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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

OR

For the transition period from              to            

Commission File Number 000-50939

INTRALASE CORP.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (949) 859-5230

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2).    Yes  ¨    No  x

As of March 21, 2005, the aggregate market value of voting stock held by non-affiliates of the registrant, based upon the closing sales price for the registrant’s Common Stock, was $455,861,306. Shares of Common Stock held by each officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

The number of shares of the registrant’s Common Stock outstanding as of March 21, 2005 was 26,831,154.

Documents Incorporated by Reference

None.

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INTRALASE CORP.

ANNUAL REPORT ON

FORM 10-K

For the Fiscal Year Ended December 31, 2004

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements as defined in Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on our management’s beliefs and assumptions and on information currently available to us. All statements regarding future events, our future financial performance and results of operations, our business strategy and our financing plans are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “can,” “might,” “will,” “could,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology.

These statements are only predictions. Our actual results may differ materially from those anticipated in these forward-looking statements. In evaluating these forward-looking statements, you should specifically consider various other risks, uncertainties and factors, including those risks discussed under “Risk Factors.”

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

We assume no obligation to publicly update or revise any of these forward-looking statements or changes in our expectations after the date of this Annual Report on Form 10-K for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

PART I

Item 1— Business

Overview

IntraLase Corp. is the leading laser technology for the first step of LASIK surgery. We have developed and market an ultra-fast laser, related software and disposable devices for use in creating the corneal flap, the first step of LASIK surgery, the most common surgical technique used to correct vision. Our patent-protected product offering consists of our INTRALASE^® FS laser combined with our proprietary IntraLASIK^® software, and our per procedure fee inclusive of a disposable patient interface required for each eye treated in the LASIK procedure. Our computer-controlled laser solution replaces the hand-held mechanical, metal-bladed microkeratome traditionally used to create the corneal flap. Our advanced laser technology improves the safety, precision and visual acuity of LASIK surgery, and we believe our product offering will become the new standard of care for corneal flap creation in LASIK surgery.

Our business model is to target the most active LASIK surgery practices in the United States and in key international markets to buy or lease our INTRALASE^® FS laser in order to generate repeat revenues by collecting a per procedure fee inclusive of a single disposable patient interface for each eye treated with our laser. We began commercial introduction of our product offering in late 2001 and, as of December 31, 2004, we had sold or leased 217 lasers and we had sold approximately 306,859 per procedure fees inclusive of disposable patient interfaces. In the three months ended December 31, 2004, we captured approximately 16% of the U.S. market for LASIK corneal flap creation.

In addition to the medical and safety benefits of our product offering, our advanced laser technology allows our surgeon customers to improve the profitability of their LASIK surgery practice. We believe this combination of “better medicine” and “better business” will continue to assist in the adoption of our product offering and in turn drive our growth.

Company Background

We were incorporated in Delaware in 1997. From 1997 through 2001, we devoted substantially all of our resources toward the development of an ultra-fast laser, as well as the related software and patient interface, and toward testing to develop a commercial product to be used for eye surgery. In 2001, we also began developing manufacturing capabilities and selling to prospective customers. In 2002 and 2003, we continued to expand our customer base, primarily in the United States. We obtained our CE Mark and ISO EN 13485 approval in March 2004, allowing us to significantly expand our international product launch and support structures.

Our initial public offering, which was effective under applicable securities laws on October 6, 2004 and closed on October 13, 2004, resulted in our receipt of net proceeds of $86.1 million from the sale of 7,295,447 shares of common stock, including the sale of 995,447 over-allotment shares. The proceeds were net of the payment of expenses for the initial public

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offering of $2.2 million. The net proceeds of the offering were used for the repayment of our bank debt in the amount of $1.3 million and the payment to the University of Michigan of $765,000 due within 15 days of the initial public offering. In addition, 22,191,333 shares of redeemable convertible preferred stock converted to 16,797,103 shares of common stock.

Financial Information

Please refer to Item 6, “Selected Financial Data,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a review of revenue, net income (loss), and total assets for the last three years.

Market Opportunity

The Surgical Vision Correction Market

Vision correction represents one of the largest medical markets in the United States. According to Market Scope, approximately 166.4 million people in the United States require some form of vision correction, and industry sources estimate that approximately $32.2 billion was spent on eyeglasses, contact lenses and other corrective eyewear in the United States in 2004. Of the approximately 166.4 million people in the United States who require vision correction, approximately 55.5 million people, or 111 million eyes, are eligible for surgical vision correction and have not yet been treated.

LASIK surgery is the most common means of surgical vision correction. According to Market Scope, approximately 90% of all surgical vision corrections today are LASIK corrections. LASIK surgery corrects refractive errors associated with myopia, the inability to see objects in the distance, and hyperopia, the inability to see up close, by reshaping the cornea. Approximately 34.4 million people, or 68.8 million eyes, are myopic, also called nearsighted, and approximately 21.1 million people, or 42.2 million eyes, are hyperopic, also called farsighted. Both of these common vision problems are caused by irregularities in the shape of the eye, called refractive errors. The vision problem which typically requires reading glasses is called presbyopia and is not treated with LASIK surgery.

The market for LASIK surgery is currently under-penetrated. To date, only about 8.2 million LASIK eye surgeries have been performed in the United States, which amounts to a nominal market penetration rate of approximately 7%. The total U.S. annual market size for LASIK surgery is approximately $2.6 billion, based on an estimated 1.45 million LASIK procedures expected to be performed in 2005 at an industry average price of approximately $1,800 per eye treated. Industry analysts expect the growth rate in U.S. LASIK procedures to be approximately 7% in 2005, based on approximately 100,000 more procedures expected in 2005 than were performed in 2004.

Outside the United States there were approximately 1.8 million surgical vision surgeries performed in 2004, primarily LASIK. Industry analysts expect the growth rate outside the United States in LASIK procedures to be approximately 9% in 2005, to over 1.9 million procedures, with LASIK volume concentrated in Europe and the Asia-Pacific region.

We believe LASIK surgery procedure volume and market penetration will be driven by the following factors:

The IntraLase Market Opportunity

There are approximately 4,500 LASIK surgery practices worldwide. Of these surgery practices, our target customers are the 1,400 most active LASIK surgery practices in the United States and in key international markets. As of December 31, 2004, approximately 217 of these 1,400 LASIK surgery practices worldwide were IntraLase customers, and, of the total number of LASIK procedures performed in the United States in the three months ended December 31, 2004, approximately 16% were performed using our product offering to create the corneal flap. We believe the other approximately 84% of total procedures performed in this time period were performed using the traditional microkeratome.

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U.S. Market

International Market

LASIK Surgery

LASIK surgery involves two steps:

Both steps are necessary for LASIK surgery. Excimer lasers, used in the second step, remove tissue at the point the beam of light comes into contact with tissue and are not capable of focusing below the surface of the clear eye tissue to create the corneal flap. Therefore, the INTRALASE^® FS laser used in the first step and the excimer lasers used in the second step are complementary in LASIK surgery.

While using the microkeratome in the first step of the LASIK procedure is a successful and relatively safe procedure, the majority of complications with LASIK arise from the use of microkeratomes. Microkeratome complications arise in up to 10% of all LASIK procedures, including the most serious complications that may affect the visual outcome in a LASIK surgery.

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The IntraLase Solution—“Better Medicine” and “Better Business”

Our INTRALASE^® FS laser and proprietary IntraLASIK^® software complement and improve LASIK surgery by providing a computer-controlled laser solution as an alternative to the microkeratome for creating flaps in the cornea during the essential first step of LASIK surgery. When the INTRALASE^® FS laser is combined with the excimer laser used in the second step of the LASIK procedure, this results in an all-laser LASIK solution. The advantages of our product offering over the traditional method include fewer complications, greater predictability, greater control, greater precision and uniformity of flap depth. Additional advantages are a more centrally located flap, better sterility and greater likelihood of completed surgeries. In all of the commercial procedures performed by our customers to date, there have been no reported incidents of loss of corneal tissue or anterior chamber penetration, serious complications historically associated with creation of the corneal flap with a bladed microkeratome. In addition, the use of our product offering significantly reduces the incidence of less serious complications such as epithelial defects and dry eye. The disadvantages of our product offering over the traditional microkeratome approach are the higher costs to the LASIK surgeon to acquire our product offering and the higher cost to the patient, as well as the additional training that is required for a surgeon to become accustomed to using our technology and the slightly higher procedure times. We believe that the advantages of our technology outweigh the disadvantages and give our LASIK surgeon customers and their patients a new level of confidence in LASIK surgery, which in turn will help further penetrate the market for LASIK surgery.

Benefits of the IntraLase Solution

We offer our surgeon customers and their patients the benefits of “Better Medicine.” LASIK surgeons who have adopted the IntraLase technology are now able to offer their patients improved safety and predictability and, as a result, patients achieve better visual acuity. Surgeons who use our solution also derive the benefits of “Better Business,” since they are able to increase their prices and procedure volume, thus enhancing profitability.

The benefits of Better Medicine and Better Business are:

Better vision. Patients achieve statistically significant better vision when the INTRALASE^® FS laser is used in the LASIK procedure, as supported in two recently conducted prospective, comparative studies. In a prospective study, the study design is made in advance of the collection of data, whereas in a retrospective study, a design is applied to existing data. In each of these prospective studies, the corneal flap for one eye of each patient was created with the INTRALASE^® FS laser, and the corneal flap for the other eye was created with the microkeratome. In one study, the 37 participants were treated with standard excimer laser vision correction, and in the other, the other 51 participants were treated with the new custom excimer laser vision correction. Results showed that the eyes treated with the INTRALASE^® FS laser had better vision and fewer induced aberrations compared to the mechanical, metal-bladed microkeratome. We believe these better vision results were achieved using our product offering, in part, due to a reduction in the variabilities caused by the microkeratome, which can affect the precision of the excimer laser.

Improved safety. Our product offering eliminates loss of corneal tissue and anterior chamber penetration, the most severe complications associated with the creation of the corneal flap with a bladed microkeratome. Seven comparative studies showed improved safety and elimination of certain risks of flap creation with our product offering, when compared to traditional microkeratomes. Additionally, since corneal flaps created with our product offering possess a unique edge profile, they are easily and securely repositioned following the excimer ablation, reducing the possibility of induced visual aberrations and slipped flaps.

