UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

or

Commission file number 0-18053

LASERSCOPE

(Exact name of Registrant as Specified in Its Charter)

3070 ORCHARD DRIVE, SAN JOSE, CALIFORNIA 95134-2011
(Address of Principal Executive Offices)

Registrant’s Telephone Number, Including Area Code: (408) 943-0636

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X]  No [  ]

The number of shares of Registrant’s common stock issued and outstanding as of October 31, 2004 was 21,421,296.

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TABLE OF CONTENTS

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PART I.   FINANCIAL INFORMATION.

Item 1.   Financial Statements.

Laserscope

See Accompanying Notes to Condensed Consolidated Financial Statements

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Laserscope

See Accompanying Notes to Condensed Consolidated Financial Statements

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Laserscope

See Accompanying Notes to Condensed Consolidated Financial Statements

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Laserscope Notes to Unaudited Condensed Consolidated Financial Statements:

1. Basis of presentation

The accompanying unaudited condensed consolidated financial statements include Laserscope (the “Company,” “Laserscope,” “management,” “we,” “us,” “our”) and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated. While the financial information in this report is unaudited, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position and results of operations as of and for the periods indicated have been recorded. We suggest that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2003 included in the Company’s annual report on Form 10-K for the year ended December 31, 2003. The December 31, 2003 balance sheet data has been derived from the audited financial statements at that date. The results of operations for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results expected for the full year or any other interim period.

2. Stock-Based Compensation

The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and its interpretations, and complies with the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company’s stock and the exercise price. SFAS No. 123 defines a “fair value” based method of accounting for an employee stock option or similar equity instrument. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services” (“EITF Issue No. 96-18”). Under SFAS No. 123 and EITF Issue No. 96-18, the fair value of options granted to non-employees is estimated using the Black-Scholes option pricing model and is periodically remeasured as the options vest.

Had compensation cost for stock-based employee compensation arrangements been determined based on the fair value at the date of the awards consistent with the provisions of SFAS No. 123, the impact on the Company’s net income would be as follows (in thousands, except per share data):

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3. Inventories

Inventories were comprised of the following (in thousands):

4. Warranty and Service Contracts

Warranty
We have a direct field service organization that provides service for our products. We generally provide a twelve month warranty on our laser systems. After the warranty period, maintenance and support is provided on a service contract basis or on an individual call basis. Our warranties and premium service contracts provide for a “99.0% Uptime Guarantee” on our laser systems. Under provisions of this guarantee, we extend the term of the related warranty or service contract if specified system uptime levels are not maintained. The number of warranties extended under this program are not material.

     The Company currently provides for the estimated cost to repair or replace products under warranty at the time of sale. The cost estimate is based on warranty costs experienced in the prior 12 months, and the outstanding warranty liability is revalued on a quarterly basis.

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Service Contracts
Deferred service contract revenue is recognized on a pro rata basis over the period of the applicable service contract. Costs are recognized as incurred.

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5. Net income per share

Basic net income per share is computed by dividing net income available to holders of common shares by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by giving effect to all dilutive potential common shares, including options, warrants, and convertible debentures. A reconciliation of the numerator and denominator used in the calculation of historical basic and diluted net income per share follows:

The Company adopted Emerging Issues Task Force Statement No. 03-06 “Participating Securities and the Two Class Method Under FASB Statement No. 128, Earnings Per Share” during the period ended June 30, 2004 and has retroactively adjusted reported earnings per share for the three and nine month periods ended September 30, 2003.

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The following outstanding options and warrants (prior to the application of the treasury stock method) and convertible debentures (on an as-converted basis) were excluded from the computation of diluted net income per common share for the periods ended September 30, 2004 and 2003 because including them would have had an anti-dilutive effect:

6. Comprehensive income

Total comprehensive income during the periods ended September 30, 2004 and 2003 consisted of (in thousands):

7. Contingencies

The Company is at times a party to legal proceedings and claims arising in the ordinary course of its business. While it is not feasible to predict or determine the outcome of the actions brought against the Company, management believes that the ultimate resolution of these claims will not ultimately have a material adverse effect on the Company’s financial position, results of operations, or future cash flows.

8. Indemnifications

In the ordinary course of business, the Company enters into contractual arrangements under which the Company may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of the Company or for losses arising from certain events as defined within the particular contract, which may include, for example, patents, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.

The Company has entered into indemnification agreements with its directors and officers that may require the Company: to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of

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any proceeding against them as to which they could be indemnified; and to make good faith determination whether or not it is practicable for the Company to obtain directors’ and officers’ insurance. The Company currently has directors’ and officers’ insurance.

9. Income Taxes

Provision for income taxes increased $562,000, from $48,000 to $610,000 during the nine months ended September 30, 2004 compared to the corresponding period in 2003. The effective tax rate in the nine month period ended September 30, 2004 was 6% compared to 4.5% in the corresponding period in 2003.

