INTRALASE CORP - 10-Q Quarterly Report

Former name, former address and former fiscal year, if changed since last report

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 27,238,753 shares of common stock, $0.01 par value, outstanding as of May 9, 2005.

During the three months ended March 31, 2004 the Company recorded accretion of $14,949 to the redemption value of redeemable convertible preferred stock.

The information set forth in these financial statements as of March 31, 2005 and December 31, 2004 and for the three months ended March 31, 2005 and 2004, is unaudited and includes the accounts of IntraLase Corp. (the “Company”). The information reflects all adjustments consisting only of normal recurring entries that, in the opinion of management, are necessary to present fairly the financial position and results of operations of the Company for the periods indicated. Results of operations for the interim periods are not necessarily indicative of the results of operations for the full fiscal year.

Certain information in footnote disclosures normally included in annual financial statements has been condensed or omitted, in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial statements.

The information contained in these interim financial statements should be read in conjunction with the Company’s audited financial statements as of and for the year ended December 31, 2004 contained in the Company’s Annual Report on Form 10-K.

Revenue Recognition—In the normal course of business, the Company generates revenue through the sale and rental of lasers, the sale of per procedure fees inclusive of a disposable patient interface and maintenance services. Revenue related to sales of the Company’s products and services is recognized as follows:

Laser revenues: Revenues from the sale or lease of lasers are recognized at the time of sale or at the inception of the lease, as appropriate. For laser sales that require the Company to install the product at the customer location, revenue is recognized when the equipment has been delivered, installed and accepted at the customer location. For laser sales to a distributor whereby installation is the responsibility of the distributor, revenue is recognized when the laser is shipped and title has transferred to the distributor. The Company does not allow customers, including distributors, to return any products. Revenues from lasers under operating leases are recognized as earned over the lease term, which is generally on a straight-line basis over 36 to 39 months.

Per Procedure Fees Inclusive of a Disposable Patient Interface revenues: Per procedure fees inclusive of a disposable patient interface revenue is recognized upon shipment to the customer and when the title has passed in accordance with sales terms. The Company does not allow customers to return product.

Maintenance revenues: Maintenance revenues are derived primarily from maintenance contracts, which the Company began selling in 2003, on the Company’s laser systems sold to customers. Prepaid maintenance expenses are deferred and recognized on a straight line basis over the term of the contracts, generally 12 months. A substantial portion of the Company’s products are sold with a one year maintenance agreement for which the Company defers an amount equal to its fair value. To the extent the Company determines revenues associated with a specific maintenance contract are not sufficient to recover the estimated costs to provide such maintenance services, the Company accrues for such excess costs upon identification of the associated embedded loss. To date, these embedded losses have been insignificant.

Revenue Recognition under Bundled Arrangements: The Company sells most of its products and services under bundled contract arrangements, which contain multiple deliverable elements. These contractual arrangements typically include the laser and maintenance for which the customer pays a single negotiated price for all elements with separate prices listed in the multiple element customer contracts. Such separate prices may not always be representative of the fair values of those elements, because the prices of the different components of the arrangement may be modified through customer negotiations, although the aggregate consideration may remain the same. Revenues under bundled arrangements are allocated based upon the residual method in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. The Company’s revenue allocation to the deliverables begins by allocating revenues to the maintenance service, and second by allocating revenue to the laser. There is reliable third-party and entity-specific evidence of the fair value of the maintenance service, and the residual method is used to allocate the arrangement consideration to the delivered item (the laser). Fair value evidence consists

of amounts charged for annual renewals of maintenance agreements by the Company, which are required for the customer to continue using the laser, prices the Company’s third party distributors charge their customers and amounts charged for maintenance by excimer laser manufacturers, for which maintenance may be different than the maintenance on the Company’s lasers.

Stock-Based Compensation—The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. The Company accounts for stock-based awards to nonemployees using the fair value method in accordance with SFAS No. 123, Accounting for Stock-Based Compensation.

