 3.625
Third Quarter............................................. 5.000 3.625
Fourth Quarter............................................ 9.500 4.188

FISCAL 1998
First Quarter............................................. $ 9.125 $ 6.500
Second Quarter............................................ 11.375 7.625
Third Quarter............................................. 8.250 3.625
Fourth Quarter............................................ 4.625 1.938
</TABLE>

FISCAL 2000

On March 20, 2000, the closing price on the NASDAQ National Market for
our Common Stock was $12.50 per share. As of January 1, 2000, there were
approximately 75 holders of record of our Common Stock.

DIVIDEND POLICY

We have never paid cash dividends on our Common Stock. We currently
intend to retain any earnings for use in our business and do not anticipate
paying cash dividends in the foreseeable future. In addition, the payment of
cash dividends to our stockholders is currently prohibited by our bank line of
credit. See Note 4 of Notes to Consolidated Financial Statements.

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data as of and for the
years ended January 1, 2000, January 2, 1999, December 31, 1997, 1996, 1995 have
been derived from, and are qualified by reference to, our audited consolidated
financial statements. The selected consolidated statement of income data as of
December 31, 1996 and 1995 and the consolidated balance sheet data as of
December 31, 1997, 1996 and 1995 has been derived from our audited financial
statements not included herein. These historical results are not necessarily
indicative of the results of operations to be expected for any future period.

17
<PAGE> 20

The data set forth below (in thousands, except per share data) are
qualified by reference to, and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
the consolidated financial statements included in Item 8. "Financial Statements
and Supplementary Data."

<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Sales ....................................................... $ 26,762 $ 23,585 $ 18,073 $ 12,364 $ 8,801
Cost of sales ............................................... 11,788 10,308 7,612 4,899 2,798
-------- -------- -------- -------- --------
Gross profit ................................... 14,974 13,277 10,461 7,465 6,003
-------- -------- -------- -------- --------

Operating expenses:
Research and development ................................ 3,925 3,099 1,716 1,286 742
Selling, general and administrative ..................... 9,224 8,358 6,074 5,197 3,787
Nonrecurring charge for acquisition of Technology ....... -- -- -- -- 80
-------- -------- -------- -------- --------
Total operating expenses ....................... 13,149 11,457 7,790 6,483 4,609
-------- -------- -------- -------- --------

Income from operations ...................................... 1,825 1,820 2,671 982 1,394
Other income (expense), net ................................. 556 511 607 699 58
-------- -------- -------- -------- --------
Income before provision for income taxes .................... 2,381 2,331 3,278 1,681 1,452

Provision for income taxes .................................. (763) (583) (1,180) (676) (452)
-------- -------- -------- -------- --------
Net income .................................................. $ 1,618 $ 1,748 $ 2,098 $ 1,005 $ 1,000
======== ======== ======== ======== ========

Net income per common share (1) ............................. $ 0.25 $ 0.27 $ 0.33 $ 0.18 $ 0.78
======== ======== ======== ======== ========
Shares used in per common share calculation(1) .............. 6,503 6,480 6,406 5,725 1,276
======== ======== ======== ======== ========

Diluted net income per common share(1) ...................... $ 0.24 $ 0.26 $ 0.31 $ 0.16 $ 0.23
======== ======== ======== ======== ========
Shares used in diluted income per common share calculation(1) 6,849 6,765 6,755 6,410 4,354
======== ======== ======== ======== ========
</TABLE>

<TABLE>
<CAPTION>
January 1, January 2, December 31,
2000 1999 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and available-for-sale securities $13,148 $10,876 $13,488 $15,114 $ 1,227
Working capital ........................................ 23,842 23,450 21,716 20,777 4,339
Total assets ........................................... 32,665 28,377 26,686 23,707 6,395
Total stockholders' equity ............................. 27,504 25,885 23,880 21,478 4,685
</TABLE>

- ----------
(1) See Note 10 of Notes to Consolidated Financial Statements for an
explanation of shares used in per share calculations.

18
<PAGE> 21

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations 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. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the factors set forth under "Factors
That May Affect Future Results" and other risks detailed from time to time in
our reports filed with the Securities and Exchange Commission.

OVERVIEW

IRIDEX Corporation is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. Our products are sold in the United States
predominantly through a direct sales force and internationally through 58
independent distributors into 74 countries. We market our products using three
brand names: IRIS Medical to the ophthalmology market, IRIDERM to the
dermatology market and Light Solutions to the research market.

Our ophthalmology products treat eye diseases, including the three
leading causes of irreversible blindness. The current family of ophthalmology
laser systems includes the IRIS Medical OcuLight SL, OcuLight SLx, OcuLight GL
and OcuLight GLx Laser Photocoagulation systems (each an "OcuLight System"). Our
dermatology products treat skin diseases, primarily vascular and pigmented
lesions. In June 1997, we launched the IRIDERM DioLite 532 Laser System to
address the dermatology market. The DioLite 532 Laser System is sold primarily
for office-based use by dermatologists. Each ophthalmic and dermatology system
consists of a small, portable laser console and interchangeable delivery
devices. We believe that our semiconductor-based systems are more portable and
economical and have a greater degree of reliability and flexibility than
competing systems which use traditional vacuum tube-based technology. Since our
first shipment in 1990, more than 3,200 IRIDEX medical laser systems have been
sold worldwide, primarily for hospital and office-based use by ophthalmologists
and dermatologists.

Our revenues arise primarily from the sale of our IRIS Medical OcuLight
Systems, IRIDERM DioLite 532 consoles, delivery devices, disposables and, to a
lesser extent, revenues from service and support activities, and the sale of
research products and grants. Revenue from product sales is generally recognized
at the time of shipment (net of allowances or discounts), while revenue from
services is recognized upon performance of the applicable services. Our sales
have increased primarily due to growth in unit sales (including additional unit
sales resulting from the introduction of the DioLite 532 in June 1997 and
OcuLight GLx in January 1999), greater market penetration and an expanded
product offering. We believe that future growth in unit sales will be derived
both from a growth in the market for photocoagulator products and from the
replacement of installed photocoagulators which use vacuum tube-based
technology.

Our sales in the United States are derived from direct sales to end
users and internationally are derived from sales to 58 distributors who resell
to hospitals and physicians. Sales to international distributors are made on
open credit terms or letters of credit. Although sales of our products
internationally currently are denominated in United States dollars,
international sales are subject to a variety of risks including shipping delays,
generally longer receivable collection periods, changes in applicable regulatory
policies, international monetary conditions, domestic and foreign tax policies,
trade restrictions, duties and tariffs and economic and political instability.
The 1997 and 1998 currency devaluation in many Asian countries had the effect of
significantly increasing the purchase price of our products to our distributors
and customers in that region. Product sales were lower for the affected Asian
region during 1999 and 1998 as a result. We expect sales to the Asian region to
continue to be less than the levels prior to the Asian economic crisis during
2000. While these currency factors and other factors listed above have been
mitigated by product sales in other international regions and in the United
States, future currency fluctuations or other factors discussed above may have a
material adverse effect on our business, financial condition or results of
operation. See "--Factors That May Affect Future Results--We Depend on
International Sales."

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<PAGE> 22
Cost of sales consists primarily of the cost of purchasing components
and sub-systems, assembling, packaging and testing components at our facility,
and the direct labor and associated overhead. Research and development expenses
consist primarily of personnel costs, materials and research support provided to
clinicians at medical institutions developing new applications which utilize our
products. Research and development costs have been expensed as incurred. Sales,
general and administrative expenses consist primarily of costs of personnel,
sales commissions, travel expenses, advertising and promotional expenses,
facilities, legal and accounting, insurance and other expenses which are not
allocated to other departments.

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Sales ..................................... 100.0% 100.0% 100.0%
Cost of sales ............................. 44.0 43.7 42.1
----- ----- -----
Gross profit ......................... 56.0 56.3 57.9
----- ----- -----
Operating expenses:
Research and development ............. 14.7 13.1 9.5
Sales, general and administrative .... 34.5 35.5 33.6
----- ----- -----
Total operating expenses ............. 49.2 48.6 43.1
----- ----- -----
Income from operations .................... 6.8 7.7 14.8
Other income, net ......................... 2.0 2.2 3.3
----- ----- -----
Income before provision for income taxes .. 8.8 9.9 18.1
Provision for income taxes ................ (2.8) (2.5) (6.5)
----- ----- -----
Net income ................................ 6.0% 7.4% 11.6%
===== ===== =====
</TABLE>

Sales. Sales were $26.8 million in 1999, $23.6 million in 1998 and
$18.1 million in 1997. These sales represented increases of 13.5% from 1998 to
1999 and 30.5% from 1997 to 1998. The increase in our sales in 1999 as compared
to 1998 was due to increased unit volumes, primarily as a result of introduction
of the OcuLight GLx, and increased sales of the OcuLight SLx and DioLite, offset
in part by decreased average selling prices, particularly with respect to our
more mature products. The increase in our sales in 1998 as compared to 1997 was
primarily attributable to increased sales of the OcuLight GL and DioLite, offset
in part by decreased average selling prices. International sales accounted for
38.6% of total sales in 1999, 36.6% in 1998 and 51.8% in 1997. International
sales as a percentage of total sales increased in 1999 from 1998 levels. The
increase is primarily due to a partial recovery of sales from the economically
weakened Asian region. We have been impacted by lower sales from the Asian
region during the second half of 1997, 1998, and partially in 1999.
International sales as a percentage of revenues decreased in 1998 from 1997
levels. The decrease is primarily due to lower sales from the Asian region. The
decrease was partially offset by increased sales into European countries. We
expect international sales as a percentage of revenues for 2000 to be
substantially equivalent to the 1999 rate. We expect future growth in sales to
be primarily derived from sales of the OcuLight SLx, and the APEX 800 hair
removal laser for dermatology, which we expect to introduce in the first half of
2000.