Greater predictability and accuracy. The INTRALASE^® FS laser produces flaps that are accurate within ± 12 microns, whereas the microkeratome manufacturers report variability up to ± 60 microns. Nine studies have shown that our approach generated significantly more predictable and accurate flap dimensions, including, most critically, reproducible flap thickness. This increased accuracy in flap creation preserves corneal tissue by precisely creating optimal flap thickness, and improves the predictability of the overall LASIK treatment.

Fewer retreatments. The number of LASIK retreatments are significantly lower when our product offering is used to create the corneal flap. This avoids the patient inconvenience and increased surgeon costs entailed with retreatments. In one study of 500 eyes treated with the traditional microkeratome, 5.8% of the eyes required retreatment within 13 months after the initial surgery while in 508 eyes where the INTRALASE^® FS laser was used, there were no retreatments in an equivalent time period. In a separate survey of our surgeon customers, retreatment rates were reduced from an average of 10% to an average of 4% when using our product offering.

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Reduced dry eye. A frequently reported side effect of LASIK surgery is dry eye. Three studies show a significant reduction in dry eye with the use of our product offering. In the largest of these three studies, comparing 300 LASIK procedures with the microkeratome to 300 LASIK procedures with the INTRALASE^® FS laser, patient incidences of dry eye were reduced by 72%. We believe that this lower occurrence of dry eye is due to our laser creating a uniform and typically thinner flap that does not sever important nerves in the cornea.

Higher procedure volume and revenues for our customers. Our surgeon customers receive an average of $334 more per eye when using our product offering instead of the traditional microkeratome. An independent survey of our U.S. customers in early 2004 indicated that our customers experienced an 11% increase in procedure volume and a 38% increase in revenues in the comparable time period during which the industry experienced a 3% increase in procedure volume and a 12% increase in revenues. Patients readily understand the safety profile of the INTRALASE^® FS laser, are attracted to the concept of a bladeless procedure and surveys of our customers demonstrate that patients are willing to pay for this new level of safety and assurance. In addition, according to a survey of our customers conducted by SM² Consulting, an independent consultant, with our laser, our customers improve the rate at which laser vision correction consultations translate into actual surgery from 64% to 77%.

The sixteen clinical studies referred to above were each conducted by LASIK surgeons who compared the attributes and results of creating the corneal flap using our laser versus with the microkeratome. The studies ranged in size from 20 to 1,000 eyes. However, we paid an aggregate of approximately $472,000 to the LASIK surgeon conducting the studies in two instances, including, in one instance, when we sponsored the study. We believe a portion of such payments was used to subsidize lower patient fees for patients to agree to participate in the studies. In addition, to the extent they provide advisory and consulting services to us separate from their work on the studies, or in connection with their presenting their studies, some of these LASIK surgeons have been issued options to purchase shares of our common stock, have been paid cash or have been reimbursed for costs.

Our Strategy

Our goals are to establish our product offering as the standard of care for corneal flap creation in LASIK surgery, and to leverage our technology to develop new products and applications. Key elements of our strategy for achieving these goals include:

Replacing microkeratome with our laser. We intend to replace the mechanical, metal-bladed microkeratome with our INTRALASE^® FS laser in LASIK surgery practices. Our business model is to target the most active LASIK surgery practices in the United States and in key international markets to buy or lease our INTRALASE^® FS laser in order to generate repeat revenues from the sale of our per procedure fee inclusive of a disposable patient interface, required in connection with each successive use of our laser. In addition, we target prestigious teaching institutions and key industry thought leaders to drive adoption of our product offering by other practicing LASIK surgeons.

Expanding our market share. We intend to expand our market share for LASIK procedures and facilitate the rapid adoption of our product offering by continuing to build a body of clinical data that supports the benefits of our product offering and with marketing activities targeting surgeons and optometrists. We believe these strategies will enable us to sell more of our higher gross margin per procedure fees inclusive of disposable patient interfaces to users of our existing installed base of lasers, in addition to new users of our laser. A recent survey indicated that our U.S. surgeon customers had adopted our product offering in 84% of all the LASIK procedures they perform. We estimate that we captured 16% of the U.S. LASIK surgery market for creation of the corneal flap in the three months ended December 31, 2004.

Providing quality products and superior customer service. We intend to continue to offer high quality products and extensive support to our direct customers and to our international distributors to continue to build our reputation as a premier service provider and establish a loyal customer base. We believe that providing superior service is instrumental in maintaining and growing our market share, as our surgeon customers often actively refer our product offering to other surgeons. We currently provide services including a 24/7 technical support hotline, installation and training for our customers. We also aim to have all of our lasers functional for customer surgery days. We believe our reputation for providing quality products and superior responsiveness will differentiate us from any potential direct competitors.

Refining and enhancing our existing product offering. We intend to continue to devote resources to improving and optimizing our technology and product offering, with the goal of continuously increasing the safety, accuracy, efficiency and ease-of-use of our solution. In addition, we intend to increase our gross margin by improving the manufacturability and serviceability of our product offering.

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Developing innovative applications for our technology. We are currently in the process of developing new therapeutic applications to expand the use of our current technology and product offering. We believe the unique capabilities of our laser will enable us to introduce additional applications within ophthalmology.

Our Product Offering

Our product offering consists of three key elements:

The creation of the corneal flap using our product offering begins with the set up of the laser, followed by the placement of our disposable patient interface onto the patient’s eye. Using the IntraLASIK^® software, the surgeon then centers a video display of a 2-millimeter circle overlaid on an image of the patient’s eye. Once the desired location has been determined and set, the surgeon initiates the flap procedure by engaging the computer- controlled laser. The laser creates the flap by focusing its beam of light below the surface of the corneal tissue, thereby creating a precise cut, leaving an uncut section of tissue to act as a hinge. It takes approximately 45 seconds for our laser to create the corneal flap.

INTRALASE^® FS Laser

Our INTRALASE^® FS laser is an ultra-fast femtosecond, or FS, laser that produces a stream of high-repetition, short-duration light pulses with an extremely high-quality optical beam. Our laser generates fifteen thousand pulses per second, with each pulse having a duration of six hundred femtoseconds, the equivalent of less than a billionth of a second per pulse.

Our IntraLASIK^® software controls our laser and beam delivery device that focuses the laser into tiny spots, passing through the outer layers of the cornea until reaching the exact focal point within the cornea. In an “inside out” process, the laser beam creates a cut, leaving an uncut section of tissue to act as a hinge. As with the traditional microkeratome procedure, the surgeon then folds the tissue back to expose the underlying layer of the cornea for the excimer laser treatment that will make the vision correction by reshaping the cornea.

Each pulse of light creates a bubble, less than five microns in diameter, a process known as photodisruption. Our laser aligns hundreds of thousands of bubbles contiguously along predetermined three-dimensional surfaces to create precise surgical incisions. Because our laser uses low energy pulses and is computer controlled, a very precise surgical procedure is accomplished without damage to the surrounding tissue.

Our laser is a solid-state laser, meaning that the light pulses are generated using solid-state optical materials. Many lasers, including the excimer lasers used for the second step of LASIK surgery, produce their pulses of light utilizing a chamber of toxic gas. By comparison, our solid-state laser does not require laser gases or dye to operate and is therefore easier to support at LASIK surgery practices.

Our laser is completely self-contained, consisting of a laser engine, a delivery system, a user interface and a chassis to house the system. The laser is extremely compatible for installation in surgical centers, as it requires only a grounded electrical supply.

IntraLASIK^® Software

We design, program, test and periodically update our IntraLASIK^® software that controls the INTRALASE^® FS laser, which enables the surgeon to cut a precise flap at predetermined parameters within the eye’s corneal tissue. Each patient’s surgical parameters, including flap diameter and thickness, location and angle of the hinge, and angle of the side cut, are input into the IntraLASIK^® software prior to surgery. The software then directs the laser to create a precise corneal flap based on the input parameters. Prior to each surgery, the software automatically performs multiple pre-procedure system checks to verify the readiness of the laser and multiple calibration checks are also available to the surgeon.

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The software allows the surgeon to perform a pre-determined number of procedures in conjunction with our per procedure fees inclusive of disposable patient interfaces separately purchased by the surgeon. To prevent reuse or unauthorized reproduction of the per procedure disposable patient interface, the software maintains a record of the number of procedures performed and available, and notifies the surgeon when to order additional per procedure disposable patient interfaces. In addition, the software includes a patient and surgeon database, system utilities and diagnostic tools. The diagnostic software is also proprietary to us and is used to detect the source of any errors in our laser. When an error is detected, a message appears with a brief description of the error. Depending upon the severity of the error, the message may provide the user with steps to follow for continued use, or for more technical issues, the information displayed may be used to contact us for diagnostic or on-site field service support.

Per Procedure Fee and Disposable Patient Interface

A per procedure fee is required for each eye treated. The per procedure fee is inclusive of a disposable patient interface. The disposable patient interface consists of a metal cone and glass lens that interfaces between our laser and the patient by attaching to the laser at one end and docking at the other end to the patient’s eye, and a proprietary plastic gripper and syringe that is used to locate the glass lens in the metal cone and create suction between the glass lens and the patient’s eye.

The disposable patient interface is integral to depth control and accuracy as the glass at the narrow end of the disposable patient interface provides the reference plane for depth control for the beam of light created by the laser. The disposable patient interface comes in a sealed, sterile package, which ensures a high level of patient safety and protection from infection. The disposable patient interface is unique to our laser and we believe that we are the only available source for these devices.

Historically, we have protected our per procedure revenue stream with a combination of contract terms, software controls and manual periodic counts of machine usage, as necessary, to compare our shipments of disposable patient interfaces with the individual counter embedded in each IntraLase®FS laser. We are in the process of converting our new and existing customers to a system of remote electronic activation when the customer orders procedures, which are inclusive of the disposable patient interface. This allows the customer to perform only the number of procedures purchased. We are making this change to remote electronic activation because we believe it to be a more scalable and secure method of protecting our per procedure revenue stream. In addition, in the future, we intend to offer our customers new features which this electronic link will facilitate, such as remote software upgrades and diagnostics.