Due to experiencing only a short history of profitability, management believes that there is sufficient uncertainty regarding the realization of deferred tax assets and a full valuation allowance was appropriate at September 30, 2004 and December 31, 2003. Management reviews its assumptions regarding the realization of deferred tax assets on an ongoing basis. Continued profitability and future changes in management’s assumptions may result in a partial or full release of the deferred tax valuation allowance. A release of the valuation allowance would have a favorable impact on the tax provision within the statement of operations. The Company’s reporting of net income would be on a fully-taxed basis following a release of the full valuation allowance.

10. Subsequent event

On October 11, 2004, Laserscope entered into a Net Lease Agreement with Realtec Properties I, L.P. (“Realtec”) for properties totaling approximately 69,000 square feet located at 3052 Orchard Drive and 3070 Orchard Drive, San Jose, California 95134. The lease commences on November 1, 2004 and has an initial term of eight years, with an option for Laserscope to renew for an additional five-year period. The base monthly rent under the lease is approximately $58,347 for the first year of the lease, approximately $59,514 for the second year of the lease, approximately $60,705 for the third year of the lease, approximately $61,919 for the fourth year of the lease, approximately $63,157 for the fifth year of the lease, approximately $64,420 for the sixth year of the lease, approximately $65,709 for the seventh year of the lease and approximately $67,023 for the eighth year of the lease.

Under the terms of the Agreement, the currently existing leases, between Laserscope and Realtec, for properties totaling approximately 41,000 square feet located at 3070 Orchard Drive and 3075 North First Street, San Jose, California terminate without penalty to Laserscope effective November 1, 2004. The base monthly rent for the terminated leases was approximately $139,222.

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

INTRODUCTORY STATEMENT

Some of the statements in this Quarterly Report on Form 10-Q, including but not limited to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this document are forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by any forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. We refer you to the factors described under the heading “Risk Factors” in this Quarterly Report on Form 10-Q as well as to our Annual Report on Form 10-K for the year ended December 31, 2003 under the heading “Risk Factors.” Readers are cautioned not to place undue reliance on forward-looking statements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of those statements. We are under no duty to publicly release any revision to the forward-looking statements after the date of this document.

Overview.

Laserscope is a leading provider of medical laser systems for surgical and aesthetic applications. Founded in 1984, we are a pioneer developer of innovative technologies with over 7,000 lasers installed worldwide in doctors’ offices, out-patient surgical centers and hospitals. Our product portfolio consists of more than 150 products, including KTP/532, Nd:YAG, Er:YAG, and Dye medical laser systems and related energy delivery devices.

Laserscope primarily serves the needs of two medical specialties: urology and aesthetic surgery. The GreenLight™ laser offers a breakthrough treatment for a urological disorder called benign prostatic hyperplasia (“BPH”), an enlargement of the prostate gland experienced by most men after the age of fifty.

For aesthetic applications, we offer a full line of products used to perform a wide variety of treatments including the removal of leg and facial veins, unwanted hair, pseudo-folliculitis and wrinkles. Our newest laser, the Gemini™ laser, was recently Food and Drug Administration cleared for the treatment of acne, permanent hair reduction and wrinkle reduction, and is now cleared for a total of 21 different procedures. This laser system can perform over 90% of all aesthetic laser procedures.

In the United States, we distribute our products to hospitals, outpatient surgical centers and physician offices through our own direct sales force and through the McKesson Corporation Medical Group, (“McKesson”). In December 2000, we signed a five year distribution agreement that grants to McKesson the exclusive distribution rights for our core aesthetic laser products in the United States. McKesson’s Primary Care Division has a sales force of more than 500 representatives throughout the United States who are supported by our own direct sales force.

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In the United Kingdom and France, we distribute our products to hospitals, outpatient surgical centers and physician offices through our own direct sales force. Elsewhere, we sell our products through regional distributor networks throughout Europe, the Middle East, Latin America, Asia and the Pacific Rim. Laserscope is both ISO 13485 and CE certified.

During the first quarter of 2004, the center for Medicare and Medicaid Services announced the assignment of the Company’s Photoselective Vaporization of the Prostate procedure for the treatment of Benign Prostate Hyperplasia, or enlarged prostate, to a New Technology Ambulatory Payment Classification (“APC”) code. The new classification carries with it a payment rate of $3,750.00 per procedure, approximately twice that of the old rate.

Results of Operations.

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes included in Part I — Item 1 of this Quarterly Report and the audited consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following table contains selected income statement information, which serves as the basis of the discussion of the Company’s results of operations for the quarter and nine months ended September 30, 2004 and 2003 (in thousands, except percentages):

(a)

expressed as a percentage of total net revenues.

Revenues from the sales of lasers and instrumentation increased during the three and nine month periods ended September 30, 2004 compared to the same periods in 2003. The increases were due in large part to a higher volume of GreenLight^TM lasers sold. In the three month period ended September 30, 2004 we sold 63 GreenLight units compared to 34 units in the corresponding period in 2003. Through the nine month period of 2004 we recorded revenue from the sale of 170 GreenLight laser units whereas in the first nine months of 2003, we had sold 60 GreenLight lasers. Also, worldwide aesthetic laser and instrumentation revenues increased during the three and nine month periods ended September 30, 2004 compared to the same periods in 2003. The increase is mainly due to continued success of the Mckesson distribution relationship and the introduction of the Gemini™ laser. The Gemini, introduced at the American Academy of Dermatology Annual Meeting, held February 7-10,

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2004, is FDA cleared for the treatment of acne, permanent hair reduction and wrinkle reduction. In total, the Gemini is now cleared for a total of 21 different procedures, and can perform over 90% of all aesthetic laser procedures available in a physician’s office. The Company expects a continued trend of increasing GreenLight and Gemini laser and accessory shipments.