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. SFAS No. 148 amends SFAS No. 123 to provide alternative methods for voluntary transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation (“the fair value method”). SFAS No. 148 also requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income (loss) in annual financial statements. The Company is required to follow the prescribed disclosure format and has provided the additional disclosures required by SFAS No. 148 for the three months ended March 31, 2005 and 2004 below.

SFAS No. 123 requires the disclosure of pro forma net income (loss) had the Company adopted the fair value method in accounting for employee stock-based awards. Under SFAS No. 123, the fair value of stock- based awards to employees is calculated through the use of option-pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock-option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company’s calculations were made using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected life of 60 months for employee stock options under our plans, six months for the employee stock purchase plan in 2005; volatility of 67% and 0% in the three months ended March 31, 2005 and 2004, respectively and risk-free interest rates averaging 4.1% and 2.7% in the three months ended March 31, 2005 and 2004, respectively; no dividends during the expected term; and forfeitures are recognized as they occur.

If the computed fair value of the awards had been amortized to expense over the vesting period of the awards, net income (loss) would have been as follows for the periods ended:

Net Income (Loss) Applicable to Common Stockholders—Net loss applicable to common stockholders for the three months ended March 31, 2004 has been calculated by adding to the net loss the accretion to the redemption value of redeemable convertible preferred stock.

Net Income (Loss) per Share Applicable to Common Stockholders—Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding for the period. Diluted

net income (loss) per share is computed giving effect to all common stock, including options, warrants, common stock subject to repurchase and redeemable convertible preferred stock, if dilutive.

The Company had 5,024,193 outstanding options to purchase common stock, 16,797,103 shares of redeemable convertible preferred stock and 39,514 warrants that were excluded from the computation of diluted net loss per share for the three months ended March 31, 2004 as they had an antidilutive effect.

Included in the calculation of net loss attributable to common stockholders is accretion to redemption value of $14,949 for the three months ended March 31, 2004 related to the issuance of the Company’s redeemable convertible preferred stock.

Comprehensive Loss—There was no difference between comprehensive loss and net loss for the three months ended March 31, 2005 and 2004.

Segment Reporting—SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, established standards for reporting information about operating segments in financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief decision maker or group, in deciding how to allocate resources and in assessing performance. The Company’s chief decision maker reviews the results of operations and requests for capital expenditures based on one industry segment: producing and selling products and procedures to improve people’s vision through laser vision correction. The Company’s entire revenue and profit stream is generated through this segment.

Substantially all of the Company’s long-lived assets are located in the United States.

Recent Accounting Pronouncements—In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This statement replaces SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB

Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB 25, Accounting for Stock Issued to Employees, and requires instead that such transactions be accounted for using a fair-value-based method. The Company is currently evaluating SFAS No. 123R to determine which fair-value-based model and transitional provision it will follow upon adoption. SFAS No. 123R will be effective for the Company beginning in its first quarter of fiscal 2006. Although the Company will continue to evaluate the application of SFAS No. 123R, management expects adoption to have a material impact on its results of operations in amounts not yet determinable.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – An amendment of APB 29, Accounting for Nonmonetary Transactions”. This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company will evaluate the effect, if any, of adopting SFAS No. 153.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) to be expensed as incurred and not included in overhead. Further, Statement No. 151 requires that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company’s current accounting policies are consistent with the accounting required by SFAS No. 151 and, as such, the adoption of this statement will have no effect on its financial statements.

The Company’s portfolio of cash, cash equivalents and marketable securities are as follows at December 31:

All of the Company’s investments, which are reported at amortized cost that approximates fair value, are classified as held-to-maturity and the Company has the positive intent and ability to hold these securities to maturity. As of March 31, 2005 the long term agency bonds had maturity dates within 24 months and all other investments had maturities within 90 days. All of the Company’s investments had maturities within 90 days at December 31, 2004.