Sales and Marketing

Our primary objective is to rapidly expand our market share for the creation of corneal flaps in the first step of LASIK surgery. Of the 1,270 LASIK surgery practices in the United States, approximately 700 perform over 50 procedures per month. Of the 3,230 LASIK surgery practices outside the United States, we estimate that there are approximately 700 laser centers performing over 50 LASIK procedures per month in our primary international target markets in the Asia-Pacific region, Europe and the Middle East. We focus our sales and marketing efforts on these high volume LASIK surgery practices.

We began selling the INTRALASE^® FS laser and our per procedure fee inclusive of a disposable patient interface in the United States during the fourth quarter of 2001, in Asia during the third quarter of 2003 and in Europe during the first quarter of 2004. As of December 31, 2004, we had sold or leased a total of 166 lasers in the United States and we had sold 51 outside the United States. In addition, we had sold approximately 307,000 per procedure disposable patient interfaces worldwide.

Sales

We sell our laser through our direct sales force in the United States and through our direct sales efforts and distributors internationally. In the United States, we have six direct sales personnel, plus an executive managing our sales efforts. The U.S. sales force primarily consists of personnel with extensive experience in the sale of lasers and other products to refractive surgeons. Internationally, we sell through local country distributors and two sales consultants and an executive devoted to direct sales efforts and international distributor development. We have signed 14 distributor contracts with distributors in the Asia Pacific region, Europe and the Middle East, and we also sell our product offering directly to customers in selected countries. Our sales team is supported by internal sales administration and customer service team based in Irvine, California. We do not anticipate adding to our sales force substantially. However, it is likely that we will continue to add international distributors as we expand into new countries.

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Each distributor contract gives the appointed distributor the exclusive right to promote, market, sell, service and support our INTRALASE FS^® Laser, IntraLASIK^® software, per procedure fee inclusive of a disposable patient interface and the associated tool kit within a specified country or set of countries, for use in the field of ophthalmology surgical centers. Distributors are obligated to develop customer prospects, sell product and provide servicing and training relating to our product offering in their territory. Distributor contract terms are between one and three years, and generally automatically renew unless either party terminates the agreement, however there are termination rights for either party in the event the other party fails to perform any material obligations. Payments by the distributor to us are in U.S. currency and contractually must be made cash in advance or by irrevocable letter of credit. However, on occasion, we have granted limited terms to distributors, usually for less than net 10 days to ensure shipment by a specified carrier. Title to the equipment transfers upon shipment and there is no right of return of any product to us. The distributor contracts provide a standard twelve month warranty for defective components, subject to customary exclusions. All of the contracts contain standard provisions regarding our ownership of our intellectual property and the distributors’ obligations to maintain the confidentiality of our intellectual property. Distributors are obligated to indemnify us for liabilities arising from the distributor’s failure to perform its obligations under the distributor contract, or for its misconduct or negligence in handling the products. Under some of the contracts, we will indemnify the distributor for claims arising out of or relating to the manufacture, use and sale of our product offering or any infringement by us of the intellectual property of third parties with respect to our product offering.

Marketing

Our marketing efforts involve two key strategies:

Customer Service and Support

Our customer support strategy is to continue to offer extensive support to our customers to build a reputation as a premier service provider. In the United States, we provide customer service through the following measures:

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We provide laser site inspection, installation and clinical training prior to the acceptance of our laser by our surgeon customers. Clinical training typically takes no more than one day, since most of our surgeon customers have already acquired some of the skills necessary for the operation of our laser based on prior experience using the excimer laser. The surgeon is likely to become more proficient with our product offering as he or she gains additional experience, similar to other devices and surgical techniques.

In international markets, we provide customer service through our distributors. Our technical services, field service and clinical applications personnel each provide training and support to our distributors and their personnel, and our distributors in turn provide all customer services and support to the end-user surgeons. All international distributors are required to send at least one service engineer to our training facility in Irvine, California, for an intensive one-month training course on the installation, routine maintenance and repair of our laser and are required to send their engineer(s) for additional training provided by IntraLase at specified times.

As of December 31, 2004, we had 45 field service, technical services and clinical applications personnel worldwide who are responsible for supporting our distributors and servicing customers in direct sales markets.

All of our direct customers who purchase or lease our laser receive a one-year limited warranty and are required to maintain a maintenance contract thereafter in order to use our laser and to receive on-going maintenance and support. International distributor agreements generally provide for a one-year parts only warranty, with the distributor responsible for customer support to the end-user surgeons. The international distributor is responsible for obtaining a fee based maintenance agreement from their customer and servicing the equipment.

Intellectual Property Rights

We rely on a combination of patent, trademark, copyright, trade secret and other intellectual property laws, nondisclosure agreements and other measures to protect our intellectual property. We believe that in order to have a competitive advantage, we must develop and maintain the proprietary aspects of our technologies. We require our employees, consultants and advisors to execute confidentiality agreements in connection with their employment, consulting or advisory relationships with us. We also require our employees, consultants and advisors who we expect to work on our product offering to agree to disclose and assign to us all inventions conceived during the work day, using our property, or which relate to our business. Despite any measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our product offering or to obtain and use information that we regard as proprietary.

Patents

We have developed a patent portfolio that covers many aspects of our laser, laser beam guidance, other components of our laser, methods for inducing breakdown of corneal tissue and our per procedure disposable patient interface. As of December 31, 2004, we own 12 issued U.S. patents and nine U.S. pending patent applications, eight issued foreign patents and 22 pending foreign patent applications. Our patents expire between 2016 and 2022. We have multiple patents covering unique aspects of our laser and per procedure disposable patient interface.

We have entered into three licenses for several key patents and patent applications covering different aspects of our laser and our per procedure fee inclusive of a disposable patient interface. As of December 31, 2004, we exclusively license, for human health, 17 issued U.S. patents, with expiration dates from 2008 through 2019, and two U.S. pending patent applications, seven foreign patents and five foreign pending patent applications. One of these licenses is for exclusive worldwide use of the intellectual property covered by such patents in the fields of lasers designed for human health applications and another is for exclusive worldwide use of the intellectual property covered by such patents in the fields of ultra-fast lasers designed for human health applications. Under two of these licenses we pay periodic license maintenance fees.

In addition, we have entered into two non-exclusive worldwide license agreements with third parties covering patents that apply either to components of our laser or our disposable patient interface, as applicable. We pay royalties on the sale or lease of our laser or the sale of our disposable patient interface, as applicable, under these license agreements and are also required to pay a minimum amount of royalties per year.

On July 15, 2004, we entered an agreement to acquire a fully-paid royalty-free irrevocable and worldwide license from the University of Michigan for the use of certain technology and to settle all past contract disputes for aggregate consideration of $2,000,000. Upon closing this agreement on July 15, 2004 we recorded a charge of $765,000, which is included within research and development expenses in 2004, related to the settlement of the contract disputes and capitalized $1,235,000, which is included within total long-term assets at December 31, 2004, associated with acquired licenses in accordance with the terms of the agreement.

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On August 23, 2004, the United States Patent and Trademark Office, or PTO, granted a request for re-examination with respect to U.S. Patent RE 37,585, one of the four U.S. patents licensed to us by the University of Michigan, which means that the PTO found that the request raised a new issue of patentability with regard to some of the claims. Re-examination may result in the scope of protection and rights provided by the patent license being lost or narrowed. The irrevocable license we acquired and the payment we made pursuant to the July 15, 2004 license agreement will not be affected by the granting of re-examination, regardless of the outcome. Although we believe that the intellectual property covered by the patent subject to the re-examination is important to our business, if this patent is invalidated there will be no effect on our ability to sell our products. However, invalidation or narrowing of this patent might allow others to market competitive products that would otherwise have infringed the patent.

The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. Patent litigation can involve complex factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may require us to pay substantial damages or discontinue the manufacture and sale of our products. Even if we were to prevail, any litigation could be costly and time consuming and would divert the attention of our management and key personnel from our business operations. Our success also will depend in part on our not infringing patents issued to others, including our competitors and potential competitors. If any key aspect of our product offering is found to infringe the patents of others, our development, manufacture and sale of our product offering could be severely restricted or prohibited. In addition, third parties including our competitors may independently develop similar technologies. Because of the importance of our patent portfolio to our business, we may lose market share to our potential competitors if we fail to protect our intellectual property rights.

If an entrant with products or technology directly competitive to our products or technology should arise, the possibility of a patent infringement claim against us grows. While we make an effort to ensure that our product offering does not infringe other parties’ patents and proprietary rights, our product offering and related methods may be covered by patents held by others. In addition, third parties may assert that future products we may market infringe their patents.

Further, a patent infringement suit brought against us may force us to stop or delay developing, manufacturing or selling potential products that are claimed to infringe a third party’s intellectual property, unless that party grants us rights to use its intellectual property. In such cases, we may be required to obtain licenses to patents or proprietary rights of others in order to continue to commercialize such potential products. However, we may not be able to obtain any licenses required under any patents or proprietary rights of third parties on acceptable terms, or at all. Even if we were able to obtain rights to the third party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business.

Under our license agreements with Escalon Medical and the University of Michigan, we are obligated to indemnify the party granting the license against claims, losses and expenses arising out of the manufacture, use, sale or other disposition by us of the products we manufacture using the licensed technology, out of any other person’s use of the products we manufacture, or our other use of the licensed technology or patents. Under our license agreement with Mr. Shui Lai, we are obligated to indemnify Mr. Lai against claims, losses and expenses arising out of the distribution of the products we manufacture using the licensed technology.

Trademarks

We own or have rights to material trademarks or trade names that we use in conjunction with the sale of our product offering, which include, among others, IntraLase^®, INTRALASE^® FS, IntraLASIK^® and The New Shape of Vision^®, as well as our dot and swoosh mark. Generally, elements of our product offering are marketed under one of these trademarks or brand names.

Manufacturing

We have one manufacturing facility located in Irvine, California where our INTRALASE^® FS laser is assembled and tested and our IntraLASIK^® software program is designed, programmed and tested. This facility is also where we assemble in a semi-automated process the metal cone and glass lens for our disposable patient interface, the components of which are manufactured by outside vendors. We then ship the disposable patient interface to a third party for sterilization and packaging.

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We have approximately 64 employees in operations, regulatory and quality assurance. At our current rate of growth, we anticipate that we will need to expand our manufacturing capacity, and as such on January 31, 2005 we entered into a lease agreement for a larger facility in Irvine, California. See further discussion at Part I, Item 2 – Properties.