Revenues from the sales of disposable supplies increased 123% and 120% during the three and nine month periods ended September 30, 2004 compared to the corresponding periods in 2003. The increases are driven by higher unit sales of GreenLight fibers. In the nine months ended September 30, 2004 we sold 24,884 GreenLight fibers whereas in the corresponding period of 2003 we sold 7,895 GreenLight fibers. Increased GreenLight fiber sales is a direct result of an increase in our GreenLight laser installed base. The Company expects revenues from the sales of disposable supplies to incrementally increase, including in the fourth quarter of this year, as a result of an April 2004 increase in the Medicare reimbursement rate for the BPH procedure that uses Laserscope’s GreenLight laser and fiber optic delivery device. Also, revenues are expected to increase as the Company ships more GreenLight lasers, which require a single-use fiber optic energy delivery device.

Laserscope’s service revenues increased during the three and nine-month periods ended September 30, 2004 compared to the same periods in 2003. Increased service revenues were primarily experienced in the domestic region as a result of a larger contract installed base. The Company believes that increases in future revenues depend on increases to the installed base of lasers as well as the acceptance of its service contracts by its customers.

Gross margin as a percentage of revenues increased seven percentage points during the three month period and seven percentage points during the nine month periods ended September 30, 2004 relative to the corresponding periods of 2003. The increase in gross margin percentage is due primarily to a change in the laser-type product mix and increased GreenLight fibers sold. Laserscope expects gross margin as a percentage of 2004 revenues to be in the range of 59% - - 61% for the full year.

Research and development expenses are the result of activities related to the development of new laser, instrumentation and disposable products and the modification and enhancement of Laserscope’s existing products. These expenses remained comparable to 2003 expenses, for the three month period in absolute terms, yet decreased 3 points as a percentage of revenues. In the nine month period ended September 30, 2004 compared to the same period in 2003, these expenses increased in absolute terms, yet decreased 2 points as a percentage of revenues. The Company expects the amounts spent in research and developments to increase in the remaining period of 2004, as a variety of development projects are pursued.

Selling, general and administrative expenses increased in absolute terms, but decreased as a percentage of revenue during the three and nine month period ended September 30, 2004. The increase is comprised of higher variable selling expenses resulting from higher revenues, increased costs associated with Sarbanes Oxley compliance and clinical education in the three and nine month periods ended September 30, 2004 relative to the same periods of 2003. We expect amounts spent in selling, general and administrative expenses to increase during the remainder of 2004 as we continue to expand marketing programs related to the Gemini and GreenLight products.

Provision for income taxes increased $562,000, from $48,000 to $610,000 during the nine months ended September 30, 2004 compared to the corresponding period in 2003. The

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effective tax rate in the nine month period ended September 30, 2004 was 6% compared to 4.5% in the corresponding period in 2003.

Due to experiencing only a short history of profitability, management believes that there is sufficient uncertainty regarding the realization of deferred tax assets and a full valuation allowance was appropriate at September 30, 2004 and December 31, 2003. Management reviews its assumptions regarding the realization of deferred tax assets on an ongoing basis. Continued profitability and future changes in management’s assumptions may result in a partial or full release of the deferred tax valuation allowance. A release of the valuation allowance would have a favorable impact on the tax provision within the statement of operations. The Company’s reporting of net income would be on a fully-taxed basis following a release of the full valuation allowance.

Liquidity and Capital Resources.

The following table contains selected balance sheet information that serves as the basis of the discussion of the Company’s liquidity and capital resources at September 30, 2004 and for the nine months then ended (in thousands):

The increase in cash and cash equivalents was primarily due to cash provided by operating and financing activities, partially offset by cash used in investing activities.

During the nine months ended September 30, 2004, cash provided by operating activities totaled $4.9 million. This was the combined result of the following sources: net income- $9.6 million; an increase in accrued compensation- $1.9 million due to an increase in accrued salaries and wages and employee bonuses; an increase in accounts payable- $1.5 million due to higher purchasing volume; an increase in deferred revenue- $1.4 million as a result of higher volume of contract revenue bookings; an increase in other current liabilities- $0.9 million partly due to higher rebates to customers who purchased fibers, travel expenses and audit and tax consulting expenses; depreciation- $0.7 million; an increase in tax payable- $0.4 million due to additional tax provision as a result of higher income; an increase in warranty reserve- $0.3 million; and an increase in inventory reserve- $0.3 million. These sources were offset by: an increase in accounts receivable- $6.4 million due to higher revenue; an increase in inventory- $5.7 million due to an increase in material purchases to meet projected demand.