Amounts charged to income for excess and obsolete inventories were $319,500 and $187,500 for the three months ended March 31, 2005 and 2004, respectively.

Indemnities and Guarantees—During its normal course of business, the Company has made certain indemnities and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include (i) certain real estate leases, under which the Company may be required to indemnify property owners for general liabilities; and (ii) certain agreements with the Company’s officers; under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship; (iii) certain agreements with its customers in which the Company provides intellectual property indemnities; and (iv) certain agreements with licensors, under which the Company indemnifies the party granting the license against claims, losses and expenses arising out of the manufacture, use, sale or other disposition of the products the Company manufactures using the licensed technology or patents. The duration of these indemnities and guarantees varies and, in certain cases, is indefinite. The majority of these indemnities and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. Historically, the Company has not been obligated to, nor does it expect to make significant payments for these obligations and no liabilities have been recorded for these indemnities and guarantees in the accompanying balance sheets.

Employment Agreement—In April 2003, the Company entered into an employment agreement with the Chief Executive Officer of the Company that calls for minimum annual payments at a rate of $450,000, effective with the initial public offering, plus reimbursement for certain expenses. The employment agreement has a three year term.

Litigation—. On June 10, 2004, the Company received notice from Escalon Medical Corp. of its intent to terminate the Company’s license agreement unless the Company paid in full certain royalties which Escalon believed the Company owed under the license agreement. Escalon sought payment of approximately $645,000 in additional royalties and other expenses, and sought additional royalties for future periods that if Escalon had prevailed on all aspects of their claims, would have represented an increase in the royalties paid to them by approximately one percent of revenues, and a subsequent one percent reduction in the Company’s future gross margins and operating profits. On June 21, 2004, the Company filed a complaint for declaratory relief and a preliminary injunction and a temporary restraining order to prevent Escalon from terminating the Company’s license agreement. Escalon subsequently agreed to stipulate to the temporary restraining order. On October 29, 2004, the court accepted a second stipulation by the parties to waive the preliminary injunction hearing. This second stipulation precluded Escalon from declaring a breach on this dispute pending a trial or dispositive ruling by the court.

ineffective. On May 5, 2005, the court entered a final judgment which in effect adopted its March 1, 2005 rulings on the parties’ cross-motions for summary judgment and ended the case. The Company believes that Escalon will persist in its attempts to terminate the license agreement, and intends to defend against such efforts vigorously. Termination of the Escalon license agreement could have a material adverse effect on the Company’s business, financial condition and results of operations.

On August 23, 2004, the United States Patent and Trademark Office (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 the Company 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 the Company acquired and the payment the Company made pursuant to the July 15, 2004 license agreement will not be affected by the granting of re-examination, regardless of the outcome. Although the Company believes that the intellectual property covered by the patent subject to the re-examination is important to its business, if this patent is invalidated there will be no effect on its ability to sell its products. However, invalidation or narrowing of this patent might allow others to market competitive products that would otherwise have infringed the patent.

The Company is also currently involved in other litigation incidental to its business. In the opinion of management, the ultimate resolution of such litigation will not likely have a significant effect on the Company’s financial statements.

Stock Option Activity—A summary of the Company’s stock option activity for the three months ended March 31, 2005 follows:

Deferred stock-based compensation is included as a component of stockholders’ equity and is being amortized to expense over the vesting period of the options in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company recorded stock-based compensation expense (benefit) of ($58,785) and $105,559 during the three months ended March 31, 2005 and 2004, respectively. This total stock-based compensation expense (benefit) included ($399,130) and $90,448 during the three months ended March 31, 2005 and 2004, respectively, in connection with stock options granted to non-employees subject to remeasurement. Options granted to non-employees are accounted for under variable accounting in accordance with SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services. Under variable accounting, the market value of the underlying common stock is remeasured during each reporting period and the excess of the fair value over the option exercise price is charged to operations ratably over the remaining period in which the awards vest. The total stock-based compensation expense also included stock-based compensation expense of $340,345 and $15,111 for the three months ended March 31, 2005 and March 31, 2004, respectively, associated with employee performance-based and employee time-based awards. As of March 31, 2005, $1,264,808 of the total remaining deferred compensation of $2,646,744 is subject to periodic remeasurement.