We purchase all of the components used in the manufacture and assembly of our product offering from outside vendors. These outside vendors produce the components we require, including the printed circuit boards and objective lens used in the laser and the metal cone, glass and packaging used for our disposable patient interface, to our specifications and in many instances to our design. Our quality assurance personnel audit our vendors for conformance to our specifications, policies and procedures and inspect and test the components at various steps in the manufacturing and assembly cycle. This process facilitates compliance with the regulatory requirements for the manufacturing and sale of our product offering.

A minor portion of components for our laser product are made by sole source vendors. Although these components constitute only a small portion of the total components in our product offering, these components are integral to the success of our product offering and as a result our success is tied to our continuing ability to obtain supplies of these components. We have never experienced any significant disruption in supply of any of our components. We endeavor to manage the risk of single sources by maintaining inventories in excess of lead time requirements and by maintaining good vendor relationships. In addition, we continuously seek to identify and qualify additional suppliers based on our volume requirements. We purchase our product inventories through standard purchase orders and do not currently have agreements with our outside vendors. In the event of any disruption in our vendor relationships, arrangements for additional or replacement suppliers for some of these parts may not be achieved quickly and our business could be harmed by such delays. See “Risk Factors—Risks Related to our Business—We depend on certain single-source suppliers and manufacturers for key components of our laser, and the loss of any of these suppliers or manufacturers, or their inability to supply us with an adequate supply of materials, could harm our business.”

Research and Development

We believe that research and development activities are essential to maintaining and enhancing our business, including sponsoring clinical studies to validate our existing product offering and developing potential new applications for our technology. Our research and development group consists of 37 individuals with research, engineering, medical and regulatory affairs experience. Our research and development expenses, including regulatory and clinical trial expenses, were approximately $12.7 million in 2004, $9.1 million in 2003 and $9.0 million in 2002.

Competition

Although we believe that our product offering has substantial advantages over existing and prospective corneal flap creation technologies, we face, and will continue to face, intense competition from medical device companies, as well as numerous academic and research institutions and governmental agencies, both in the United States and abroad. The principal elements of competition in the surgical vision correction market include safety, quality, functionality, better outcomes, support and service, the ability to develop new technologies and new therapeutic applications, as well as pricing. We believe that overall we compete favorably with respect to the increased safety, precision and visual acuity achieved when using our laser technology and our extensive support structure.

The principal sources of this competition are as follows:

Competition in Creating the Corneal Flap

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Competition Against LASIK

Because our technology is used in the first step of the LASIK surgery, we also compete against other vision correction technologies that bypass the need for the creation of the corneal flap. LASIK competes with other treatments such as eyeglasses, contact lenses and other surgical techniques. Such techniques include corneal inlays and epithelial flaps, which are currently in the early stages of commercialization and do not have a significant presence in the market.

Government Regulation

Our product offering is regulated as a medical device. Accordingly, our product design and development, testing, labeling, manufacturing, processes, promotional activities and sales are regulated extensively by government agencies in the United States and other countries in which we market and sell our product offering. We have clearance from the U.S. Food and Drug Administration, or FDA, to market our laser in the United States. We also have the approvals necessary to sell our product offering in the European Union and other international markets in which we currently sell our product offering.

United States

In the United States, the FDA regulates the design, manufacture, distribution, quality standards and marketing of medical devices. FDA regulation includes, among other things, post-market surveillance and adverse event reporting requirements.

There are two principal methods by which FDA regulated devices may be marketed in the United States: 510(k) clearance and pre-market approval, or PMA. To obtain 510(k) clearance, we must demonstrate that our product offering is substantially equivalent to a previously cleared 510(k) device or other appropriate predicate device. A PMA application is a longer and more complicated process, and is required for a device that does not qualify for 510(k) clearance. We intend to utilize the 510(k) notification procedure whenever possible. To date, all components of our product offering have qualified for 510(k) clearance, and have not required a PMA application.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance, or could even require a PMA application. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing or recall the modified device until 510(k) clearance or a PMA is obtained.

We received 510(k) clearance in December 1999 to market our INTRALASE^® FS laser and our disposable patient interface in the United States. In addition, we have received 510(k) clearances for the creation of channels for intracorneal ring segments and for lamellar keratoplasty, both of which are used in therapeutic corneal procedures. As we develop new products and applications or make significant modifications to our existing product offering, we will need to obtain the regulatory approvals necessary to market such products for vision correction and other medical procedures in our target markets.

After the FDA permits a device to enter commercial distribution, numerous regulatory requirements apply. These include:

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We also are subject to unannounced inspections for our U.S. facility by the FDA and the Food and Drug Branch of the California Department of Health Services, and these inspections may include the manufacturing facilities of our subcontractors.

Our laser is a radiation emitting product as well as a medical device. Therefore, we are also regulated by the FDA under the Radiation Control for Health and Safety Act. This law is intended to ensure that medical devices are safe and effective and seeks to reduce unnecessary exposure to radiation from medical, occupational, and consumer products.

If we do not comply with the FDA’s regulatory requirements we may be subject to an FDA enforcement action, which may include any of the following sanctions:

To date, we have not been subject to any material enforcement action by the FDA.

International

Sales of our laser-based product offering outside the United States are subject to the regulatory requirements of the foreign country or, if applicable, the harmonized standards of the European Union. These regulatory requirements vary widely among countries and may include technical approvals, such as electrical safety, as well as demonstration of clinical efficacy. In Europe, the 25 member countries of the European Union have promulgated rules that require medical products to receive the certifications necessary to affix the CE Mark to the device. The CE Mark is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. Certification under the ISO standards for quality assurance and manufacturing processes is one of the CE Mark requirements. We are licensed to apply the CE Mark to our product offering in accordance with the European Medical Device Directives, which permits us to commercially distribute our lasers throughout the European Union and to perform the flap procedure using our product offering. We rely on foreign regulatory approvals and export certifications from the FDA to comply with certain regulatory requirements in several foreign jurisdictions, such as Australia, Canada, Korea, Taiwan and countries in Western Europe. We intend to meet applicable foreign country regulatory requirements for our product offering.

Other Regulatory Requirements

We also are subject to extensive and frequently changing regulations under many other laws administered by U.S. and foreign governmental agencies on the national, state and local levels, including requirements regarding occupational health and safety and the use, handling and disposing of toxic or hazardous substances.

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Product Liability Insurance

We maintain product liability insurance with respect to our product offering with a general coverage limit of $5 million in the aggregate. Since commencing the sale of our systems, no material product liability claims have been initiated against us.

Employees

As of December 31, 2004, we had 202 full-time employees and 8 full-time equivalent consultants, most of whom are located in our facilities in Irvine, California, with the exception of worldwide-based sales, field service and clinical applications personnel. We have 28 sales and marketing employees; 37 research, development and engineering employees; 18 regulatory affairs and quality assurance employees: 45 technical services, field services and clinical applications employees: 46 operations employees and 28 general and administrative employees. None of our employees is represented by a collective bargaining agreement and we have not experienced any work stoppage. We believe that we have good relations with our employees.

Available Information

Our website is located at www.intralase.com. We make available free of charge through this website all of our SEC filings including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after those reports are electronically filed with the SEC. You also may obtain all our SEC filings free of charge via EDGAR through the SEC website at www.sec.gov.

Risk Factors

Risks Related to our Industry

Our success depends upon the continued acceptance of LASIK surgery.

Our business depends upon continued market acceptance of LASIK surgery by both surgeons and patients in the United States and international markets. LASIK surgery has only been approved since 1995 and commercially available since 1996 and, to date, has penetrated approximately 7% of the eligible U.S. population. We believe that if market acceptance of LASIK surgery declines, demand for our product offering by LASIK surgery practices and potential patients will decline, resulting in a decrease in our revenues.

Some consumers may choose not to undergo LASIK surgery due to concerns with the safety and efficacy of an elective surgery in general or the LASIK procedure in particular, due to concerns about price or due to their belief that improved technology or alternative methods of treatment will be available in the near future. LASIK surgery itself can result in potential complications and side effects, such as post-operative discomfort, unintended over- or under- corrections, disorders in corneal healing, undesirable visual sensations caused by bright lights such as glare or halos and dry eye.

Should either the ophthalmic community or the general population turn away from LASIK surgery as an alternative to existing methods of treating refractive vision disorders, or if future technologies replace LASIK surgery, these developments would have a material adverse effect on our business, financial condition and results of operations.

Weak or uncertain economic conditions could adversely affect demand for our product offering.

Because LASIK surgery is not generally paid for through insurance programs or government reimbursement, patients typically pay for LASIK surgery directly with their own discretionary funds. Accordingly, weak or uncertain economic conditions may cause individuals to be less willing to pay for LASIK surgery, as was evidenced by the 14% decline in LASIK procedures in the United States in 2002 as compared to 2001. A decline in economic conditions in the United States or in international markets could result in a decline in demand for LASIK surgery and could have a material adverse effect on our business, financial condition and results of operations.

Changes in U.S. federal tax laws governing the ability of potential LASIK patients to use pre-tax dollars to pay for LASIK surgery could adversely affect demand for our product offering.

We believe a significant number of U.S. patients pay for LASIK surgery with pre-tax dollars pursuant to plans sponsored under Section 125 of the Internal Revenue Code. These plans are commonly referred to as cafeteria plans. Changes in the U.S. tax laws or regulations governing cafeteria plans could reduce or eliminate the ability of patients to use pre-tax

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dollars to pay for LASIK surgery, resulting in an increase in the total cost borne by patients, which would likely reduce the volume of LASIK surgeries, and thus demand for our per procedure fee inclusive of a disposable patient interface, which would have a material adverse effect on our business, financial condition and results of operations.

Risks Related to our Business

We are subject to extensive government regulation, and a failure to comply may increase our costs and prevent us from selling our product offering.