During the nine months ended September 30, 2004, cash provided by financing activities consisted of the sale of common stock under stock plans — $2.7 million.

During the nine months ended September 30, 2004, cash used in investing activities consisted of capital expenditures of $2.1 million. A significant portion of total capital spending is attributable to in-progress Enterprise Resource Planning (ERP) costs. The Company expects lower accounting system costs for the remainder of the year. Additional increases were in office equipment, test and production equipment, and capitalized laser systems used by Service and Research and Development.

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We have in place an asset based line of credit which provides up to $5.0 million in borrowings off-set against $1.0 million in letter of credit reserve requirements. The line of credit was renewed September 24, 2004 and currently expires September 2006. Credit is extended based on the Company’s eligible accounts receivable and inventory. At September 30, 2004, the Company had approximately $4.0 million in borrowing capacity under the line of credit facility. The Company’s assets collateralize the line of credit which bears an interest rate equivalent to the bank’s prime rate plus 2.0%. The prime rate at September, 2004 was 4.75%. Borrowings against the line of credit are paid down as the Company collects its accounts receivable. Provisions of the bank loan agreement prohibit the payment of dividends on non-preferred stock, or the redemption, retirement, repurchase or other acquisition of Company stock. The agreement further requires the Company to maintain a minimum tangible net worth. As of September 30, 2004, the Company was in compliance with all covenants and had no outstanding borrowings under the line of credit facility.

We anticipate that future changes in cash and working capital will be dependent on a number of factors including:

•		our ability to effectively manage inventory and accounts receivable;
•		our ability to anticipate and adapt to the changes in our industry such as new and alternative medical procedures;
•		our level of profitability;
•		our determination to acquire or invest in products and businesses complementary to ours; and
•		the market price for our common stock as it affects the exercise of stock options and sale of common stock under stock plans.

We have historically financed acquisitions using our existing cash resources. While we believe our existing cash resources, including our bank line of credit, will be sufficient to fund our operating needs for the next twelve months, additional financing may be required for our currently envisioned long-term needs.

There can be no assurance that any additional financing will be available on terms acceptable to us, or at all. In addition, future equity financings could result in dilution to our shareholders, and future debt financings could result in certain financial and operational restrictions.

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Contractual Obligations.

We did not enter into any additional material contractual obligations during the quarter ended September 30, 2004.

The following table discloses aggregate information about our contractual obligations and the periods in which payments are due as of September 30, 2004

The long-term commitments under operating leases shown above includes payments related to our new real estate lease in Santa Clara, California, commencing November 2004 and expiring October 2012. This agreement was entered into during October 2004.

Risk Factors.

Our business, financial condition and results of operations have been, and in the future may be, affected by a variety of factors, including those set forth below and elsewhere in this report.

Limited Working Capital; Potential Need to Raise Additional Capital.

Current and anticipated demand for our products as well as procurement and production affect our need for capital. Changes in these or other factors could have a material impact on capital requirements and may require us to raise additional capital.

History of Losses; Uncertainty of Future Profitability.

There can be no assurance that we can maintain profitability on a quarterly basis or at all.

Government Regulation; Uncertainty of Obtaining Regulatory Approval.

Government regulation in the United States and other countries is a significant factor in the development, manufacturing and marketing of many of our products.

Laserscope and its products are regulated in the United States by the Food and Drug Administration (the “FDA”) under the Federal Food, Drug and Cosmetic Act (the “FDC Act”) and the Radiation Control for Health and Safety Act. The FDC Act provides two basic review procedures for medical devices. Certain products qualify for a Section 510(k) (“510(k)”) procedure under which the manufacturer gives the FDA pre-market notification of the manufacturer’s intention to commence marketing the product. The manufacturer must, among other things, establish that the product to be marketed is “substantially equivalent” to a previously marketed product. In some cases, the manufacturer may be required to include clinical data gathered under an investigational device exemption (“IDE”) granted by the FDA allowing human clinical studies.

There can be no assurance that the FDA will grant marketing clearance for our future products on a timely basis, or at all. Delays in receiving such clearances could have a significant adverse impact on our ability to compete in our industry, as well as our business, financial condition, results of operations, and future cashflows. The FDA may also require post-market testing and surveillance programs to monitor certain products.

If the product does not qualify for the 510(k) procedure, the manufacturer must file a pre-market approval application (“PMA”) based on testing intended to demonstrate that the product is both safe and effective. The PMA requires more extensive clinical testing than the 510(k) procedure and generally involves a significantly longer FDA review process. Approval of a PMA allowing commercial sale of a product requires pre-clinical laboratory and animal tests and human clinical studies conducted under an IDE establishing safety and effectiveness. Generally, because of the amount of information required, the 510(k) procedure takes less time than the PMA procedure.

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To date, all of our products (except for the 600 Series Dye Module) have been marketed through the 510(k) procedure. Future products, however, may require clearance through the PMA procedure. There can be no assurance that such marketing clearances can be obtained on a timely basis, or at all. Delays in receiving such clearances could have a significant adverse impact on our ability to compete in our industry. The FDA may also require post-market testing and surveillance programs to monitor certain products.