Sales into the research segment were $0.5, $1.3 and $1.1 million for
1999, 1998 and 1997, respectively. Research sales decreased in 1999 due to
redirecting development and marketing resources from the research segment to the
medical segment. International sales into the research segment were 33.0%, 21.4%
and 14.0% for 1999, 1998 and 1997, respectively. Sales other than research

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<PAGE> 23
segment sales are medical segment sales, which includes ophthalmology and
dermatology sales.

Gross Profit. Gross profit was $15.0 million in 1999, $13.3 million in
1998 and $10.5 million in 1997. Gross profit represented 56.0% of sales in 1999,
56.3% in 1998 and 57.9% in 1997. Gross profit as a percentage of sales decreased
in 1999 as compared to 1998 due primarily to lower average selling prices on
most international product sales and first year sales of the OcuLight GLx, a
lower margin product. Such gross profit margin decreases were offset in part by
increased sales of the higher margin OcuLight SLx product. Gross profit as a
percentage of sales decreased in 1998 as compared to 1997 due primarily to
proportionately higher overhead production costs resulting from our move to a
larger facility in September 1997, increased unit volume of lower gross margin
products and lower average selling prices. Such gross profit margin decreases
were offset in part by a decrease in international sales, which have lower gross
profit margins, and an increase in the sales of the DioLite, which have higher
gross profit margins. Moreover, increasing competition has continued to result
in a downward trend in average selling prices and has led to lower gross profit
margins. We intend to continue our efforts to reduce the cost of components and
thereby mitigate the impact of price reductions on our gross profit. We believe
gross profit in dollars will increase as volumes increase and unit production
costs will decrease as costs are engineered out of new products. However, gross
margins as a percentage of sales will continue to fluctuate due to changes in
the relative proportions of domestic and international sales, the mix of product
sales, costs associated with future product introductions and a variety of other
factors.

Research and Development. Research and development expenses increased by
26.7% in 1999 to $3.9 million and by 80.6% in 1998 to $3.1 million. These
expenses were 14.7% of sales in 1999, 13.1% of sales in 1998 and 9.5% of sales
in 1997. The increase in 1999 was primarily due to increased clinical study
costs, such as our many Age-related Macular Degeneration (AMD) studies,
personnel and prototype expenses related to the development of the new Apex 800
hair removal dermatology system and first year sustaining engineering costs for
the OcuLight GLx. The increase in 1998 was primarily due to increased personnel
and prototype expenses related to the OcuLight GLx and Slit Lamp Adapters with
UltraView optics and unreleased products and a decrease in the volume of
research work conducted under grants from the U.S. Federal Government as
described below. In addition, a portion of the increase was attributable to
development expenses for the Apex 800. We expect these expenses for research and
development to continue to increase in absolute dollars during 2000 in
connection with clinical studies and new product development activities.
Occasionally we also conduct research and development pursuant to grants from
the U.S. Federal Government. Under the terms of these grants, we typically
retain the right to commercially market the technology developed by us. The
amounts we receive for these research and development efforts are recognized as
sales, and the related labor and material costs are charged to cost of sales. As
a result, our reported research and development expense does not entirely
reflect our research and development efforts.

Sales, General and Administrative. Sales, general and administrative
expenses grew by 10.4% in 1999 to $9.2 million and by 37.6% in 1998 to $8.4
million. These expenses were 34.5% of sales in 1999, 35.5% of sales in 1998 and
33.6% of sales in 1997. The increases in sales, general and administrative
expenses in these periods were primarily due to the hiring of additional sales
and marketing employees to address new sales opportunities and to support
expanding unit volumes, higher sales commissions and the growth in the
infrastructure of our finance and administrative group which were necessary to
support our expanded operations. Costs associated with communicating clinical
results during 1999 and the January 1999 launch of the OcuLight GLx, which
affected 1999 and 1998, also increased sales and marketing expenses during these
periods.

21
<PAGE> 24

Other income, net. Other income, net consists primarily of interest
income. Interest income was $469,000, $483,000 and $623,000 in 1999, 1998 and
1997, respectively. This income was primarily from interest earned on
available-for-sale securities. Interest income decreased in 1999 and 1998
compared to 1997 because of increased investments in lower yield, tax preferred
securities and overall lower cash balances in connection with internal
investments in the enterprise resource planning ("ERP") system and in leasehold
improvements associated with our new facility.

Income Taxes. We had an effective tax rate of 32%, 25% and 36% in 1999,
1998 and 1997, respectively. The tax rate for 1999, 1998 and 1997 was lower than
the Federal and State combined statutory rate of 40% because of certain tax
benefits associated with tax-exempt interest on tax preferred securities and
with tax credits for research and experimental activities.

LIQUIDITY AND CAPITAL RESOURCES

At January 1, 2000, our primary sources of liquidity included cash, cash
equivalents and available-for-sale securities of $13.1 million. In addition, we
have available $2.0 million under our unsecured line of credit which bears
interest at the bank's prime rate and expires in September 2000. As of January
1, 2000, no borrowings were outstanding under this credit facility. We believe
that, based on current estimates, our current cash, available-for-sale
securities and the credit facility will be sufficient to meet our working
capital and capital expenditure requirements at least through the next twelve
months. However, we believe that the level of financial resources is a
significant competitive factor in our industry, and accordingly we may choose to
raise additional capital through debt or equity financing prior to the end of
2000.

Net cash generated from operations totaled $2,862,000 in 1999. Net cash
used in operations totaled $1,976,000 and $88,000 in 1998 and 1997,
respectively. In 1999, sources of cash included net income of $1.6 million,
depreciation of $721,000, increases in accrued expenses of $2.4 million and
increases in accounts payable of $249,000, partially offset by uses of cash with
increases of deferred income taxes of $846,000, increases in inventories, net,
of $752,000 and increases in accounts receivable of $623,000. In 1998, sources
of cash included net income of $1.7 million and increases in accounts payable of
$127,000, offset by uses of cash with increases in inventories of $2.5 million,
increases in accounts receivable of $1.6 million and decreases of accrued
expenses of $438,000.

We generated $982,000 from investing activities in 1999. We used
approximately $2.4 million and $4.4 million from investing activities in 1998
and 1997, respectively. The generation or use was primarily from the sale or
purchase of available-for-sale securities and the acquisition of fixed assets.

Net cash provided by financing activities during 1999, 1998 and 1997 was
$10,000, $245,000 and $299,000, respectively, which consisted primarily of
issuance of stock, offset in part by purchase of treasury stock of $315,000 in
1999.

In December 1998, we instituted a stock repurchase program whereby up to
150,000 shares of our Common Stock may be repurchased in the open market. We
plan to utilize all of the reacquired shares for reissuance in connection with
employee stock programs. In 1999 we purchased 76,000 shares of our Common Stock
from the open market.

22
<PAGE> 25

YEAR 2000 ISSUES

The Year 2000 computer problem refers to the potential for system and
processing failures of date-related data as a result of computer controlled
systems using two digits rather than four digits to define the applicable year.
Prior to January 1, 2000, there was a great deal of concern regarding the
ability of computers to adequately recognize 21st century dates from 20th
century dates due to the two-digit fields used by many systems. Most reports to
date, however, are that the computer systems are functioning normally and the
compliance and remediation work accomplished leading up to 2000 was effective to
prevent any problems. Computer experts have warned that there may still be
residual consequences of the change in centuries. If not corrected, these
residual problems could result in miscalculations, data corruption, system
failures or disruptions in operations during or beyond the year 2000. Any such
difficulties could result in a decrease in sales of our products, an increase in
allocation of resources to address Year 2000 problems of our customers without
additional revenue commensurate with such dedication of resources, or an
increase in litigation costs relating to losses suffered by our customers due to
such Year 2000 problems.

Because our products are used in connection with components and systems
designed and manufactured by others, residual Year 2000 problems affecting these
components and systems could cause our products to fail. If residual Year 2000
problems cause the failure of any of the technology, software or systems used
with our products, we could lose customers, suffer disruptions in our business,
lose revenues and incur substantial liabilities and expenses. We could also
become involved in costly litigation resulting from residual Year 2000 problems.
Any of these occurances could materially harm our business, financial condition
or results of operations.

To date, we have not experienced any Year 2000 issues with any of our
internal systems or our products, or with any of our key third party suppliers,
vendors, customers or service providers. The costs associated with remediating
our internal systems have not been material to date.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The accounting and disclosures prescribed by SAB 101 will be
effective for the fiscal year ended December 31, 2000. The Company is currently
evaluating the impact of SAB 101 on its financial statements and related
disclosures and does not expect any material impact from its application.

In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, or SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
SFAS 133 will be effective for fiscal quarters beginning after June 15, 2000.
The Company is currently evaluating the impact of the requirements of SFAS 133
and the effects if any on its financial statements and does not expect any
material impact from its application. The Company does not currently hold
derivative instruments or engage in hedging activities.