We are subject to extensive government regulation, including inspections and controls over research and development, testing, manufacturing, safety and environmental controls, efficacy, labeling, advertising, promotion, pricing, record keeping and the sale and distribution of our product offering. Although we have obtained all necessary clearances from the Food and Drug Administration, or FDA, as well as all necessary foreign governmental approvals to market and sell our product offering, we must continue to comply with such regulations to continue to manufacture, market and sell our product offering. Noncompliance with FDA requirements can result in fines, injunctions, penalties, mandatory recalls or seizures, manufacturing suspensions, recommendations by the FDA against governmental contracts, suspension in the issuance of export certificates and criminal prosecution. The FDA also has authority to request repair, replacement or the refund of the cost of any product we manufacture or distribute. Regulatory authorities outside of the United States may impose similar sanctions for noncompliance with applicable regulatory requirements. If we are subject to any sanctions by the FDA or a foreign regulatory agency, our costs may increase and we may be prevented from manufacturing or selling our product offering, which would have a material adverse effect on our business, financial condition and results of operations.

LASIK surgeons must continue to adopt our product offering as an attractive alternative to the microkeratome for creating the corneal flap.

In the three months ended December 31, 2004, we captured approximately 16% of the U.S. market for creating the corneal flap. We believe that LASIK surgeons may not continue to adopt our product offering unless they determine, based on experience, clinical data and studies and published journal articles, including peer review articles, that our product offering provides significant benefits or an attractive alternative over the traditional method of creating the corneal flap using the microkeratome. A small number of surgeons have informed us, based on their experiences, of the following issues with our product offering when compared to the traditional microkeratome approach:

LASIK surgeons also must determine that the advantages and benefits of our product offering outweigh the increased costs associated with switching to our technology from the microkeratome. The microkeratome device costs between $40,000 and $60,000 per device, and, because the devices must be cleaned after each patient use and must be returned to the manufacturer for any service, LASIK surgeons typically purchase multiple devices to ensure a device is available for each surgery being performed. In comparison, our laser costs approximately $375,000. Additionally, using the microkeratome results in a cost between $25 and $50 per procedure to purchase the disposable blades, while our per procedure fee inclusive of a disposable patient interface costs new LASIK surgeons approximately $160 per procedure. The additional costs associated with our product offering could hinder continued adoption of our technology by LASIK surgeons, which would have a material adverse effect on our business, financial condition and results of operations.

In addition, we believe that recommendations and support of our laser by influential LASIK surgeons are essential for its market acceptance and adoption. If we do not receive support from such surgeons or from the data and experience of users, it may become difficult to have additional LASIK surgeons adopt our product offering. In such circumstances, we may not achieve expected revenues and may never become profitable.

Presently unknown side effects related to the use of our laser could emerge in the future.

Use of the INTRALASE^® FS laser to create the LASIK flap is a relatively new technique. Consequently there is no long term follow up data beyond five years that might reveal unknown side effects or complications associated specifically with this technique. The possibility of unfavorable side effects, and any concomitant adverse publicity, could seriously harm our business. In addition to the potential side effects and complications associated with LASIK generally, some LASIK

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surgeons have observed incidents of transient light sensitivity in patients treated with our system, although this has affected only a small percentage of patients and appears to resolve quickly with treatment. Any future reported adverse outcomes or pattern of side effects involving the use of our laser specifically, or with respect to LASIK procedures generally, could have a material adverse effect on our business, financial condition and results of operations.

Patients must continue to be willing to pay for LASIK surgery using our product offering despite it being more expensive than LASIK surgery with the microkeratome.

LASIK surgeons typically receive an average of $334 more per eye when using our product offering instead of the traditional microkeratome. To date, LASIK surgeons have been able to improve the rate at which laser vision correction consultations translate into actual surgery from 64% to 77% when using our product offering instead of the traditional microkeratome, according to a survey of our customers conducted by SM² Consulting, an independent consultant. This indicates that patients have been willing to pay for LASIK surgery using our product offering despite its higher cost. We cannot assure you that this trend will continue.

We may not be able to compete successfully against our current and future competitors.

We compete primarily with manufacturers of the microkeratome, the traditional method used to create the corneal flap as the first step in LASIK surgery. Principal manufacturers of the microkeratome include Bausch & Lomb, with approximately half of the U.S. microkeratome and blade market, Moria/Microtech, the second largest supplier of microkeratomes and blades in the U.S. market, Advanced Medical Optics and Nidek. Microkeratomes are less expensive to manufacture than our laser and our competitors may offer microkeratome systems at a lower price, may in the future price their microkeratome systems as part of a bundle of products or services, including the excimer laser used in the second step of LASIK surgery, or may enhance or further develop products to improve performance and accuracy of their existing product to compete against us. Any of these actions could decrease demand for our product offering, which would have a material adverse effect on our business, financial condition and results of operations. Some of these competitors, particularly Bausch & Lomb, have substantially greater resources, larger customer bases, longer operating histories and greater name recognition than we have.

We may also in the future compete with manufacturers of alternative technologies to create the corneal flap, such as other ultra-fast lasers or high pressure water jet products. If any of these alternative technologies gain market acceptance, this may reduce demand for our product offering.

In addition, since our product offering is used in the first step of LASIK surgery, we also compete with other vision disorder treatments that compete with LASIK, such as eyeglasses, contact lenses and other surgical products and techniques. Such techniques include corneal inlays and epithelial flaps, which are currently in the early stages of commercialization. If any of these alternative treatments result in decreased demand for LASIK surgery, this would decrease demand for our product offering. In addition, medical companies, academic and research institutions and others could develop new therapies, medical devices or surgical procedures that could potentially render LASIK surgery obsolete. Any such developments would have a material adverse effect on our business, financial condition and results of operations.

The medical device and ophthalmic laser industries are subject to rapid and significant technological change, frequent new device introductions and evolving surgical techniques. Demand for our product offering may decline if a new or alternative product or technology is introduced by one of our competitors that represents a substantial improvement over our existing product offering, which would have a material adverse effect on our business, financial condition and results of operations.

Measures we take to ensure collection of per procedure charges may be inadequate.

Generating per procedure revenues from our installed base of lasers is a key aspect of our business. We charge our customers a per procedure fee for each eye treated. This fee is inclusive of our disposable patient interface, which is intended to be used on a single eye and discarded. We typically charge our customers procedure fees based on our shipments to them of per procedure disposable interfaces.

We believe that a small percentage of our customers, in an effort to avoid procedure fees, are using a single patient interface to treat multiple eyes. If this practice (or other fee avoidance practices) were to proliferate, it could have a material adverse affect on our business.

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Our proprietary IntraLASIK^® software contains a feature which we must periodically reprogram to enable the laser to function. The frequency of reprogramming is determined solely by us on a laser by laser basis. Our software also tracks the number of procedures each laser has performed. This allows us to identify and address procedure fee violations. We are continuing to augment these capabilities through remote activation and other means. However, if these capabilities prove inadequate, or if other fee avoidance methods are devised which we are unable to detect or counter, this could have a material adverse affect on our business. By way of example, circumstances that could potentially hamper our enforcement efforts include: theft or disclosure of confidential passwords, improper or unauthorized tampering with laser hardware or software, lack of cooperation from international distributors, inability to obtain access to lasers in the field, legal impediments imposed by foreign jurisdictions and/or counterfeit patient interfaces.

Product liability suits brought against us could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.

If our INTRALASE^® FS laser or our per procedure disposable patient interface is defectively designed or manufactured or contains defective components, our IntraLASIK^® software is defective, any component of our product offering is misused or if a customer fails to adhere to operating guidelines, or if someone claims any of the foregoing, whether or not such claims are meritorious, we may become subject to substantial and costly litigation. Any product liability claims brought against us, with or without merit, could divert management’s attention from our business, be expensive to defend, result in sizable damage awards against us, damage our reputation, increase our product liability insurance rates, prevent us from securing continuing coverage, or prevent or interfere with commercialization efforts for our product offering, any of which occurrences would have a material adverse effect on us. In addition, we may not have sufficient insurance coverage for all future claims. Product liability claims brought against us in excess of our insurance coverage would likely be paid out of cash reserves, harming our financial condition and results of operations.

From time to time, we make field corrections to our laser, which are made by our field service representatives during scheduled service calls. Although these field corrections have not had a financial impact on us to date, any future corrections or recalls, especially any that result in preventing use of our laser or customers returning the laser to us for repair, would have a material adverse effect on us.

Our inability to adequately protect our intellectual property could allow our competitors and others to produce products based on our intellectual property rights, which could substantially impair our ability to compete.

Our success and ability to compete depends in part upon our ability to maintain the proprietary nature of our technologies. We rely on a combination of patent, trade secret, copyright and trademark law and license agreements, as well as nondisclosure agreements, to protect our intellectual property. These legal means, however, afford only limited protection and may not be adequate to protect our rights. In addition, we cannot assure you that any of our pending patent applications will issue. The U.S. Patent and Trademark Office, or PTO, may deny or significantly narrow claims made under our patent applications and, even if issued, these patents may be challenged or may otherwise not provide us with commercial protection. On August 23, 2004, the PTO granted a request for re-examination with respect to U.S. Patent RE 37,585, one of the patents licensed to us by the University of Michigan, which means that the PTO found that the request raised a new issue of patentability with regard to a number of claims. Re-examination may result in the scope of protection and rights provided by the patent license being lost or narrowed.

We may in the future need to assert claims of infringement against third parties to protect our intellectual property. Regardless of the final outcome, any litigation to enforce our intellectual property rights in patents, copyrights, or trademarks could be highly unpredictable and result in substantial costs and diversion of resources, which could have a material adverse effect on our business, financial condition and results of operations. In the event of an adverse judgment, a court could hold that some or all of our asserted intellectual property rights are not infringed, or are invalid or unenforceable, and could award attorneys’ fees to the other party. In addition, the laws of other countries in which our product offering is or may be sold may not protect our product offering and intellectual property to the same extent as U.S. laws, if at all. We also may be unable to protect our rights in trade secrets and unpatented proprietary technology in these countries. Despite our efforts to safeguard our unpatented and unregistered intellectual property rights, we may not be successful in doing so, or the steps taken by us in this regard may not be adequate to detect or deter misappropriation of our technology or to prevent an unauthorized third party from copying or otherwise obtaining and using our products, technology or other information that we regard as proprietary. Our inability to adequately protect our intellectual property could allow our competitors and others to produce products based on our patented or proprietary technology and other intellectual property rights, which could substantially impair our ability to compete.

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We may become subject to claims of infringement or misappropriation of the intellectual property rights of others, which could prohibit us from selling our product offering, require us to obtain licenses from third parties to develop non-infringing alternatives and/or subject us to substantial monetary damages and injunctive relief.