Certain other countries require medical device manufacturers to obtain clearances for products prior to marketing the products in those countries. The requirements vary widely from country to country and are subject to change.

We are also required to register with the FDA and state agencies, such as the Food and Drug Branch of the California Department of Health Services (CDHS), as a medical device manufacturer. We are inspected routinely by these agencies to determine our compliance with the FDA’s current “Quality Systems” regulations. Those regulations impose certain procedural and documentation requirements upon medical device manufacturers concerning manufacturing, testing and quality control activities. If these inspections determine violations of applicable regulations, the continued marketing of any products manufactured by us may be adversely affected.

In addition, our laser products are covered by a performance standard for laser products set forth in FDA regulations. The laser performance standard imposes certain specific record-keeping, reporting, product testing, and product labeling requirements on laser manufacturers. These requirements also include affixing warning labels to laser systems, as well as incorporating certain safety features in the design of laser products.

Complying with applicable governmental regulations and obtaining necessary clearances or approvals can be time consuming and expensive. There can be no assurance that regulatory review will not involve delays or other actions adversely affecting the marketing and sale of our products. We also cannot predict the extent or impact of future legislation or regulations.

We are also subject to regulation under federal and state laws regarding, among other things, occupational safety, the use and handling of hazardous materials and protection of the environment. We believe that we are in material compliance with these requirements.

Insurance Reimbursement.

Demand for certain of our products depends on government and private insurance reimbursement of hospitals and physicians for health care costs, including, but not limited to, reimbursement of capital equipment costs. Reductions or delays in such insurance coverage or reimbursement may negatively impact hospitals’ and physicians’ decisions to purchase our products, adversely affecting our future sales, as well as our business, financial condition, results of operations, and future cash flows.

A substantial portion of our laser sales are for aesthetic procedures that are generally not subject to reimbursement by government or private health insurance. The general absence of insurance coverage for these cosmetic procedures may restrict the development of this market.

In November 2003, CMS notified Laserscope that its application for assignment of Photoselective Vaporization of the Prostate (“PVP”) to treat BPH with a new technology APC had been accepted. In March 2004, CMS determined that PVP meets the new technology APC qualification criteria and assigned a new APC code effective April 1, 2004. The new

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classification carries with it a “Facility Fee” national average payment rate of $3,750.00, approximately twice that of the old rate. Over the next several quarters, we will continue to work closely with CMS and the American Urological Association to ensure that the hospital outpatient reimbursement rates for furnishing PVP continue to reflect the appropriate costs of performing the procedure.

In addition to the “Facility Fee” or outpatient hospital reimbursement, the adoption of PVP is also dependent upon the payment, known as the “Fee Schedule” reimbursement, that is paid directly to the physician for performing the procedure. The adoption rate of PVP may also be affected by changes in the Fee Schedule reimbursement. Over the next several quarters, Laserscope will work closely with CMS and the American Urological Association in an attempt to ensure that the reimbursement paid to the physician for performing PVP accurately reflects the work value and appropriate costs of performing the procedure in a site of service of the physician’s choosing.

If CMS were to reduce reimbursement rates or if Laserscope is unsuccessful in obtaining improved Fee Schedule reimbursement for the physicians, it will likely have an adverse effect on the adoption and sales growth of the PVP procedure in the United States as some customers who would normally consider adopting the PVP procedure delay their purchases or adoption in hopes of a favorable change in the reimbursement climate or would select other more profitable treatment solutions for their patients.

Uncertainty of Technological Change; Uncertainty of New Product Development and Acceptance.

We operate in an industry that is subject to rapid technological change. Our ability to remain competitive and future operating results will depend upon, among other things, our ability to anticipate and respond rapidly to such change by developing, manufacturing and marketing technologically innovative products in sufficient quantities at acceptable costs to meet such demand. As we introduce new products this may cause some of our existing products to become obsolete, which may result in the write-off of inventory. However, without new products and enhancements, our existing products will likely become obsolete due to technological advances by other companies, which could result in the write-off of inventory as well as diminished revenues. Therefore, we intend to continue to invest significant amounts in research and development.

We anticipate that our ability to compete will require significant research and development expenditures with a continuing flow of innovative, high-quality products. We cannot assure that we will be successful in designing, manufacturing or selling enhanced or new products in a timely manner. Nor can we assure that a competitor could not introduce a new or enhanced product or technology that could have an adverse effect on our competitive position.

Our current research and development programs are directed toward the development of new laser systems and delivery devices. We cannot assure that these markets will develop as anticipated or that our product development efforts will prove successful. Nor can we assure that such new products, if developed and introduced, will be accepted by the market.

Dependence on Single-Source Suppliers and Certain Third Parties.

Certain of the components used in our laser products, including certain optical components, are purchased from single sources. While we believe that most of these components are available from alternate sources, an interruption of these or other supplies could adversely affect our ability to manufacture lasers.

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Manufacturing.