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<PAGE> 26

FACTORS THAT MAY AFFECT FUTURE RESULTS

We Rely on Continued Market Acceptance of Our Products. We currently
market visible and infrared light semiconductor-based photocoagulator medical
laser systems to the ophthalmic market. We also market a visible light
semiconductor-based photocoagulator medical laser system to the dermatology
market. We believe that continued and increased sales, if any, of these medical
laser systems is dependent upon the following factors:

- Product performance, procedures and price;

- Opinions of medical advisors and associates;

- Recommendations by ophthalmologists, dermatologists, clinicians,
and their associated opinion leaders;

- Performance of these laser systems and treatments which are a
beneficial alternative to competing technologies and treatments;

- The willingness of ophthalmologists and dermatologists to
convert to semiconductor-based or infrared laser systems from
visible argon gas or ion-based or other laser systems;

- The level of reimbursement for treatments administered with our
products; and

- Our ability to introduce new products into these markets.

Any significant decline in market acceptance of our products would have a
material adverse effect on our business, results of operations and financial
condition.

Our Market is Competitive. Competition in the market for devices used
for ophthalmic and dermatologic treatments is intense and is expected to
increase. This market is also characterized by rapid technological innovation
and change and our products could be rendered obsolete as a result of future
innovations. 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
Coherent, Inc., Nidek, Inc. ("Nidek"), Carl Zeiss, Inc. ("Zeiss"), Alcon
International, Keeler Instruments, Inc. ("Keeler") and HGM Medical Laser
Systems, Inc. ("HGM") and our principal competitors in dermatology are
Laserscope and HGM. The Apex 800 Laser Hair Removal System will compete with
products from Coherent, Inc., Candela Corporation, ESC Medical Systems, Ltd. and
Cynosure, Inc. Some competitors have substantially greater financial,
engineering, product development, manufacturing, marketing and technical
resources than we do. In addition to other companies that manufacture
photocoagulators, we compete with pharmaceutical solutions, other technologies
and other surgical techniques. Some 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.

We Face Risks of Manufacturing. The manufacture of our infrared and
visible light photocoagulators and the related delivery devices is a highly
complex and precise process. Although our OcuLight Systems and our DioLite 532
have been successfully introduced, we continue to face risks associated with
manufacturing these products. Various difficulties may occur despite testing.
Furthermore, we depend on third parties to manufacture substantially all of the
components used in our products and have in the past experienced delays in
manufacturing when a sole source supplier was unable to deliver components in
volume and on a timely basis. Such a problem may recur. See "--We Depend on Key

24
<PAGE> 27
Manufacturers and Suppliers." As a result of these factors, we may not be able
to continue to manufacture our existing products or future products on a
cost-effective and timely basis.

We Depend on Key Manufacturers and Suppliers. We rely on third parties
to manufacture substantially all of the components used in our products,
although we assemble critical subassemblies and the final product at our
facility in Mountain View, California. There are risks associated with the use
of independent manufacturers, including unavailability of or delays in obtaining
adequate supplies of optics and laser diodes. We have qualified two or more
sources for most of the components used in our products. In the past, we
experienced delays in manufacturing the OcuLight GL due to the inability of a
supplier to deliver components in volume and on a timely basis. We have
qualified a second source for this diode component. The process of qualifying
suppliers is ongoing and may be lengthy, particularly as new products are
introduced. We do not have long-term or volume purchase agreements with any of
our suppliers and currently purchase components on a purchase order basis. These
components may not be available in the quantities required, on reasonable terms,
or at all. Establishing our own capabilities to manufacture these components
would be expensive and could significantly decrease our profit margins. Our
business, results of operations and financial condition would be adversely
affected if we are unable to continue to obtain components as required at a
reasonable cost.

We Depend on International Sales. We derive and expect to continue to
derive a large portion of our revenue from international sales. In 1999, 1998
and 1997, our international sales were $10.3 million, $8.6 million and $9.4
million, or 38.6%, 36.6%, and 51.8%, respectively, of total sales. Therefore, a
large portion of our revenues will continue to be subject to the risks
associated with international sales. Economic difficulties in Asia and the
devaluation of the currencies of many Asian countries in the past couple of
years has significantly increased the purchase price of our products to our
distributors in that region. Product sales were lower for the affected Asian
region during the fourth quarter of 1997, 1998 and partially in 1999 as a result
of the economic downturn and currency problem. We expect partially lower sales
or a modest increase in sales from this Asian region to continue into 2000. Each
of the factors stated above could have a material adverse effect on our ability
to deliver products on a competitive and timely basis.

Our Operating Results Fluctuate from Quarter to Quarter. Although we
have been profitable on an annual and quarterly basis for the last seven years,
our sales and operating results have varied substantially on a quarterly basis
and may continue to do so 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:

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

- The cost and availability of components and subassemblies;

- Changes in our pricing and our competitors;

- Our long and highly variable sales cycle;

- Changes in customers' or potential customers' budgets; and

- Increased product development costs.

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<PAGE> 28

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. 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. As a result of the above factors, sales for any future quarter are
not predictable with any significant degree of accuracy and operating results in
any period should not be considered indicative of the results to be expected for
any future period. There can be no assurance that we will remain profitable in
the future or that operating results will not vary significantly.

We Depend on Development of New Products and New Applications. Our
future success is dependent upon, among other factors, our ability to develop,
obtain regulatory approval, manufacture and market new products. 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. These variables include price, safety, efficacy,
reliability, marketing and sales efforts, the development of new applications
for these products and general economic conditions affecting purchasing
patterns. Any failure in our ability to successfully develop and introduce new
products or enhanced versions of existing products could have a material adverse
effect on our business, operating results and financial condition. We are
seeking to expand the market for our existing and new products by working with
clinicians and third parties to identify new applications and procedures for our
products. Failure to develop and achieve market acceptance of new applications
or new products would have a material adverse effect on our business, results of
operations and financial condition.

We Must Manage Growth. We have experienced, and may continue to
experience growth in production, the number of employees, the scope of our
business, our operating and financial systems and the geographic area of our
operations. This growth has resulted in new and increased responsibilities for
management personnel and our operating, inventory and financial systems. To
effectively manage future growth, if any, we have been required to continue to
implement and improve operational, financial and management information systems,
procedures and controls. We have implemented a new enterprise-wide management
information system. We must also expand, train, motivate and manage our work
force. Our personnel, systems, procedures and controls may not be adequate to
support our existing and future operations. Any failure to implement and improve
our operational, financial and management systems or to expand, train, motivate
or manage employees could have a material adverse effect on our business,
results of operations and financial condition.

We Depend on Collaborative Relationships. We have entered into
collaborative relationships with academic medical centers and physicians in
connection with the research and development and clinical testing of our
products. We plan to collaborate with third parties to develop and commercialize
existing and new products. In May 1996, we executed an agreement with Miravant,
formerly known as PDT, Inc., a maker of photodynamic drugs to collaborate on a
device that emits a laser beam to activate a photodynamic drug developed by
Miravant for the treatment of wet AMD. This collaborative development effort may
not continue or it may not result in the successful development and introduction
of a photodynamic system and the amount and timing of resources to be devoted to
these activities are not within our control. Additionally, 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. The failure of any current or future collaboration
efforts

26
<PAGE> 29

We Rely on Patents and Proprietary Rights. 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 eight United States patents on the
technologies related to our products and processes. Our patent applications may
not issue as patents, any patents now or in the future may not offer any degree
of protection, or our patents or patent applications may be challenged,
invalidated or circumvented in the future. 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. Because patent applications are
maintained in secrecy in the United States until patents are issued and are
maintained in secrecy for a period of time outside the United States, we have
not conducted any searches to determine whether our technology infringes any
patents or patent applications. 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. This may adversely impact
our operating results.

Any claims, with or without merit, could 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. Although patent and intellectual property
disputes in the medical device area have often been settled through licensing or
similar arrangements, costs associated with such arrangements may be substantial
and could include ongoing royalties. An adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses 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.
Conversely, litigation may be necessary to enforce patents issued to us, to
protect trade secrets or know-how owned by us or to determine the
enforceability, scope and validity of the proprietary rights of others. Both the
defense and prosecution of intellectual property suits or interference
proceedings are costly and time consuming.

We Are Subject To Government Regulation. The medical devices that we
market and manufacture are subject to extensive regulation by the FDA and by
foreign and state governments. Under the FDA Act and 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. Before a new device can be introduced into

27
<PAGE> 30
the market, the manufacturer must obtain market clearance through either the
510(k) premarket notification process or the lengthier premarket approval
("PMA") application process. Obtaining these approvals can take a long time and
delay the introduction of a product. For example, the introduction of the
OcuLight GL in the United States was delayed about three months from our
expectations due to the longer than expected time period required to obtain FDA
premarket clearance. Noncompliance with applicable requirements, including
Quality System Regulations ("QSRs"), can result in, among other things, fines,
injunctions, civil penalties, recall or seizure of products, total or partial
suspension of production, failure of the government to grant premarket clearance
or premarket approval for devices, 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.
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.

International regulatory bodies often establish 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" registered, an international symbol affixed to all
products demonstrating compliance to the European Medical Device Directive and
all applicable standards. In July 1998 we received CE registration under Annex
II guidelines, the most stringent path to CE registration. With Annex II CE
registration, IRIDEX Corporation has demonstrated its ability to both understand
and comply with all applicable European standards. This allows us to register
any product upon our internal verification of compliance to all applicable
European Standards. Currently all released IRIS Medical and IRIDERM products are
CE registered. Continued registration is based on successful review of the
process by our European Registrar during their annual audit. Any loss of
registration would have a material adverse effect on our business, results of
operations and financial condition.