Third parties could assert infringement or misappropriation claims against us with respect to our current or future product offerings, whether or not such claims are valid. We cannot be certain that we have not infringed the intellectual property rights of such third parties or others. Any infringement or misappropriation claim could result in significant costs, substantial damages and our inability to manufacture, market or sell our existing or future product offerings that are found to infringe. If a court determined, or if we independently discovered, that our product offering violated third-party proprietary rights, there can be no assurance that we would be able to re-engineer our product offering to avoid those rights or obtain a license under those rights on commercially reasonable terms, if at all. As a result, we could be prohibited from selling products that are found to infringe. Even if obtaining a license were feasible, it may be costly and time-consuming. A court also could enter orders that temporarily, preliminarily or permanently enjoin us and/or our customers from making, using, selling, offering to sell or importing our product offering, or could enter orders mandating that we undertake certain remedial activities. A court also could order us to pay compensatory damages for such infringement, plus prejudgment interest, and could in addition treble the compensatory damages and award attorneys’ fees. These damages could be substantial and could harm our reputation, business, financial condition and results of operations.

We depend on certain single-source suppliers and manufacturers for key components of our laser, and the loss of any of these suppliers or manufacturers, or their inability to supply us with an adequate supply of materials, could harm our business.

We rely upon certain suppliers and contract manufacturers to supply key parts for our laser on a sole or limited source basis. Our arrangements with these key suppliers and manufacturers are not on a contractual basis and can be terminated by either party without advance notice. If any of these suppliers and manufacturers were to fail to supply our needs on a timely basis or cease providing us these key components, we would be required to locate and contract with substitute suppliers. We could have difficulty identifying a substitute supplier in a timely manner or on commercially reasonable terms. If this were to occur, we may not be able to meet our sales goals or continue manufacturing lasers, either of which would have a material adverse effect on our business, financial condition and results of operations.

Our failure to manage our rapid growth may strain the capabilities of our managers, operations and facilities.

We are growing rapidly. In 2004 we sold or leased 111 lasers and sold 191,861 per procedure fees inclusive of a disposable patient interface; in 2003, we sold or leased 67 lasers and sold 84,230 per procedure fees inclusive of a disposable patient interface; and in 2002, we sold 35 lasers and 29,622 per procedure fees inclusive of a disposable patient interface. This growth has resulted in, and continued growth will create in the future, additional capacity requirements, new and increased responsibilities for our management team and may create pressures on our operating and financial systems.

If we continue to grow, our current facilities are unlikely to be adequate for our needs. As a result, on January 31, 2005 we entered into a lease agreement for a larger facility in Irvine, California with approximately 128,670 square feet. The lease is for a period of ten years and four months beginning May 1, 2005. Any delays in moving into this new facility could cause us to incur additional expenses and could divert management time and energy from the operation and growth of our business. In addition, our expected growth will require us to hire, train and manage additional qualified personnel sufficiently in advance to be in a position to meet the requirements of such growth. Continued growth also will require us to improve existing, and implement new operating, financial and management information controls, reporting systems and procedures, and effectively manage multiple relationships with our customers, suppliers and other third parties. In addition, our anticipated growth may strain the ability of our suppliers to deliver an increasingly large supply of components in accordance with agreed-upon specifications on a timely basis. Additional growth may also prevent us from being able to respond to new opportunities and challenges quickly.

If we are unable to effectively manage our expected growth, this could have a material adverse effect on our business, financial condition and results of operations.

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We plan to expand further into markets outside the United States, which subjects us to additional business and regulatory risks.

Our international sales commenced in 2003 and represented 29% of our total revenues in 2004 and 18% of our total revenues in 2003. We intend to derive an increasing portion of our total revenues from sales of our product offering in foreign countries. We plan to focus most of our efforts on the Asia-Pacific region, Europe and the Middle East.

Conducting business internationally subjects us to a number of risks and uncertainties. In addition to being subject to political and economic instability in foreign markets, we require export licenses and are subject to tariffs and other trade barriers and overlapping tax structures. In addition, we must comply with foreign regulatory requirements. In creating and building our infrastructure internationally, we must also educate LASIK surgeons and optometrists about our product offering and attract and maintain relationships with third-party distributors. If we are unable to do any of this successfully, we may not be able to grow our international presence, and this could have an adverse effect on our business, financial condition and results of operations.

Our success is tied to a single product offering.

We have a single product offering used in LASIK surgery. As a result, our success is tied to the success of this product offering since we are not currently able to derive revenues from alternate product offerings. If for any reason we are unable to continue to manufacture or sell our product offering or if production of our product offering were interrupted or could not continue in a cost-effective or timely manner, whether due to regulatory sanctions, manufacturing constraints, product defects or recalls, obsolescence of our technology, increased competition, intellectual property concerns or otherwise, our business would be materially harmed.

All of our operations are conducted at a single location. Any disruption at our existing or at a new facility could increase our expenses.

All of our operations are currently and, with our new lease signed in 2005, will continue to be conducted at a single location. We take precautions to safeguard our existing facility and intend to take substantially similar precautions at any new or additional facility, including insurance, health and safety protocols and off-site storage of computer data. However, a natural disaster, such as an earthquake or fire could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. The insurance we maintain against fires and other natural disasters and the property and business interruption insurance we maintain may not be adequate to cover our losses in any particular case.

A loss of key executives or failure to attract qualified personnel could limit our growth and adversely affect our business.

Our future success depends in part on the continued service of key personnel, particularly our Chief Executive Officer, Robert Palmisano, our Chief Technical Officer and co-founder, Tibor Juhasz, our Medical Director and co-founder, Ron Kurtz, as well as our sales and marketing executives and our regulatory and compliance officer. We do not have employment agreements with any of our employees other than with our Chief Executive Officer; our Executive Vice President, Chief Operating Officer; our Senior Vice President and General Counsel; our Vice President, Corporate Communications and Investor Relations; and our Vice President, Human Resources; and we do not have key person insurance on any of our executives. The loss of any one or more of these individuals could place a significant strain on our remaining management team and we may have difficulty replacing any of these individuals. Furthermore, our future growth will depend in part upon our ability to identify, hire and retain additional key personnel, including qualified management, research and other highly skilled technical personnel.

Our new products or applications may not be commercially viable.

While we devote significant resources to research and development, our research and development may not lead to improved or new products or applications that are commercially successful. The research and development process is expensive, prolonged and entails considerable uncertainty. Development of medical devices, from discovery through testing and registration to initial product launch, typically takes between three and seven years. Each of these periods varies considerably from product to product and country to country. Because of the complexities and uncertainties associated with ophthalmic research and development, products and applications we are currently developing may not complete the development process or obtain the regulatory approvals required to market such products or applications successfully. The products and applications currently in our development pipeline may not be approved by regulatory entities and may not be commercially successful, and our current and planned products and applications could be surpassed by more effective or advanced products and applications developed and marketed by others.

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If we choose to acquire new or complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete those acquisitions or to successfully integrate them in a cost-effective and non-disruptive manner.

While we have not made any acquisitions in the past and do not have current commitments to do so, we may in the future choose to acquire businesses, products or technologies to retain our competitive position within the marketplace or to expand into new markets. We cannot assure you, however, that we would be able to successfully complete any acquisition we choose to pursue, or that we would be able to successfully integrate any acquired business, product or technology in a cost-effective and non-disruptive manner. If we were unable to integrate any acquired businesses, products or technologies effectively, our business would likely suffer.

We have a history of net losses and may never achieve or maintain profitability.

We have incurred significant operating losses every year since our inception in 1997. We incurred net losses applicable to common stockholders of $10.2 million in 2004, $12.0 million in 2003 and $12.0 million in 2002. As of December 31, 2004, we had an accumulated deficit of approximately $63.4 million. In order to achieve profitability, we will need to significantly increase our revenues from sales of our product offering, and we will also need to continue to derive an increasing percentage of our total revenues from sales of our per procedure fee inclusive of a disposable patient interface, which generate a higher gross margin than sales and leases of our INTRALASE^® FS laser. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis due to, among other things, competitive pressures and regulatory compliance, in which case the price of our common stock may decline.

Our ability to use net operating loss carryforwards may be limited.

Section 382 of the Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in its stock ownership. We have internally reviewed the applicability of the annual limitations imposed by Section 382 caused by previous changes in our stock ownership and believe such limitations should not be significant. Based on our review, we believe that as of December 31, 2004 approximately $55.5 million of net operating loss carryforwards were available to us for federal income tax purposes. Based on the size and price of our initial public offering, which was effective October 6, 2004 and closed October 13, 2004, we may trigger the annual limitations imposed by Section 382 and may limit our ability to use our remaining net operating loss carryforwards to approximately $15.3 million annually. In addition, any future ownership changes may affect our ability to use our remaining net operating loss carryforwards. If we lose our ability to use net operating loss carryforwards, our income will be subject to tax earlier, resulting in lower net income.

Changes to our accounting for stock options will adversely affect our earnings and may adversely affect stock price.

We currently are not required to record stock-based compensation charges if an employee’s stock option exercise price equals or exceeds the fair value of our common stock at the date of grant. However, in December 2004 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, or SFAS, No. 123 (Revised 2004) that will require us to expense the fair value of stock options granted. If we were to change our accounting policy in accordance with the existing SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure and retroactively restate all prior periods as if we had adopted SFAS 123 for all periods presented, our operating expenses would increase by approximately $509,000 and $168,000 for 2004 and 2003, respectively. We believe the adoption of SFAS No. 123 (Revised 2004) will have a material impact on our results of operations

We may incur increased costs as a result of recently enacted and proposed changes in laws and regulations.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules proposed by the Securities and Exchange Commission and by the Nasdaq Stock Market, are expected to result in increased costs to us as a public company. The new rules could make it more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring

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developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. Additionally, unearned deferred stock compensation for non-employees is periodically remeasured through the vesting date under current and future accounting rules. This periodic remeasurement could have a significant impact on our results of operations.

Item 2—Properties

We lease 41,400 square feet of office and manufacturing space for our corporate, research and development and manufacturing headquarters in Irvine, California, under a five-year renewable lease, the initial term of which expires on October 31, 2005. It is not our intention to renew this lease at the end of the lease term. To address our expected increased demand for administrative offices and manufacturing capacity, we have rented 11,449 square feet of additional office space nearby on a month-to-month basis, and on January 31, 2005 we entered into a lease agreement for a larger facility in Irvine, California with approximately 128,670 square feet. The lease is for a period of ten years and four months beginning May 1, 2005. We believe the new facility will be adequate to meet our current requirements.