We manufacture in the United States the laser resonators, system chassis and certain accessories including disposable products and re-usable hand pieces used in our laser systems. Our laser manufacturing operations concentrate on the assembly and test of components and subassemblies manufactured to our designs and specifications by outside vendors. We believe that we have sufficient manufacturing capacity in our present facilities to support current operations at least through the end of 2004.

Competition.

We compete in the non-ophthalmic surgical segment of the worldwide medical laser market. In this market, lasers are used in hospital operating rooms, outpatient surgery centers and individual physician offices for a wide variety of procedures. This market is highly competitive. Our competitors are numerous and include some of the world’s largest organizations as well as smaller, highly specialized firms. Our ability to compete effectively depends on such factors as:

	•		market acceptance of our products;
	•		product performance;
	•		price;
	•		customer support;
	•		the success and timing of new product development; and
	•		continued development of successful distribution channels.

Some of our current and prospective competitors have or may have significantly greater financial, technical, research and development, manufacturing and marketing resources than we have. To compete effectively, we will need to continue to expand our product offerings, periodically enhance our existing products and continue to enhance our distribution.

Certain surgical laser manufacturers have targeted their efforts on narrow segments of the market, such as angioplasty and lithotripsy. Their products may compete for the same capital equipment funds as our products, and accordingly, these manufacturers may be considered our competitors. Generally, surgical laser manufacturers such as Laserscope compete with standard surgical methods and other medical technologies and treatment modalities including pharmaceuticals. We cannot assure that we can compete effectively against such competitors. In addition, we cannot assure that these or other companies will not succeed in developing technologies, products or treatments that are more effective than ours or that would render our technology or products obsolete or non-competitive.

Reliance on Patents and Licenses.

We hold several patents issued in the United States, generally covering surgical laser systems, delivery devices, calibration inserts and the laser resonator. We have also licensed certain technologies from others.

We cannot assure that any patents or licenses that we hold or that may be issued as a result of our patent applications will provide any competitive advantages for our products. Nor can we assure that any of the patents that we now hold or may hold in the future will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure that competitors, many of which have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, issue, use and sell our products.

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Furthermore, we cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

We believe that we own or have the right to use the basic patents covering our products. However, the laser industry is characterized by a very large number of patents, many of which are of questionable validity and some of which appear to overlap with other issued patents. As a result, there is a significant amount of uncertainty in the industry regarding patent protection and infringement. Because patent applications are maintained in secrecy in the United States until such patents are issued and are maintained in secrecy for a period of time outside the United States, we can conduct only limited searches to determine whether our technology infringes any patents or patent applications of others.

Potential Intellectual Property Litigation.

Our industry has been characterized by frequent demands for licenses and litigation. Our competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. In addition, we do not know whether our competitors will apply for and obtain patents that will prevent, limit or interfere with our ability to make, use, sell or import our products. Although we may seek to resolve any potential future claims or actions, we may not be able to do so on reasonable terms, or at all. If following a successful third-party action for infringement, we cannot obtain a license or redesign our products, we may have to stop manufacturing and marketing our products, and our business would suffer as a result.

We may become involved in litigation not only as a result of alleged infringement of a third party’s intellectual property rights but also to protect our own intellectual property. We have and may hereafter become involved in litigation to protect the trademark rights associated with our company name or the names of our products. If we have to change the name of our products, we may experience a loss in goodwill associated with customer confusion and a loss of sales.

Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate, and could divert management’s attention from our core business. We do not know whether necessary licenses would be available to us on satisfactory terms, or whether we could redesign our products or processes to avoid infringement. If we lose this kind of litigation, a court could require us to pay substantial damages, and prohibit us from using technologies essential to our products, any of which would have a material adverse effect on our business, results of operations and financial condition.

Failure to Attract or Retain Key Personnel Can Adversely Affect Results.

We depend upon the efforts and abilities of a number of current key personnel. If we are unable to attract and retain key employees it would have a material adverse effect on our business, financial condition, results of operations, and future cash flows.

Reliance on Key Customers.

In December 2000, Laserscope and McKesson entered into a five year agreement whereby McKesson would obtain exclusive distribution rights for the Company’s aesthetic product lines to doctors’ offices in the United States. At September 30, 2004, accounts receivable from McKesson accounted for approximately 16% of our total accounts receivable. If we are unable to maintain a favorable relationship with McKesson or if McKesson encounters financial difficulties, it would have a material adverse effect on our business, financial condition, results of operations, and future cashflows.

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Fluctuations in Quarterly Operating Results.

A number of factors affect our quarterly financial results including the timing of shipments and orders. Our laser products are relatively expensive pieces of medical capital equipment and the precise shipment date of specific units can have a marked effect on our results of operations on a quarterly basis. Any delay in product shipments near the end of a quarter could cause our quarterly results to fall short of anticipated levels. Furthermore, to the extent we receive orders near the end of a quarter, we may not be able to fulfill the order during the balance of that same quarter. Moreover, we typically receive a disproportionate percentage of orders toward the end of each quarter. To the extent that we do not receive anticipated orders or orders are delayed beyond the end of the applicable quarter, our results may be adversely affected and may be unpredictable from quarter to quarter. In addition, because a significant portion of our revenues in each quarter result from orders received in that quarter, we base our production, inventory and operating expenditure levels on anticipated revenue levels. Thus, if sales do not occur when expected, expenditure levels could be disproportionately high and operating results for that quarter and potentially future quarters, would be adversely affected. We cannot assure that Laserscope will accomplish revenue growth or profitability on a quarterly or annual basis. Nor can we assure that revenue growth or profitability will not fluctuate significantly from quarter to quarter.