We Face Product Liability Risks. We may be subject to product liability
claims in the future. Our products are highly complex and are used to treat
extremely delicate eye tissue and skin conditions on and near a patient's face.
In addition, although we recommend that our disposable products only be used
once and so prominently label these disposables, we believe that certain
customers may nevertheless reuse these disposable products. Accordingly, the
manufacture and sale of medical products entails significant risk of product
liability claims. Although we maintain product liability insurance with coverage
limits of $11.0 million per occurrence and an annual aggregate maximum of $12.0
million, our coverage from our insurance policies may not be adequate. Such
insurance is expensive and in the future may not be available on acceptable
terms, 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. To date, we have not experienced any
product liability claims which would result in payments in excess of our policy
limits.

Our Stock Price is Volatile. The trading price of our Common Stock has
been subject to wide fluctuations in response to a variety of factors since our
initial public offering in February 1996. Volatility in price and volume has had
a substantial effect on the market prices of many technology companies for
reasons unrelated or disproportionate to the operating performance of such
companies. These broad market fluctuations could have a significant impact on
the market price of our Common Stock.

Residual Year 2000 issues may disrupt our operations, subject us to
liabilities and costs and affect the timing of our revenues. Prior to January 1,
2000, there was a great deal of concern regarding the ability of computers to
adequately recognize 21st century dates from 20th century dates due to the
two-digit fields used by many systems. Most reports to date, however, are that
the computer systems are functioning normally and the compliance and remediation
work accomplished leading up to 2000 was effective to prevent any problems.
Computer experts have warned that there may still be residual consequences of
the change in the related regulations, the FDA regulates the design,
development, clinical testing, manufacture, labeling, sale, distribution and
promotion of medical devices.

28
<PAGE> 31

centuries. If not corrected, these residual problems could result in
miscalculations, data corruption, system failures or disruptions in operations
during or beyond the year 2000. Any such difficulties could result in a decrease
in sales of our products, an increase in allocation of resources to address Year
2000 problems of our customers without additional revenue commensurate with such
dedication of resources, or an increase in litigation costs relating to losses
suffered by our customers due to such Year 2000 problems.

Because our products are used in connection with components and systems
designed and manufactured by others, residual Year 2000 problems affecting these
components and systems could cause our products to fail. If residual Year 2000
problems cause the failure of any of the technology, software or systems used
with our products, we could lose customers, suffer disruptions in our business,
lose revenues and incur substantial liabilities and expenses. We could also
become involved in costly litigation resulting from Year 2000 problems. Any of
these occurrences could materially harm our business, financial condition or
results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio and generally conduct all transactions
in U.S. dollars. Our investment portfolio only includes highly liquid
instruments with an original maturity of less than one year. We have no
long-term debt obligations at January 1, 2000.

We are subject to fluctuating interest rates that may impact, adversely
or otherwise, our results of operations or cash flows for our available-for-sale
securities and cash and cash equivalents.

The table below presents principal amounts and related weighted average
interest rates as of January 1, 2000 (in thousands) for our investment portfolio
and cash and cash equivalents. All amounts mature in fiscal year 2000.

<TABLE>
<S> <C>
Assets
Cash and cash equivalents....................... $ 9,645
Average interest rate........................... 4.32%

Available-for-sale securities................... $ 3,503
Average interest rate........................... 4.68%
</TABLE>

The estimated fair value of our cash and cash equivalents approximates
the principal amounts reflected above based on the short maturities of these
financial instruments.

Although payments under the operating lease for our facility are tied to
market indices, we are not exposed to material interest rate risk associated
with the operating lease.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our consolidated balance sheets as of January 1, 2000 and January 2,
1999 and the consolidated statements of income, comprehensive income,
stockholders' equity and cash flows for each of the three years in the period
ended January 1, 2000, together with the related notes and the report of
PricewaterhouseCoopers LLP, independent accountants, are on the following pages.
Additional required financial information is described in Item 14.

29
<PAGE> 32

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of IRIDEX Corporation:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, of shareholders' equity, of
cashflows, and of comprehensive income present fairly, in all material respects,
the financial position of Iridex Corporation and its subsidiaries (the
"Company") at January 1, 2000 and January 2, 1999 and the results of their
operations and their cash flows for each of the three years in the period ended
January 1, 2000 in conformity with accounting principles generally accepted in
the United States. In addition, in our opinion, the financial statement schedule
in the index appearing under Item 14(a)(2) on page 49 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

San Jose, California
January 26, 2000

30
<PAGE> 33

IRIDEX CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
JANUARY 1, JANUARY 2,
2000 1999
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 9,645 $ 5,791
Available-for-sale securities ................................ 3,503 5,085
Accounts receivable, net of allowance for doubtful accounts of
$396 in 1999 and $327 in 1998 ................................ 8,162 7,608
Inventories .................................................. 7,256 6,504
Prepaids and other current assets ............................ 437 347
Deferred income taxes ........................................ 0 607
-------- --------
Total current assets .................................... 29,003 25,942
Property and equipment, net ..................................... 2,144 2,274
Intangible assets ............................................... 0 96
Deferred income taxes ........................................... 1,518 65
-------- --------
Total assets ............................................ $ 32,665 $ 28,377
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................. $ 1,128 $ 879
Accrued expenses ............................................. 4,033 1,613
-------- --------
Total liabilities ....................................... 5,161 2,492
-------- --------

Commitments and Contingencies (Note 5).

Stockholders' Equity
Convertible Preferred Stock, $.01 par value:
Authorized: 2,000,000 shares;
Issued and outstanding: none ........................... -- --
Common Stock, $.01 par value:
Authorized: 30,000,000 shares;
Issued and outstanding: 6,540,358 shares in 1999 and
6,506,010 shares in 1998 ................................ 66 65
Additional paid-in capital ................................... 22,124 21,800
Accumulated other comprehensive income (loss) ................ (2) 7
Retained earnings ............................................ 5,316 4,013
-------- --------
Total stockholders' equity .............................. 27,504 25,885
-------- --------
Total liabilities and stockholders'equity ........ $ 32,665 $ 28,377
======== ========
</TABLE>

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

31
<PAGE> 34

IRIDEX CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
-------- -------- --------
<S> <C> <C> <C>
Sales ............................................ $ 26,762 $ 23,585 $ 18,073
Cost of sales .................................... 11,788 10,308 7,612
-------- -------- --------
Gross profit ................................ 14,974 13,277 10,461
-------- -------- --------

Operating expenses:
Research and development ......................... 3,925 3,099 1,716
Sales, general and administrative ................ 9,224 8,358 6,074
-------- -------- --------
Total operating expenses ....................... 13,149 11,457 7,790
-------- -------- --------
Income from continuing operations .............. 1,825 1,820 2,671
Interest income ..................................... 469 483 623
Other income (expense), net ......................... 87 28 (16)
-------- -------- --------
Income before provision for income taxes ....... 2,381 2,331 3,278
Provision for income taxes .......................... (763) (583) (1,180)
-------- -------- --------
Net income .......................................... $ 1,618 $ 1,748 $ 2,098
======== ======== ========

Net income per common share ......................... $ 0.25 $ 0.27 $ 0.33
======== ======== ========
Shares used in income per common share calculation .. 6,503 6,480 6,406
======== ======== ========

Diluted net income per common share ................. $ 0.24 $ 0.26 $ 0.31
======== ======== ========
Shares used in diluted income per common share
calculation ................................. 6,849 6,765 6,755
======== ======== ========
</TABLE>

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

32
<PAGE> 35

IRIDEX CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Stock Paid-in Comprehensive Retained
Shares Amount Capital Income (Loss) Earnings Total
------ ------ ------- ------------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1996............ 6,350,180 $63 $21,248 $ $167 $21,478
Issuance of Common Stock
under Stock Option Plan......... 65,896 1 59 60
Issuance of Common Stock
under Employee Stock
Purchase Plan................... 39,407 1 245 246
Unrealized losses on available-
for-sale securities............ (2) (2)
Net Income............................. 2,098 2,098
-------- ------ ------ ------ ----- -------
Balances, December 31, 1997............ 6,455,483 65 21,552 (2) 2,265 23,880
Issuance of Common Stock
under Stock Option Plan......... 9,086 38 38
Issuance of Common Stock
under Employee Stock
Purchase Plan................... 41,441 204 204
Tax benefit of employee stock
transactions.................... 6 6
Change in unrealized gains on
available-for-sale
securities...................... 9 9
Net income............................. 1,748 1,748
-------- ------ ------ ----- ----- -----
Balances, January 2, 1999.............. 6,506,010 65 21,800 7 4,013 25,885
Issuance of Common Stock
under Stock Option Plan........ 51,544 107 107
Issuance of Common Stock
under Employee Stock
Purchase Plan................... 58,804 1 217 218
Purchase of Treasury Stock............. (76,000) (315) (315)
Change in unrealized gains on
available-for-sale
securities...................... (9) (9)
Net income............................. 1,618 1,618
-------- ------ ------- ----- ----- -----
Balances, January 1, 2000.............. 6,540,358 $66 $22,124 $(2) $5,316 $27,504
========= === ======= ==== ====== =======
</TABLE>