Item 3—Legal Proceedings

From time to time we are involved in various legal proceedings and disputes that arise in the normal course of business. These matters have included product liability actions, intellectual property disputes, contract disputes, employment disputes and other matters. We do not believe that the resolution of any of these matters has had or is likely to have a material adverse effect on our business, financial condition or future results of operations.

We are currently involved in litigation with Escalon Medical Corp., tentatively set for trial in May of 2005. On June 10, 2004, we received notice from Escalon of its intent to terminate our license agreement unless we paid in full certain royalties which Escalon believes we owe under the license agreement. Escalon seeks payment of approximately $645,000 in additional royalties and other expenses, and seeks additional royalties for future periods that would, if Escalon prevailed on all aspects of their claims, represent an increase in the royalties paid to them by approximately one percent of revenues, and a subsequent one percent reduction in our future gross margins and operating profits. On June 21, 2004, we filed a complaint for declaratory relief and a preliminary injunction and a temporary restraining order to prevent Escalon from terminating our license agreement until the court rules. Escalon subsequently agreed to stipulate to the temporary restraining order to prevent an immediate termination of the license agreement until a preliminary injunction hearing. On October 29, 2004, the court accepted a second stipulation by the parties to waive the preliminary injunction hearing. This second stipulation precludes Escalon from declaring a breach on this dispute pending a trial or dispositive ruling by the court.

On February 7, 2005, the parties submitted cross motions for summary judgment to the court. On March 1, 2005, the court entered its order on the parties’ cross-motions for summary judgment, ruling on the majority of issues in the case. The court ruled in our favor on some issues and in Escalon’s favor on others. We believe that neither the court’s order nor the ultimate resolution of the case will have a material adverse effect on our business, financial condition and results of operations. Our financial statements were not affected at December 31, 2004.

On August 23, 2004, the United States Patent and Trademark Office, or PTO, granted a request for re-examination with respect to U.S. Patent RE 37,585, one of the four U.S. patents licensed to us by the University of Michigan, which means that the PTO found that the request raised a new issue of patentability with regard to some of the claims. Re-examination may result in the scope of protection and rights provided by the patent license being lost or narrowed. The irrevocable license we acquired and the payment we made pursuant to the July 15, 2004 license agreement will not be affected by the granting of re-examination, regardless of the outcome. Although we believe that the intellectual property covered by the patent subject to the re-examination is important to our business, if this patent is invalidated there will be no effect on our ability to sell our products. However, invalidation or narrowing of this patent might allow others to market competitive products that would otherwise have infringed the patent.

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

No matters were submitted to a vote of our stockholders during the quarter ended December 31, 2004.

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PART II

Item 5—Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock has been traded on the Nasdaq National Market under the symbol “ILSE” since October 7, 2004.

The following table shows the high and low closing prices of our common stock as reported on the Nasdaq National Market for the periods indicated:

As of March 21, 2005, there were 100 holders of record based on the records of our transfer agent.

We have never paid cash dividends on our common stock. We currently anticipate that we will retain earnings, if any, to support operations and to finance the growth and development of our business and do not anticipate paying cash dividends in the foreseeable future.

The following table sets forth all purchases made by us of our common stock during each month within the fourth quarter of 2004. No purchases were made pursuant to a publicly announced repurchase plan or program.

The information required by this item regarding equity compensation plan information is set forth in Part III, Item 12 of this Annual Report on Form 10-K.

For a listing of our sales of unregistered equity securities during fiscal 2004 see our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004.

The initial public offering of our common stock was effected through a Registration Statement on Form S-1 (File No. 333-116016) that was declared effective by the Securities and Exchange Commission on October 6, 2004. On October 13, 2004, 7,295,447 shares of common stock were sold on our behalf and for our account at an initial public offering price of $13.00 per share, for an aggregate net offering price of $88.2 million. In addition, 336,314 shares of our common stock were sold for the account of the Regents of the University of Michigan and the Wolverine Venture Fund for an aggregate net offering price of $4.07 million. The managing underwriters for the offering were Banc of America Securities LLC, Wachovia Capital Markets LLC, First Albany Capital Inc. and ThinkEquity Partners LLC. The amounts sold on October 13, 2004 included the exercise of the underwriters’ over-allotment option. The offering did not terminate until the sale of all the registered securities set forth above to the underwriters. As of December 31, 2004, all of the net proceeds from this offering were invested in short-term, high-grade interest-bearing marketable securities, certificates of deposit or direct or guaranteed obligations of the U.S. government.

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Item 6—Selected Financial Data

The following statements of operations data and balance sheet data for the five years ended December 31, 2004 were derived from our audited consolidated financial statements. The information set forth below is not necessarily indicative of the results to be expected for any future periods and should be read in conjunction with the audited consolidated financial statements, related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K.

Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of our financial condition and results of operations together with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements due to known and unknown risks, uncertainties and other factors, including those risks discussed under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements as defined within the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the use of words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.” Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Those risks and uncertainties include, but are not limited to: the degree of continued acceptance of LASIK surgery; potential complications revealed by long term follow

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up; general economic conditions; changes in federal tax laws governing the ability of potential LASIK patients to use pre-tax dollars to pay for LASIK surgery; the scope of government regulation applicable to our products; the extent of adoption of our product offering by LASIK surgeons; patients’ willingness to pay for LASIK surgery; our ability to compete against our competitors; the effectiveness of our measures to ensure full payment of procedure fees; the occurrence and outcome of product liability suits against us; our ability to adequately protect our intellectual property; whether we become subject to claims of infringement or misappropriation of the intellectual property rights of others; the continued availability of supplies from single-source suppliers and manufacturers of our key laser components; the ability of our managers, operations and facilities to manage our growth; the success of our expansion into markets outside the United States; whether we lose any of our key executives or fail to attract qualified personnel; or if our new products or applications fail to become commercially viable.

Overview

Background

We are a medical device company focused on the design, development and marketing of an ultra-fast laser, related software and disposable devices for use in LASIK surgery. Our product offering is used to create the corneal flap in the first step of LASIK surgery. From our incorporation in late 1997 through late 2001, we devoted substantially all of our resources to designing, developing, commercializing and marketing our INTRALASE^® FS laser, our IntraLASIK^® software and our disposable patient interface. In late 2001, we introduced our product offering to the U.S. market, and we began expanding into key international markets in the second half of 2003. In the three months ended December 31, 2004, we captured approximately 16% of the U.S. market for LASIK corneal flap creation.

Our quarterly laser sales or leases, cumulative lasers installed and per procedure patient interface units in 2002, 2003 and 2004 by territory were as follows:

Since inception we have been unprofitable. We incurred net losses applicable to common stockholders of approximately $15.8 million in 2001, $12.0 million in 2002, $12.0 million in 2003 and $10.2 million in 2004. As of December 31, 2004, we had an accumulated deficit of approximately $63.4 million.

Initial Public Offering of Common Stock

Our initial public offering, which was effective under applicable securities laws on October 6, 2004 and closed on October 13, 2004, resulted in our receipt of net proceeds of $86.1 million from the sale of 7,295,447 shares of common stock, including the sale of 995,447 over-allotment shares. The proceeds were net of the payment of expenses for the initial public offering of $2.2 million. The net proceeds of the offering were used for the repayment of our bank debt in the amount of $1.3 million and the payment to the University of Michigan of $765,000 due within 15 days of the initial public offering. In addition, 22,191,333 shares of redeemable convertible preferred stock converted to 16,797,103 shares of common stock.

Revenues

We generate revenues primarily from the sale or lease of our INTRALASE^® FS laser and the sale of our per procedure fee inclusive of a disposable patient interface. We derive a smaller portion of our revenues from product maintenance.

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The following table sets forth the sources and amounts of our revenues for the periods indicated:

We target the most active LASIK surgery practices in the United States and in key international markets to adopt our product offering in order to generate recurring business from our per procedure disposable patient interfaces. We expect that, even with increased sales and leases of our INTRALASE^® FS laser, repeat revenues from the higher gross margin per procedure fees inclusive of disposable patient interfaces will continue to increase as a percentage of our total revenues, which will, in turn, drive higher overall gross margin.

Terms of Sale and Revenue Recognition

Laser

In 2004, 85% of our new laser sales or leases were sales, representing 96% of our total laser revenues, and 15% were operating leases, representing 4% of our total laser revenues. In comparison, in 2003, the first year in which we began leasing lasers on a direct basis, 52% of our new unit placements were sales, representing 96% of our total laser revenues, and 48% were operating leases, representing 4% of our total revenues.

Outside the United States, we sell to our international distributors and, in selected instances, directly to LASIK surgery practices. Payment terms are cash in advance or irrevocable letter of credit. However, on occasion, we have granted limited terms to distributors, usually for less than net 10 days to ensure shipment by a specified carrier.

Per procedure fee and disposable patient interface

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Product maintenance

International Revenue Expansion

We introduced our product offering in the United States in late 2001 and internationally in the second half of 2003. As of December 31, 2004, we had sold or leased 166 lasers in the United States and we had sold 51 internationally, primarily in the Asia-Pacific region, Europe and the Middle East. In international markets, we mainly sell our product offering through local country third-party distributors. These distributors are responsible for sales, customer support and product maintenance, and as a result generally pay a lower price for our product offering. As a result, the mix between direct sales in the United States and distributor sales internationally may create fluctuations in our gross margin.

Seasonality

Lasers. Sales and leases of our lasers are seasonal. The second and fourth calendar quarters are typically stronger than the first and third calendar quarters. Two of the largest ophthalmology shows for refractive surgeons, the American Society of Cataract and Refractive Surgery, or ASCRS, and the American Academy of Ophthalmology, or AAO, are held in the second and fourth quarters, leading prospective customers to delay purchases in the first and third quarters until they have an opportunity to attend the shows, visit with us and attend lectures and symposiums on our product offering. In addition, tax incentives typically help to drive U.S. capital equipment spending higher in the fourth quarter. Sales and leases of our lasers in the third quarter are generally slower as surgeons in the United States and internationally typically take increased vacation time during the summer.