Potential of Product Defects.

Laser systems are inherently complex in design and require ongoing regular maintenance. The manufacture of our lasers, laser products and systems involves a highly complex and precise process. As a result of the technical complexity of our products, changes in our or our suppliers’ manufacturing processes or the inadvertent use of defective materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve such yields or product reliability, our business, operating results, financial condition and customer relationships would be adversely affected.

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

	•		loss of customers;
	•		increased costs of product, returns and warranty expenses;
	•		damage to our brand reputation;
	•		failure to attract new customers or achieve market acceptance;
	•		diversion of development and engineering resources; and
	•		legal actions by our customers.

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

Product Liability Risk; Limited Insurance Coverage.

Our business has significant risks of product liability claims. We have experienced product liability claims from time to time, which we believe are ordinary for our business. While we cannot predict or determine the outcome of the actions brought against us, we believe that

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these actions will not ultimately have a material adverse impact on our financial position, results of operations and/or future cash flows.

At present, we maintain product liability insurance on a “claims made” basis with coverage of $10.0 million in the aggregate with a deductible of $0.1 million per occurrence and an annual maximum aggregate deductible of $0.5 million. We cannot assure that such insurance coverage will be available to us in the future at a reasonable cost, if at all. Nor can we assure that other claims will not be brought against us in excess of our insurance coverage.

Natural Catastrophic Events; Terrorism and Other Manmade Problems.

Our corporate headquarters, including our research and development operations, our manufacturing facilities, and our principal sales, marketing and service offices, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results, and financial condition. The terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and intensified the uncertainty of the United States and other economies. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

Factors Affecting Financial Results and Stock Price.

A number of factors affect our financial results and stock price including, but not limited to:

	•		product mix;
	•		competitive pricing pressures;
	•		material costs;
	•		revenue and expenses related to new products and enhancements to existing products;
	•		delays in customer purchases in anticipation of new products or product enhancements by Laserscope or its competitors; and
	•		the risk of loss or interruption to our operations or increased costs due to earthquakes, the availability of power and energy supplies and other events beyond our control.

The market price of our common stock may be subject to significant fluctuations. These fluctuations may be due to factors specific to Laserscope, such as:

	•		quarterly fluctuations in our financial results;
	•		changes in analysts’ estimates of future results;
	•		changes in investors’ perceptions of our products or business prospects;
	•		announcement of new or enhanced products by us or our competitors;
	•		announcements relating to acquisitions and strategic transactions by us or our competitors;

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	•		general conditions in the medical equipment industry; and
	•		general conditions in the financial markets.

The stock market has from time to time experienced extreme price and volume fluctuations, particularly among stocks of high technology companies, which, on occasion, have been unrelated to the operating performance of particular companies. Factors not directly related to Laserscope’s performance, such as negative industry reports or disappointing earnings announcements by publicly traded competitors, may have an adverse impact on the market price of our common stock.

As of October 31, 2004, we had 21,421,296 shares of outstanding common stock. The sale of a substantial number of shares of common stock or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock.

International Business.

Our international sales are made through international distributors and wholly-owned subsidiaries with payments to us typically denominated in the local currencies of the United Kingdom and France, and in U.S. Dollars in the rest of the world. We intend to continue our operations outside of the United States and potentially to enter additional international markets, These activities, require significant management attention and financial resources and further subject us to the risks of operating internationally. These risks include, but are not limited to:

	•		changes in regulatory requirements;
	•		delays resulting from difficulty in obtaining export licenses for certain technology;
	•		customs, tariffs and other barriers and restrictions; and
	•		the burdens of complying with a variety of foreign laws.

We are also subject to general geopolitical risks in connection with our international operations, such as:

	•		differing economic conditions;
	•		changes in political climate;
	•		differing tax structures; and
	•		changes in diplomatic and trade relationships and war.

In addition, fluctuations in currency exchange rates may negatively affect our ability to compete in terms of price against products denominated in local currencies.

Accordingly, our future results could be materially adversely affected by changes in these regulatory, geopolitical and other factors.

We do not engage in hedging transactions for speculative or trading purposes.

Legal Proceedings.

Laserscope is a party to a number of legal proceedings and claims arising in the ordinary course of business. While it is not feasible to predict or determine the outcome of the actions brought against us, we believe that the ultimate resolution of these claims will not have a material adverse effect on Laserscope’s financial position, results of operations, or future cash flows.

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Interest Rate Risk.

(See Item 3. Quantitative and Qualitative Disclosures About Market Risk in this Quarterly Report on Form 10-Q.)

Warranty Obligations.