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

33
<PAGE> 36

IRIDEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ............................................................ $ 1,618 $ 1,748 $ 2,098
Adjustments to reconcile net income to net cash provided by ( used in)
operating activities:
Depreciation and amortization .................................. 721 653 357
Provision for doubtful accounts ................................ 69 22 65
Provision for inventory ........................................ 192 184 (2)
Amortization of intangible asset ............................... 96 -- --
Changes in operating assets and liabilities:
Accounts receivable ......................................... (623) (1,573) (732)
Inventories ................................................. (944) (2,712) (2,115)
Prepaids and other current assets ........................... (90) 104 (329)
Deferred income taxes ....................................... (846) (91) (14)
Accounts payable ............................................ 249 127 217
Accrued expenses ............................................ 2,420 (438) 367
-------- -------- --------
Net cash provided by (used in) operating activities ......... 2,862 (1,976) (88)
-------- -------- --------
Cash flows from investing activities:
Purchases of available-for-sale securities ............................ (3,511) (7,675) (6,364)
Proceeds from sale and maturity of available-for-sale securities ...... 5,084 6,187 3,783
Acquisition of property and equipment ................................. (591) (794) (1,837)
Acquisition of intangible assets ...................................... -- (96) --
-------- -------- --------
Net cash provided by (used in) investing activities ......... 982 (2,378) (4,418)
-------- -------- --------
Cash flows from financing activities:
Payments of capital lease obligations .......................... -- (3) (7)
Purchase of Treasury Stock ..................................... (315) -- --
Issuance of Common Stock under stock option plans .............. 325 248 306
-------- -------- --------
Net cash provided by financing activities ................... 10 245 299
-------- -------- --------
Net (decrease) increase in cash and cash equivalents ..... 3,854 (4,109) (4,207)
Cash and cash equivalents, beginning of year ............................... 5,791 9,900 14,107
-------- -------- --------

Cash and cash equivalents, end of year ..................................... $ 9,645 $ 5,791 $ 9,900
======== ======== ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Income taxes ...................................................... 360 575 671
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Change in unrealized gains (losses) on available-for-sale securities .. $ (9) $ 9 $ (2)
</TABLE>

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

34
<PAGE> 37

IRIDEX CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31
2000 1999 1997
------- ------- -------
<S> <C> <C> <C>
Net Income .............................. $ 1,618 $ 1,748 $ 2,098
Other Comprehensive income:
Changes in unrealized gain (loss) on
Available for sale securities . (9) 9 (2)
------- ------- -------
Comprehensive income .................... $ 1,609 $ 1,757 $ 2,096
======= ======= =======
</TABLE>

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

35
<PAGE> 38

IRIDEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS OF THE COMPANY

Description of Business

IRIDEX Corporation is the leading worldwide provider of
semiconductor-based laser systems used to treat eye diseases in ophthalmology
and skin lesions in dermatology. We market our products using three brand names:
IRIS Medical to the ophthalmology market, IRIDERM to the dermatology market, and
Light Solutions to the research market. The terms "Company," "IRIDEX," "we,"
"us" and "our" refer to IRIDEX Corporation, a Delaware corporation, and, when
the context so requires, our wholly-owned subsidiaries, IRIS Medical
Instruments, Inc. and Light Solutions Corporation, both California corporations
and IRIDEX Foreign Sales Corporation, a Barbados corporation, and our
dermatology division IRIDERM.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Statement Presentation

The consolidated financial statements include our accounts and our
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.

Cash and Cash Equivalents

We consider all highly liquid investments with original maturities of 90
days or less at the time of purchase to be cash equivalents.

Available-for-Sale Securities

All marketable securities as of January 1, 2000 are considered to be
available-for-sale and therefore are carried at fair value. Available-for-sale
securities are classified as current assets when they have scheduled maturities
of less than one year. Available-for-sale securities are classified as non
current assets when they have scheduled maturities of more than one year.
Unrealized holding gains and losses on such securities are reported net of
related taxes as a separate component of stockholders' equity until realized.
Realized gains and losses on sales of all such securities are reported in
interest and other income and are computed using the specific identification
cost method.

Intangible Assets

Intangible assets include patents that are being amortized on a
straight-line basis over seven years. We periodically assess the recoverability
of intangible assets by determining whether amortization of the asset balance
over the remaining life can be recovered through undiscounted future operating
cash flows of the acquired operation. The amount of impairment, if any, is
measured based on projected discounted future operating cash flows and is
recognized as a write down of the asset to net realizable value.

Inventories

Inventories are stated at the lower of cost or market. 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.

36
<PAGE> 39

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally three years.
Amortization of leasehold improvements and property and equipment acquired under
capital lease obligations is computed using the straight-line method over the
shorter of the remaining lease term or the estimated useful life of the related
assets, typically three years.

Revenue Recognition

We recognize product sales when product is shipped to the customer, when
acceptance terms, if any, are fulfilled and when contractual obligations are
completed. We accrue for warranty costs and sales returns at the time of
shipment based on our experience.

Research and Development

Research and development expenditures are charged to operations as
incurred.

Advertising

We expense advertising costs as they are incurred. Advertising expenses
for 1999, 1998 and 1997 were $359,000, $317,000 and $170,000, respectively.

Fair Value of Financial Instruments

Carrying amounts of our financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities
approximate fair values due to their short maturities. Estimated fair values for
available-for-sale securities, which are separately disclosed elsewhere, are
based on quoted market prices for the same or similar instruments.

Income Taxes

Income taxes are accounted for under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under SFAS No. 109,
deferred assets and liabilities are recognized for the future consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Valuation allowances are established when necessary to
reduce deferred tax assets to the amounts expected to be realized.

Concentration of Credit Risk and Other Risks and Uncertainties

Our cash and cash equivalents are deposited in demand and money market
accounts of three financial institutions. Deposits held with banks may exceed
the amount of insurance provided on such deposits. Generally these deposits may
be redeemed upon demand and therefore, bear minimal risk.

We market our products to distributors and end-users throughout the
world. Sales to international distributors are generally made on open credit
terms and letter of credit. Management performs ongoing credit evaluations of
our customers and maintains an allowance for potential credit losses.
Historically, we have not experienced any significant losses related to
individual customers or group of customers in any particular geographic area.

37
<PAGE> 40
As of January 1, 2000, no customer accounted for greater than 10% of accounts
receivable.

Our products require approvals from the Food and Drug Administration and
international regulatory agencies prior to commercialized sales. Our future
products may not receive required approvals. If we were denied such approvals or
if such approvals were delayed, it would have a materially adverse impact on our
business, results of operations and financial condition.

Use of Estimates

Management makes estimates and assumptions to prepare the financial
statements in conformity with generally accepted accounting principles. These
estimates and assumptions affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Fiscal Year

On June 8, 1998, the Board of Directors approved a resolution to adjust
our fiscal year end from December 31 to the 52 or 53-week period that ends the
Saturday nearest December 31, effective for fiscal year 1998, a 52-week year.
Fiscal year 1999 was a 52-week year.

Computation of Net Income Per Common Share and Per Diluted Common Share

Net income per common share is computed using the weighted average
number of shares of common stock outstanding. Diluted net income per common
share is computed using the weighted average number of dilutive shares of common
stock and common equivalent shares from stock options.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, or SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
SFAS 133 will be effective for fiscal quarter beginning after June 15, 2000. The
Company is currently evaluating the impact of the requirements of SFAS 133 and
the effects if any on its financial statements and does not expect any material
impact from its application. The Company does not currently hold derivative
instruments or engage in hedging activities.

38
<PAGE> 41

3. BALANCE SHEET DETAIL

Available-for-sale securities (in thousands):

<TABLE>
<CAPTION>
AMORTIZED UNREALIZED ESTIMATED MATURITY
COST GAINS (LOSSES) FAIR VALUE DATES
--------- -------------- ---------- -----
<S> <C> <C> <C> <C>
As of January 1, 2000, available-for-sale
securities consisted of the following:

Corporate notes ......................... $ 2,550 $ -- $ 2,550 1/00 - 5/00
Government agencies ..................... 955 (2) 953 5/00
------- ------- ------- -----------
$ 3,505 $ (2) $ 3,503

As of January 2, 1999, available-for-sale
securities consisted of the following:

Obligations of state and local
government agencies..... $ 5,078 $ 7 $ 5,085 2/99 - 6/99
</TABLE>

There were no realized capital gains or losses recognized in 1999, 1998 and
1997.

<TABLE>
<CAPTION>
JANUARY 1, JANUARY 2,
2000 1999
------- -------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Raw materials and work in process ................. $ 3,839 $ 3,877
Finished goods .................................... 3,417 2,627
------- -------
Total inventories .............................. $ 7,256 $ 6,504
======= =======

Property and Equipment:
Equipment ......................................... $ 2,667 $ 2,157
Leasehold improvements ............................ 1,739 1,700
Less: accumulated depreciation and amortization ... (2,262) (1,583)
------- -------
Property and equipment, net ....................... $ 2,144 $ 2,274
======= =======

Accrued Expenses:
Accrued payroll, vacation and related expenses .... $ 1,102 $ 655
Distributor commissions ........................... -- 37
Accrued warranty .................................. 536 200
Income taxes payable .............................. 1,621 14
Other accrued expenses ............................ 774 707
------- -------
Total accrued expenses ............................ $ 4,033 $ 1,613
======= =======
</TABLE>

4. BANK BORROWINGS

We have a revolving line of credit agreement with a bank expiring on
October 1, 2000, which provides for borrowings of up to $2.0 million at the
bank's prime rate (8.25% at January 1, 2000). The agreement contains restrictive
covenants including prohibiting payment of dividends without the bank's prior
consent. There were no borrowings against the credit line at January 1, 2000.

39
<PAGE> 42

5. COMMITMENTS AND CONTINGENCIES

Lease Agreements

We lease our operating facilities under a noncancelable operating lease.
The lease expires in 2002 and contains a renewal option. Rent expense, net of
sublease income, totaled $282,000, $331,000 and $224,000 for the years ended
January 1, 2000, January 2, 1999 and December 31, 1997, respectively. Rental
income related to a facility sublease was $183,000, $182,000 and $48,000 for the
years ended January 1, 2000, January 2, 1999 and December 31, 1997,
respectively.