Per procedure fees and disposable patient interfaces. Sales of our per procedure fees inclusive of disposable patient interfaces are also seasonal. The first quarter typically shows an increase in volume in the United States. We believe this is because many potential LASIK patients in the United States access annual funding accounts established under Internal Revenue Code Section 125 pre-tax medical savings plans, or cafeteria plans, to purchase LASIK surgery, as LASIK surgery is not generally paid for through insurance programs or government reimbursement. The second and fourth quarter do not show any significant seasonal change. However, procedure volume is slower during the third quarter, as surgeons in the United States and internationally typically take increased vacation time during the summer.

Results of Operations

The following table sets forth our results of operations expressed as a percentage of total revenues for the periods indicated.

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Comparison of the years ended December 31, 2004 and December 31, 2003

Revenues

Total revenues increased to $60.0 million in 2004 from $25.4 million in 2003. The increase was attributable to continued market acceptance of our product offering and our further expansion into international markets, primarily in the Asia-Pacific region, Europe and the Middle East, with the European increase due primarily to obtaining our CE mark in the first quarter of 2004. During 2004, we sold or leased 111 lasers and generated $33.2 million in revenues. In comparison, during 2003, we sold or leased 67 lasers and generated $14.8 million in revenues. In 2004, 85% of our total new laser sales or leases were sales, representing 96% of our total laser revenues, and 15% were operating leases, representing 4% of our total laser revenues. In comparison, in 2003, the first year in which we began leasing lasers on a direct basis, 52% of our total new unit placements were sales, representing 96% of our total laser revenues, and 48% were operating leases, representing 4% of our total revenues. The average selling price per laser sold or leased in 2004 increased 36 percent as compared to 2003 primarily because we had 19 fewer leases, which generate revenue over 39 months, in 2004 as compared to 2003. The average selling price per laser excludes the deferral of the fair value of the maintenance agreement from laser revenue, which is amortized over the twelve month warranty period as maintenance revenue, and is also effected by the mix of international distributor sales and domestic sales and the mix of laser leases versus laser sales in the US.

In 2004, we sold 191,861 per procedure fees inclusive of disposable patient interfaces and generated $22.3 million in revenues. In comparison, during 2003, we sold 84,230 per procedure fees inclusive of disposable patient interfaces and generated $9.1 million in revenues. We attribute the increase in sales of per procedure fees inclusive of disposable patient interfaces to an increased installed base of lasers, as we entered 2004 with approximately 2.5 times the installed base of lasers as compared to the same period in 2003. We expect sales of our per procedure fees inclusive of disposable patient interfaces to continue to increase as the installed base of lasers increases.

The increase in our installed base of lasers also led to an increase in our maintenance revenues to $4.5 million during 2004, as compared to $1.5 million during 2003. We expect our maintenance revenues to continue to increase as the installed base of lasers increases.

Gross Margin

Gross margin, as a percentage of total revenues, increased to 42% in 2004 from 33% in 2003. Costs of goods sold, as a percentage of total revenues, decreased due to higher average selling prices for our laser, lower royalty expenses on our laser due to lower amortization costs for our licensing fees as compared to the royalties previously paid to the University of Michigan, lower material costs and lower per unit labor and overhead costs for both our laser and our patient interface in 2004 as compared to the prior year period. Per unit material, labor and overhead costs were lower as the increase in the number of lasers sold or leased and the increase in the number of per procedure fees inclusive of disposable patient interfaces sold resulted in volume discounts for material components and lower fixed overhead costs per unit. Additionally, changes in our laser product reduced vendor material costs.

We expect gross margins to continue to improve for the next several years at rates that are similar to, or slightly lower than, the rates of improvement in gross margin between 2003 and 2004. We believe that the primary drivers of this continued improvement in 2005 will be increases in the percentage of total revenues derived from per procedure fees inclusive of disposable patient interfaces.

Research and Development

Research and development expenses consist of costs of product research, product development, engineering, regulatory compliance and clinical support studies. Research and development expenses increased by $3.6 million to $12.7 million in 2004 from $9.1 million in 2003. This increase resulted from increased expenses for stock based compensation of $1.3

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million, a $765,000 expensed portion of converting a royalty agreement to a full-paid royalty free technology license from the University of Michigan, $698,000 of higher personnel costs, $306,000 to reimburse the selling stockholders for discounts and commissions to underwriters payable by the selling stockholders, $236,000 in increased depreciation expense on higher fixed assets, increased legal fees associated with our intellectual property and licensing agreements of $175,000, increased expenses of $117,000 for regulatory and quality costs incurred in connection with obtaining our ISO EN 13485 certification and CE mark in the first quarter of 2004.

Selling, General and Administrative

Selling, general and administrative expenses consist of expenses associated with sales, marketing, field service and clinical applications that are not otherwise direct costs of installing and supporting our product offering, finance, information technology and human resources. Selling, general and administrative expenses increased by $12.1 million to $23.4 million in 2004 from $11.2 million in 2003. The increase resulted from higher personnel costs in sales, marketing and general and administrative departments of $2.9 million; an increase in stock based compensation of $2.7 million; an increase in travel, relocation and recruiting fees of $2.6 million; higher marketing, advertising, promotion and event costs of $1.1 million; increase in commissions paid to sales representatives on higher sales totaling $791,000; higher personnel costs primarily for the addition of international sales and sales support personnel totaling $777,000; an increase in facilities expense of $629,000 and higher legal and accounting fees of $486,000.

Stock-Based Compensation

Over the next several years, we will incur non-cash expenses for employee stock-based compensation, decreasing quarterly, for stock-based compensation for stock options determined to have been issued at less than estimated fair value. In addition, we expect to incur stock-based compensation expenses, primarily for options granted to non-employees, that may decrease or increase quarterly, depending upon future fluctuations in our stock price. In December 2004, FASB issued SFAS No 123 (revised 2004) (“SFAS 123R”), Share-Based Payment .We are currently evaluating SFAS No. 123R to determine which fair-value-based model and transitional provision we will follow upon adoption. SFAS No. 123R will be effective for us beginning in our third quarter of fiscal 2005. Although we will continue to evaluate the application of SFAS No. 123R, management expects adoption to have a material impact on our results of operations in amounts not yet determinable. Additionally, unearned deferred stock compensation for non-employees is periodically remeasured through the vesting date under current and future accounting rules. This periodic remeasurement could have a significant impact on our results of operations. See “—Critical Accounting Policies—Stock-Based Compensation.”

Comparison of the Years Ended December 31, 2003 and December 31, 2002

Revenues

Total revenues increased to $25.4 million in 2003 from $18.1 million in 2002. The increase in 2003 resulted from the continued market acceptance of our product offering.

The growth rate of our laser revenues slowed in 2003, notwithstanding our growth in laser unit volume. This resulted from the change in our sales model in early 2003. First, in response to market feedback, we reduced the fixed acquisition price of our laser by approximately 12%. Second, we began placing lasers using operating leases, where we recognize revenues ratably over the term of the lease, which results in a deferral of our laser revenues. These two factors resulted in a 46% decrease in revenues per average laser sold or leased in 2003 as compared to lasers sold in 2002.

During 2003, we also made changes to our model for selling per procedure fees inclusive of disposable patient interfaces, which are purchased on an as-needed basis by surgeons. These changes included increasing the list price of the per procedure fees inclusive of a disposable patient interface by 50% to new customers, introducing a volume discount pricing to higher volume customers, commencing international sales to distributors at a discounted distributor price, and reducing the price to some existing customers for purchases in excess of their expected monthly volumes. This new pricing model resulted in an overall 4% decrease in the average sales price of each per procedure fee inclusive of a disposable patient interface in 2003 compared with 2002.

Revenues associated with maintenance services increased to $1.5 million in 2003 from $351,000 in 2002 primarily from the increase in our installed base of lasers. During 2003, our cost of providing maintenance services approximated our maintenance revenues.

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Gross Margin

Gross margin was 33% of total revenues in 2003 and 26% in 2002. The increase in gross margin to 33% in 2003 from 26% in 2002 was primarily due to a $5.7 million increase in sales of our per procedure fee inclusive of a disposable patient interfaces, which have a higher gross margin than our lasers. This was an increase as a percentage of total revenues from to 36% in 2003 from 19% in 2002. In addition, the gross margin of our per procedure fee inclusive of a disposable patient interface improved by approximately 10% due to cost savings associated with higher volume purchasing and manufacturing. The improvement in gross margin was offset in part by lower revenues per average laser sold or leased of approximately 46%, resulting in a 42% decrease in the gross margin on our laser. In addition, overall gross margins improved as additions to inventory reserves decreased by $1.0 million from 2002 to 2003. The decrease in inventory reserves occurred because, as our products matured, there were fewer design changes and thus fewer components became obsolete. Upon determining component parts are obsolete, we establish a 100% reserve. We believe these components will ultimately be scrapped, and to date, no component parts reserved have been subsequently resold.

Research and Development

Research and development expenses totaled $9.1 million in 2003 and $9.0 million in 2002. The increase in 2003 resulted primarily from higher regulatory spending of $649,000 due to expanded commercial activities requiring a larger regulatory organization, partially offset by lower spending in research and development activities and clinical support studies in the amount of $544,000.

Selling, General and Administrative

Selling, general and administrative expenses totaled $11.2 million in 2003 and $8.0 million in 2002. The increase reflects higher sales and commission costs of $1.7 million in 2003. The increase also reflects higher marketing costs of $828,000 in 2003 associated with increased sales of our product offering, and higher personnel costs of $566,000 in 2003.

Seasonality and Quarterly Results

Our business is seasonal. Sales and leases of our lasers are typically stronger in the second and fourth quarters and sales of our higher gross margin per procedure fees inclusive of disposable patient interfaces are typically stronger in the first quarter and slower in the third quarter. See “—Overview—Seasonality” for a discussion of the reasons for the seasonality of our business.

The following table presents unaudited quarterly information for each quarter of fiscal years 2004 and 2003. This information has been derived from our unaudited financial statements prepared on the same basis as our financial statements, which, in our opinion, reflects all adjustments, which include only normal recurring adjustments, necessary to present fairly the unaudited quarterly results when read in conjunction with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. These historical operating results are not necessarily indicative of the results to be expected for any future period.