We have a direct field service organization that provides service for our products. We generally provide a twelve month warranty on our laser systems. After the warranty period, maintenance and support is provided on a service contract basis or on an individual call basis. Our warranties and premium service contracts provide for a “99.0% Uptime Guarantee” on our laser systems. Under provisions of this guarantee, we extend the term of the related warranty or service contract if specified system uptime levels are not maintained. Although most systems covered by this guarantee have achieved a 99.0% uptime rate to date, we cannot assure that we can maintain such uptime rates in the future.

No Dividends.

We have never paid cash dividends on our common stock and do not anticipate paying cash dividends on the common stock in the foreseeable future. The payment of dividends on the common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the Board of Directors may consider relevant.

“Penny Stock” Rules.

Our common stock is traded on the National Association of Securities Dealers Automated Quotation (“NASDAQ”) National Market System, which requires that a company have, among other things, a minimum bid price of $1.00 in order to qualify for continued listing. If we fail to maintain our listing for our common stock on the NASDAQ National Market System, and no other exclusion from the definition of “penny stock” under the Exchange Act is available, any brokers engaging in transactions in our securities would be required to provide their customers with a risk disclosure document, the compensation of the broker/dealer in the transaction and monthly account statements showing the market values of our securities held in the customers’ accounts. The bid and offer quotations and compensation information must be provided prior to effecting the transaction and must be contained on the customer’s confirmation. If brokers become subject to the “penny stock” rules when engaging in transactions in our securities, they may become less willing to engage in such transactions, thereby making it more difficult for shareholders to dispose of their shares of Laserscope common stock.

Dilution.

Shareholders may experience dilution in the net tangible book value of their investment upon the exercise of outstanding options and warrants granted under Laserscope’s stock option plans and other options and warrants currently outstanding.

Other.

Other risks are detailed from time to time in our press releases and other public disclosure filings with the United States Securities and Exchange Commission (“SEC”), copies of which are available upon request from the Company.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Laserscope is exposed to a variety of risks, including changes in interest rates affecting the return on its investments, outstanding debt balances and foreign currency fluctuations. In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in interest rates and foreign currency values.

Interest Rate Risk.

Our exposure to market rate risk for changes in interest rates relates primarily to our outstanding debt. However, at September 30, 2004, we had no bank loans or debentures. Also, in the nine months ended September 30, 2004 and 2003, we did not use derivative financial instruments. We invest our excess cash in money market funds. Historically, our debt financings generally consisted of convertible debentures and bank loans requiring either fixed or variable rate interest payments. Investments in and borrowings under both fixed-rate and floating-rate interest-earning instruments carry a degree of interest rate risk. On the investment side, fixed-rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating-rate securities may produce less income than expected if interest rates fall. In addition, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. On the debt side, borrowings that require fixed-rate interest payments require greater than current market rate interest payments if interest rates fall, while floating rate borrowings may require greater interest payments if interest rates rise. While we had no borrowing in the current quarter, if we borrow in the future, our interest expense may be greater than expected due to changes in interest rates.

Foreign Currency Risk.

Our international revenues were 23% and 25% of total revenues in each of the quarters ended September 30, 2004 and 2003, respectively. Our international sales are made through international distributors and wholly owned subsidiaries with payments to the Company typically denominated in the local currencies of the United Kingdom and France, and in United States dollars in the rest of the world. Our international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. We do not engage in hedging transactions for speculative or trading purposes.

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Item 4. Controls and Procedures.

(a) Our Chief Executive Officer and Chief Financial Officer have reviewed, as of the end of the period covered by this report, the “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-, 15(e) and 15d-15(e)) that ensure that information relating to the Company required to be disclosed by us in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported in a timely and proper manner. Based upon this review, we believe that the controls and procedures in place are effective to ensure that information relating to the Company that is required to be disclosed by us in the reports that we file or submit under the Exchange Act is properly disclosed as required by the Exchange Act and related regulations.

(b) Changes in internal controls.
No change in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the Company’s third fiscal quarter has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 5. Other Information.

We have in place an asset based line of credit which provides up to $5.0 million in borrowings off-set against $1.0 million in letter of credit reserve requirements. The line of credit was renewed September 24, 2004 and currently expires September 2006. Credit is extended based on the Company’s eligible accounts receivable and inventory. At September 30, 2004, the Company had approximately $4.0 million in borrowing capacity under the line of credit facility. The Company’s assets collateralize the line of credit which bears an interest rate equivalent to the bank’s prime rate plus 2.0%. The prime rate at September, 2004 was 4.75%. Borrowings against the line of credit are paid down as the Company collects its accounts receivable. Provisions of the bank loan agreement prohibit the payment of dividends on non-preferred stock, or the redemption, retirement, repurchase or other acquisition of Company stock. The agreement further requires the Company to maintain a minimum tangible net worth. As of September 30, 2004, the Company was in compliance with all covenants and had no outstanding borrowings under the line of credit facility.

Item 6.     Exhibits

Exhibits filed herewith (numbered in accordance with Item 601 of Regulation S-K):

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SIGNATURES

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

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Exhibit Index

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