Future minimum lease payments and receivables under current operating
leases at January 1, 2000 are summarized as follows (in thousands):

<TABLE>
<CAPTION>
Fiscal Year Operating Lease Payments Sublease Receivables Net Operating Lease Payments
----------- ------------------------ -------------------- ----------------------------
<S> <C> <C> <C>
2000 541 262 279
2001 554 11 543
2002 93 -- 93
------ ---- ----
$1,188 $273 $915
</TABLE>

License Agreements

The Company is obligated to pay royalties equivalent to 4% and 5% of
sales on certain products under certain license agreements. Royalty expense was
$42,000, $125,000 and $58,900 for the years ended January 1, 2000, January 2,
1999 and December 31, 1997, respectively.

Contingencies

From time to time, the Company may be engaged in certain administrative
and legal proceedings, incidental to its normal business activities. Management
believes that liabilities resulting from such proceedings, or claims which are
pending or known to be threatened, are adequately covered by liability
insurance and will not have a material adverse effect on the Company's
financial position or results of operations.

6. STOCKHOLDERS' EQUITY

CONVERTIBLE PREFERRED STOCK

During 1996, we amended our Articles of Incorporation to authorize
2,000,000 shares of undesignated preferred stock. Preferred Stock may be issued
from time to time in one or more series. As of January 1, 2000, we had no
preferred stock issued and outstanding.

TREASURY STOCK

In December 1998, we instituted a stock repurchase program whereby up to
150,000 shares of our Common Stock may be repurchased in the open market. We
plan to utilize all of the reacquired shares for reissuance in connection with
employee stock programs. We repurchased 76,000 shares of Common Stock for
$315,000 in 1999.

40
<PAGE> 43

STOCK OPTION PLANS

Amended and Restated 1989 Incentive Stock Plan

The Amended and Restated 1989 Plan (the "1989 Plan") provided for the
grant of options and stock purchase rights to purchase shares of our Common
Stock to employees and consultants. The terms of the 1989 Plan, which expired in
August 1999, are substantially the same as the 1998 Plan described below.

1998 Stock Plan

The 1998 Stock Plan (the "1998 Plan") provides for the granting to
employees (including officers and employee directors) of incentive stock options
and for the granting to employees (including officers and employee directors)
and consultants of nonstatutory stock options and stock purchase rights
("SPRs"). The exercise price of incentive stock options and SPRs granted under
the 1998 Plan must be at least equal to the fair market value of the shares at
the time of grant. With respect to any recipient who owns stock possessing more
than 10% of the voting power of our outstanding capital stock, the exercise
price of any option or SPR granted must be at least equal to 110% of the fair
market value at the time of grant. Options granted under the 1998 Plan are
exercisable at such times and under such conditions as determined by the
Administrator; generally over a four year period. The maximum term of incentive
stock options granted to any recipient must not exceed ten years; provided,
however, that the maximum term of an incentive stock option granted to any
recipient possessing more than 10% of the voting power of our outstanding
capital stock must not exceed five years. In the case of SPRs, unless the
Administrator determines otherwise, we have a repurchase option exercisable upon
the voluntary or involuntary termination of the purchaser's employment with us
for any reason (including death or disability). Such repurchase option lapses at
a rate determined by the Administrator. The purchase price for shares
repurchased by us is the original price paid by the purchaser. The form of
consideration for exercising an option or stock purchase right, including the
method of payment, is determined by the Administrator. The 1998 Plan expires in
June 2008.

1995 Director Option Plan

In October 1995, we adopted the 1995 Director Option Plan (the "Director
Plan"), under which members of the Board of Directors are granted options to
purchase 11,250 shares upon the first to occur of their appointment or the
adoption of the Director Plan ("First Option") and an option to purchase 3,750
shares ("Subsequent Option") on July 1 of each year thereafter provided that he
or she has served on the Board for at least the preceding six months. The
options granted are at fair market value on the date of grant. The First Option
becomes exercisable as to one-twelfth (1/12) of the shares subject to the First
Option for each quarter over a three-year period. Each Subsequent Option becomes
exercisable as to one-fourth (1/4) of the shares subject to the Subsequent
Option for each quarter, commencing one quarter after the First Option and any
previously granted Subsequent Options have become fully exercisable. Options
granted under the Director Plan have a term of 10 years.

In the event of our merger with or into another corporation, resulting
in a change of control, or the sale of substantially all of our assets, each
Director Plan option becomes exercisable in full and shall be exercisable for 30
days after written notice to the holder of the event causing the change in
control.

Unless terminated sooner, the Director Plan will terminate in 2005. The
Board has authority to amend or terminate the Director Plan, provided no such
amendment may impair the rights of any optionee without the optionee's consent.

41
<PAGE> 44

1995 Employee Stock Purchase Plan

Our 1995 Employee Stock Purchase Plan (the "Purchase Plan") was adopted
by the Board of Directors in October 1995. On April 28, 1997, the shareholders
approved an amendment to increase the total number of shares of common stock for
issuance under the Purchase Plan from 50,000 to 100,000. The Purchase Plan
permits eligible employees (including officers and employee directors) to
purchase Common Stock through payroll deductions, which may not exceed 10% of an
employee's compensation. No employee may purchase more than $25,000 worth of
stock in any calendar year or more than 1,000 shares of Common Stock in any
twelve-month period. The price of shares purchased under the Purchase Plan is
85% of the lower of the fair market value of the Common Stock at the beginning
of the offering period or the end of the offering period. The Purchase Plan will
terminate in 2005, unless terminated sooner by the Board of Directors.

Information with respect to activity under these option plans are set
forth below (in thousands except share and per share data):

<TABLE>
<CAPTION>
OUTSTANDING
SHARES OPTIONS
AVAILABLE NUMBER AGGREGATE WEIGHTED AVG
FOR GRANT OF SHARES PRICE EXERCISE PRICE
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balances, December 31, 1996 ......... 137,998 633,244 $ 2,206 $ 3.48
Additional shares reserved ........ 500,000 -- -- --
Options granted at market price ... (437,775) 437,775 2,922 6.68
Options exercised ................. -- (65,896) (60) .91
Options terminated ................ 43,336 (43,336) (208) 4.80
--------- ---------- ----------

Balances, December 31, 1997 ......... 243,559 961,787 4,860 5.05
Additional shares reserved ........ 310,000 -- -- --
Options granted at market price ... (936,889) 936,889 4,628 4.94
Options exercised ................. (9,101) (38) 4.18
Options terminated ................ 572,074 (572,074) (4,031) 7.05
--------- ---------- ----------

Balances, January 2, 1999 ........... 188,744 1,317,501 5,419 4.11
Additional shares reserved ........ 150,000 -- -- --
Options granted at market price ... (218,394) 218,394 1,128 5.16
Options exercised ................. (47,568) (107) 1.89
Options expired ................... (11,819)
Options terminated ................ 81,134 (81,134) (364) 4.45
--------- ---------- ----------
Balances, January 1, 2000 ....... 189,665 1,407,193 $ 6,076 $ 4.33
========= ========== ==========
</TABLE>

In December 1998, we offered non-executive officer employees the right
to cancel certain outstanding Stock Options and receive new options with an
exercise price of $4.00 per share, the closing price of the common stock on the
date individual employees agreed to cancel their original outstanding stock
options. Options to purchase a total of 548,000 shares at original exercise
prices ranging from $5.00 to $14.75 per share were canceled and new options were
issued in December 1998. Under the terms of this offer, new options were subject
to new vesting terms from the date of issuance.

42
<PAGE> 45

The following table summarizes information with respect to stock options
outstanding at January 1, 2000:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF EXERCISE OUTSTANDING CONTRACTUAL LIFE EXERCISE EXERCISABLE EXERCISE
PRICES AT 1/1/00 (YEARS) PRICE AT 1/1/00 PRICE
- ------ --------- ------- ----- --------- -----
<S> <C> <C> <C> <C> <C>
$ 0.16 - $ 0.16 38,578 1.16 0.16 38,578 0.16
$ 1.00 - $ 1.00 172,280 4.68 1.00 172,280 1.00
$ 2.00 - $ 2.00 78,750 5.79 2.00 78,750 2.00
$ 3.93 - $ 5.75 898,285 8.01 4.28 247,487 4.48
$ 6.25 - $ 9.25 204,300 7.59 8.38 81,774 8.13
$14.88 - $14.88 15,000 6.49 14.88 7,500 14.88
-------- --------
$0.16 - $14.88 1,407,193 7.21 4.33 624,025 3.53
========= ========
</TABLE>

At January 2, 1999 and December 31, 1997, options to purchase 1,317,501
and 961,787 shares of Common Stock were exercisable at weighted average exercise
prices of $2.43 and $2.49, respectively.

The following information concerning our stock option and employee stock
purchase plans is provided in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation." We account for such plans in accordance with
Accounting Principles Board No. 25 and related Interpretations.

The fair value of each option grant has been estimated on the date of
grant using the Black-Scholes multiple option pricing model with the following
weighted average assumptions:

<TABLE>
<CAPTION>
1999 1998 1997
GROUP A GROUP B GROUP A GROUP B GROUP A GROUP B
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Risk-free Interest Rates. .... 5.58% 5.34% 4.82% 4.79% 5.84%-6.72% 5.69%-6.72%
Expected Life from Date of
Vesting....................... 3 yrs. 2 yrs. 3 yrs. 2 yrs. 3 yrs. 2 yrs.
Volatility.................... 0.78 0.78 0.78 0.78 0.62 0.62
Dividend Yield................ -- -- -- -- -- --
</TABLE>

The weighted average expected life was calculated based on the exercise
behavior of each group. Group A represents officers and directors who are a
smaller group holding a greater average number of options than other option
holders and who tend to exercise later in the vesting period. Group B are all
other option holders, virtually all of whom are employees. This group tends to
exercise earlier in the vesting period.

The weighted average fair value per share of those options granted in
1999, 1998 and 1997 was $3.37, $3.12 and $3.85, respectively.

We have also estimated the fair value for the purchase rights issued
under our 1995 Employee Stock Purchase Plan, under the Black-Scholes valuation
model using the following assumptions for 1999, 1998 and 1997:

<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Risk-free Interest Rates .... 4.91% 5.61% 5.09%
Expected Life ............... 0.5 year 0.5 year 0.5 year
Volatility .................. 0.78 0.78 0.62
Dividend Yield .............. -- -- --
</TABLE>

The weighted average fair value per share of those purchase rights
granted in 1999, 1998 and 1997 was $1.55, $3.33 and $2.27, respectively.

<PAGE> 46

The following proforma income information has been prepared following the
provisions of SFAS No. 123:

<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
(amounts in thousands except per share data)
<S> <C> <C> <C>
Net income -- as reported ............................ $ 1,618 $ 1,748 $ 2,098
Net income -- proforma ............................... $ 768 $ 815 $ 1,564

Net income per common share -- as reported ........... $ 0.25 $ 0.27 $ 0.33
Net income per common share -- proforma .............. $ 0.12 $ 0.13 $ 0.24

Diluted net income per common share -- as reported ... $ 0.24 $ 0.26 $ 0.31
Diluted net income per common share -- proforma ...... $ 0.11 $ 0.12 $ 0.23
</TABLE>

7. EMPLOYEE BENEFIT PLAN

We have a plan known as the IRIS Medical Instruments 401(k) trust to
provide retirement benefits through the deferred salary deductions for
substantially all employees. Employees may contribute up to 15% of their annual
compensation to the plan, limited to a maximum amount set by the Internal
Revenue Service. The plan also provides for Company contributions at the
discretion of the Board of Directors. No Company contributions have been made to
the plan since inception. On February 29, 2000 the Compensation Committee
approved a company match for the 401(k) in the amount of 50% of employee
contributions up to an annual maximum of $1,000 per year. The match will become
effective April 1, 2000.

8. INCOME TAXES

The provision for income taxes includes:

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal .................. $ 1,323 $ 425 $ 1,010
State .................... 286 67 234
Deferred:
Federal .................. (613) 105 (95)
State .................... (233) (14) 31
------- ------- -------
Income tax provision ... $ 763 $ 583 $ 1,180
======= ======= =======
</TABLE>

The Company's effective tax rate differs from the statutory federal
income tax rate as shown in the following schedule:

44
<PAGE> 47

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
----------- ----------- ------------
<S> <C> <C> <C>
Income tax provision at statutory rate ....... 34% 34% 34%
State income taxes, net of federal benefit ... 6% 3% 6%
Tax Exempt Interest .......................... (3%) (5%) (2%)
Research and experimental credits ............ (10%) (5%) (2%)
Other ........................................ 5% (2%) --
--- --- ---
Effective tax rate ........................... 32% 25% 36%
=== === ===
</TABLE>

The tax effect of temporary differences and carry-forwards that give
rise to significant portions of the deferred tax assets are presented below (in
thousands):

<TABLE>
<CAPTION>
JANUARY 1, JANUARY 2,
2000 1999
---------- ----------
<S> <C> <C>
Fixed assets and intangible ..................... $ 464 $ 67
Accrued liabilities ............................. 436 255
Allowance for excess and obsolete inventories ... 147 70
Research credit ................................. 116 --
State tax ....................................... 47 12
Allowance for doubtful accounts ................. 194 115
Other ........................................... 114 153
------ ------
Net deferred tax asset .......................... $1,518 $ 672
====== ======
</TABLE>

9. MAJOR CUSTOMERS AND BUSINESS SEGMENTS

We operate in two reportable segments: the laser medical device segment
and the laser research segment. In the laser medical device segment, we develop,
manufacture and market medical devices for the ophthalmology and dermatology
markets. Our revenues arise from the sale of consoles, delivery devices,
disposables and service and support activities. In the laser research segment we
conduct research and development under research grants from the U.S. Federal
Government and others. Under the terms of these grants we typically retain the
right to commercially market the technology developed.

In the years ended January 1, 2000, January 2, 1999 and December 31,
1997, no customer individually accounted for more than 10% of our revenue.

Revenue information shown in thousands by geographic region is as
follows:

<TABLE>
<CAPTION>
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
---------- ---------- ------------
<S> <C> <C> <C>
United States .. $16,443 $14,958 $ 8,709
Europe ......... 4,673 4,503 3,690
Rest of Americas 1,689 1,552 1,706
Asia/Pacific Rim 3,957 2,572 3,968
------- ------- -------
$26,762 $23,585 $18,073
======= ======= =======
</TABLE>

Revenues are attributed to countries based on location of customers.

45
<PAGE> 48

In the years ended January 1, 2000, January 2, 1999 and December 31,
1997, no country individually accounted for more than 10% of our sales, except
for the United States, which accounted for 61.4% of sales in 1999, 63.4% in 1998
and 48.1% in 1997.

Information on reportable segments for the three years ended January 1,
2000, January 2, 1999 and December 31, 1997 is as follows:

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, 2000 JANUARY 2, 1999 DECEMBER 31, 1997
--------------------- --------------------- ---------------------
Laser Laser Laser
Medical Laser Medical Laser Medical Laser
Devices Research Devices Research Devices Research
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Sales ............................ $26,302 $ 460 $22,280 $ 1,305 $16,970 $ 1,103

Depreciation ..................... 705 16 627 26 347 10

Interest and other expense ....... 14 -- 17 -- 35 --

Income before provision
for income taxes .............. 2,146 235 1,504 827 2,503 775
</TABLE>

Income before provision for income taxes of the laser research segment
does not include indirect costs of manufacturing, research and development and
selling, general and administrative costs. Such costs are not allocated and
therefore are included in the Laser Medical Device segment.

46
<PAGE> 49

10. COMPUTATION OF NET INCOME PER COMMON SHARE AND PER DILUTED COMMON
SHARE

A reconciliation of the numerator and denominator of net income per
common share and diluted net income per common share is provided as follows (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 1, JANUARY 2, DECEMBER 31,
2000 1999 1997
----------- ---------- ------------
<S> <C> <C> <C>
Numerator -- Net income per common share and per diluted common
share
Net income .............................................. $1,618 $1,748 $2,098
====== ====== ======
Denominator -- Net income per common share
Weighted average common stock outstanding .................. 6,503 6,480 6,406
====== ====== ======
Net income per common share ................................... $ 0.25 $ 0.27 $ 0.33
====== ====== ======
Denominator - Diluted net income per common share
Weighted average common stock outstanding .................. 6,503 6,480 6,406
Effect of dilutive securities
Weighted average common stock options ...................... 346 285 349
------ ------ ------
Total weighted average stock and options outstanding .......... 6,849 6,765 6,755
====== ====== ======
Diluted net income per common share ........................ $ 0.24 $ 0.26 $ 0.31
====== ====== ======
</TABLE>

During 1999, 1998 and 1997, there were 431,077, 300,500, and 64,037 outstanding
options to purchase shares, respectively, at a weighted average exercise price
of $5.28, $7.69, and $9.49 per share, respectively. These shares were not
included in the computations of diluted net income per common share because the
exercise price of the common shares exceeded, the market price of the related
options.

11. SELECTED QUARTERLY FINANCIAL DATA, (UNAUDITED)

<TABLE>
<CAPTION>
INTERIM FINANCIAL INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------------------------------------------
QUARTER
---------------------------------------------
FIRST SECOND THIRD FOURTH
------ ------ ------ ------
<S> <C> <C> <C> <C>
Year Ended January 1, 2000
Sales ............................. $5,697 $6,463 $6,295 $8,307
Gross Profit ...................... $3,081 $3,552 $3,524 $4,817
Net Income ........................ $ 185 $ 325 $ 325 $ 783
Net income per common share ....... $ 0.03 $ 0.05 $ 0.05 $ 0.12
Diluted net income per common share $ 0.03 $ 0.05 $ 0.05 $ 0.11
Year Ended January 2, 1999
Sales ............................. $5,872 $6,002 $5,200 $6,511
Gross profit ...................... $3,382 $3,515 $2,550 $3,830
Net income ........................ $ 655 $ 525 $ 43 $ 525
Net income per common share ....... $ 0.10 $ 0.08 $ 0.01 $ 0.08
Diluted net income per common share $ 0.10 $ 0.08 $ 0.01 $ 0.08
</TABLE>

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

47
<PAGE> 50

PART III

Certain information required by Part III has been omitted from this Form
10-K. This information is instead incorporated by reference to our definitive
proxy statement (the "Proxy Statement"), which we will file within 120 days
after the end of our fiscal year pursuant to Regulation 14A in time for our
Annual Meeting of Stockholders to be held June 7, 2000.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding our directors is incorporated by reference to
"Election of Directors--Nominees" in our Proxy Statement for the Company's 2000
Annual Meeting of Stockholders. The information concerning our current executive
officers is found under the caption "Executive Officers of the Registrant" in
Part I hereof is also incorporated by reference into this Item 10.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference to
"Executive Compensation" in our Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated by reference to
"Security Ownership of Certain Beneficial Owners and Management" in our Proxy
Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

48
<PAGE> 51

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
PAGE IN
FORM 10-K
REPORT
------
<S> <C> <C>
(a) The following documents are filed in Part II of this Annual Report
on Form 10-K:

1. FINANCIAL STATEMENTS
Report of Independent Accountants .......................................... 30
Consolidated Balance Sheets as of January 1, 2000 and
January 2, 1999 ....................................................... 31
Consolidated Statements of Income for the years ended
January 1, 2000, January 2, 1999 and December 31, 1997 ................... 32
Consolidated Statements of Stockholders' Equity for the years
ended January 1, 2000, January 2, 1999 and December 31, 1997 ............. 33
Consolidated Statements of Cash Flows for the years ended
January 1, 2000, January 2, 1999 and December 31, 1997 ................ 34
Consolidated Statements of Comprehensive Income for the years
ended January 1, 2000, January 2, 1999 and December 31, 1997 .......... 35
Notes to Consolidated Financial Statements ................................. 36
2. FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule is included in Item 14(d):
Schedule II - Valuation and Qualifying Accounts .................... 52
</TABLE>

Other schedules have been omitted because they are either not required,
not applicable, or the required information is included in the consolidated
financial statements or notes thereto.

3. EXHIBITS

Refer to (c) below.

(b) REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the fourth quarter of 1999.

49
<PAGE> 52

<TABLE>
<CAPTION>
Exhibits Exhibit Title
-------- -------------
<S> <C>
3.1(1) Amended and Restated Certificate of Incorporation of Registrant
3.2(3) Amended and Restated Bylaws of Registrant.
10.1(1) Form of Indemnification Agreement with directors and officers.
10.2(1) Amended and Restated 1989 Incentive Stock Plan and form of agreement
thereunder.
10.3(1) 1995 Employee Stock Purchase Plan, as amended and form of agreement
thereunder.
10.4(1) 1995 Director Option Plan and form of agreement thereunder.
10.5(1) 1995 Profit Sharing Plan
10.6(1) Third Restated Registration Rights Agreement dated
as of October 27, 1995 by and among Registrant and
certain individuals and entities named therein.
10.7(1) Lease Agreement dated December 6, 1996 by and between Zappettini
Investment Co. and the Registrant.
10.8(1) Business Loan Agreement dated October 4, 1995
between Mid-Peninsula Bank and the Registrant.
10.9(4) 1998 Stock Option Plan, as amended
10.10(2)* Development and Distribution Agreement dated as of May 28, 1996
between Miravant, Inc. (formerly PDT, Inc.) and the Company.
22.1(1) Subsidiaries of Registrant.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (See page 51).
27.1 Financial Data Schedule.
</TABLE>
- -------------------

* Confidential treatment has been granted with respect to certain portions
of this exhibit.

(1) Incorporated by reference to the like-numbered exhibits filed with the
Registration Statement on Form SB-2 (No. 333-00320-LA) which was
declared effective on February 15, 1996.

(2) Incorporated by reference to the Exhibits in Registrant's Report on Form
10-Q for the quarter ended June 30, 1996.

(3) Incorporated by reference to the Exhibits in Registrant's Report on Form
10-Q for the quarter ended October 3, 1998.

(4) Incorporated by reference to the Exhibits in Registrant's Proxy
Statement for the Company's 1998 Annual Meeting of Stockholders which
was filed April 30, 1998.

TRADEMARK ACKNOWLEDGMENTS

IRIDEX, the IRIDEX logo, IRIS Medical, OcuLight, SmartKey, and EndoProbe
are our registered trademarks. IRIDERM, G-Probe, DioPexy, DioVet, TruFocus,
TrueCW, UltraView and DioLite 532 product names are our trademarks. All other
trademarks or trade names appearing in the Form 10-K are the property of their
respective owners.

50
<PAGE> 53

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Mountain
View, State of California, on the 30th day of March, 2000.

IRIDEX CORPORATION

By: /s/ Theodore A. Boutacoff
---------------------------------
Theodore A. Boutacoff
President, Chief Executive
Officer, and Director

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Theodore A. Boutacoff and Robert
Kamenski, jointly and severally, their attorney-in-fact, each with full power of
substitution, for him in any and all capacities, to sign on behalf of the
undersigned any amendments to this Report on Form 10-K, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, and each of the undersigned does hereby
ratifying and confirming all that each of said attorneys-in-fact, of his
substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following persons in the capacities and on the dates
indicated.

<TABLE>
<S> <C> <C>
/s/ Theodore A. Boutacoff President, Chief Executive Officer, and March 30, 2000
- ---------------------------------- Director (Principal Executive Officer)
(Theodore A. Boutacoff)

/s/ Robert Kamenski Chief Financial Officer and Vice March 30, 2000
- ---------------------------------- President, Administration (Principal
(Robert Kamenski) Financial and Accounting Officer)

/s/ James L. Donovan Vice President, Corporate Business March 30, 2000
- ---------------------------------- Development and Director
(James L. Donovan)

/s/ Robert K. Anderson Director March 30, 2000
- ----------------------------------
(Robert K. Anderson)

/s/ William Boeger, III Director March 30, 2000
- ----------------------------------
(William Boeger, III)

/s/ Milton Chang Director March 30, 2000
- ----------------------------------
(Milton Chang)

/s/ Donald L. Hammond Director March 30, 2000
- ----------------------------------
(Donald L. Hammond)

/s/ Joshua Makower Director March 30, 2000
- ----------------------------------
(Joshua Makower)

/s/ John M. Nehra Chairman of the Board March 30, 2000
- ----------------------------------
(John M. Nehra)
</TABLE>

51
<PAGE> 54

SCHEDULE II

IRIDEX CORPORATION AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING OF COSTS AND AT END OF
DESCRIPTION THE PERIOD EXPENSES DEDUCTIONS THE PERIOD
----------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance for the year ended
December 31, 1997:
Allowance for doubtful accounts
receivable $ 265 $ 55 $ (15) $ 305
Provision for inventory $ --- $ --- $ --- $ ---
Balance for the year ended
January 2, 1999:
Allowance for doubtful accounts
receivable $ 305 $ 113 $ (91) $ 327
Provision for inventory $ --- $ 437 $ (253) $ 182
Balance for the year ended
January 1, 2000:
Allowance for doubtful accounts
receivable $ 327 $ 128 $ (59) $ 396
Provision for inventory $ 182 $ 197 $ (5) $ 374
</TABLE>

<PAGE> 55

<TABLE>
<CAPTION>
Exhibits Exhibit Title
- -------- -------------
<S> <C>
3.1(1) Amended and Restated Certificate of Incorporation of Registrant
3.2(3) Amended and Restated Bylaws of Registrant.
10.1(1) Form of Indemnification Agreement with directors and officers.
10.2(1) Amended and Restated 1989 Incentive Stock Plan and form of agreement
thereunder.
10.3(1) 1995 Employee Stock Purchase Plan, as amended and form of agreement
thereunder.
10.4(1) 1995 Director Option Plan and form of agreement thereunder.
10.5(1) 1995 Profit Sharing Plan
10.6(1) Third Restated Registration Rights Agreement dated
as of October 27, 1995 by and among Registrant and
certain individuals and entities named therein.
10.7(1) Lease Agreement dated December 6, 1996 by and between Zappettini
Investment Co. and the Registrant.
10.8(1) Business Loan Agreement dated October 4, 1995
between Mid-Peninsula Bank and the Registrant.
10.9(4) 1998 Stock Option Plan, as amended
10.10(2)* Development and Distribution Agreement dated as of May 28, 1996
between Miravant, Inc. (formerly PDT, Inc.) and the Company.
22.1(1) Subsidiaries of Registrant.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (See page 51).
27.1 Financial Data Schedule.
</TABLE>
- -------------------

* Confidential treatment has been granted with respect to certain portions
of this exhibit.

(1) Incorporated by reference to the like-numbered exhibits filed with the
Registration Statement on Form SB-2 (No. 333-00320-LA) which was
declared effective on February 15, 1996.

(2) Incorporated by reference to the Exhibits in Registrant's Report on Form
10-Q for the quarter ended June 30, 1996.

(3) Incorporated by reference to the Exhibits in Registrant's Report on Form
10-Q for the quarter ended October 3, 1998.

(4) Incorporated by reference to the Exhibits in Registrant's Proxy
Statement for the Company's 1998 Annual Meeting of Stockholders which
was filed April 30, 1998.

<PAGE> 1
EXHIBIT 23.01

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-86091) of Iridex Corporation of our report dated
January 26, 2000 relating to the financial statements and financial statement
schedule, which appears in this Form 10-K.

PricewaterhouseCoopers LLP
San Jose, California
March 30, 2000

<ARTICLE> 5
<MULTIPLIER> 1

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-01-2000
<PERIOD-START> JAN-03-1999
<PERIOD-END> JAN-01-2000
<CASH> 9,645
<SECURITIES> 3,503
<RECEIVABLES> 8,558
<ALLOWANCES> (396)
<INVENTORY> 7,256
<CURRENT-ASSETS> 29,003
<PP&E> 4,406
<DEPRECIATION> (2,262)
<TOTAL-ASSETS> 32,665
<CURRENT-LIABILITIES> 5,161
<BONDS> 0
0
0
<COMMON> 66
<OTHER-SE> 27,438
<TOTAL-LIABILITY-AND-EQUITY> 32,665
<SALES> 26,762
<TOTAL-REVENUES> 26,762
<CGS> 11,788
<TOTAL-COSTS> 11,788
<OTHER-EXPENSES> 13,149
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,381
<INCOME-TAX> (763)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,618
<EPS-BASIC> 0.25
<EPS-DILUTED> 0.24

</TABLE>