During the fifteen month period ended March 31, 2005, the Company granted stock options to employees with exercise prices as follows:

The intrinsic value per share is being recognized as compensation expense over the applicable vesting period.

This Quarterly Report on Form 10-Q 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 up; the extent of adoption of our product offering by LASIK surgeons; 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; 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.

Certain of these risks and uncertainties, in addition to other risks, are more fully described under “Factors that May Affect Results of Operations and Financial Condition” contained elsewhere herein and in our annual report on Form 10-K, as filed with the Securities and Exchange Commission on March 29, 2005.

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 March 31, 2005, we captured approximately 17% 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 2005, 2004 and 2003 were as follows:

We became profitable for the first time during the three months ended March 31, 2005 with net income of $2.0 million. We incurred net losses applicable to common stockholders of approximately $10.2 million in 2004 and $12.0 million in 2003. As of March 31, 2005, we had an accumulated deficit of approximately $61.4 million.

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

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 fees inclusive of a disposable patient interface. We expect that, even with increased sales and leases of our INTRALASE^® FS laser, repeat revenues from the higher gross margin per procedure fees will continue to increase as a percentage of our total revenues, which will, in turn, drive higher overall gross margin.

In the three months ended March 31, 2005, approximately 70% of our new domestic laser unit sales or leases were sales, representing 93% of our total domestic laser revenues, and approximately 30% were operating leases, representing 7% of our total domestic laser revenues. In comparison, in the three months ended March 31, 2004, 50% of our new domestic laser unit placements were sales, representing 88% of our total domestic laser revenues, and 50% were operating leases, representing 12% of our total domestic laser 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.

We introduced our product offering in the United States in late 2001 and internationally in the second half of 2003. As of March 31, 2005, we had sold or leased 184 lasers in the United States and we had sold 72 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 revenues and gross margin.

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 inclusive of a disposable patient interface. Sales of our per procedure fees inclusive of a disposable patient interface 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.

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

Total revenues increased to $21.2 million for the three months ended March 31, 2005 from $9.5 million for the three months ended March 31, 2004. 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. During the three months ended March 31, 2005, we sold or leased 39 lasers and generated $10.4 million in revenues. In comparison, during the three months ended March 31, 2004, we sold or leased 17 lasers and generated $4.0 million in revenues. In the three months ended March 31, 2005, approximately 70% of our new domestic laser unit sales or leases were sales, representing 93% of our total domestic laser revenues, and approximately 30% were operating leases, representing 7% of our total domestic laser revenues. In comparison, in the three months ended March 31, 2004, 50% of our total new domestic laser unit placements were sales, representing 88% of our total domestic laser revenues, and 50% were operating leases, representing 12% of our total revenues. The average selling price per laser sold or leased in the three months ended March 31, 2005 increased 15% as compared to the three months ended March 31, 2004 primarily because we had fewer leases, which generate revenue over 39 months, in the three months ended March 31, 2005 as compared to the three months ended March 31, 2004. 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 affected by the mix of international distributor sales and domestic sales and the mix of laser leases versus laser sales in the US.

In the three months ended March 31, 2005, we sold 75,118 per procedure fees inclusive of a disposable patient interface and generated $9.0 million in revenues. In comparison, during the three months ended March 31, 2004, we sold 41,094 per procedure fees inclusive of a disposable patient interface and generated $4.7 million in revenues. We attribute the increase in sales of per procedure fees to an increased installed base of lasers, as we entered 2005 with approximately twice the installed base of lasers as compared to the same period in 2004. We expect sales of our per procedure fees inclusive of a disposable patient interface 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 $1.7 million during the three months ended March 31, 2005, as compared to $800,000 during the three months ended March 31, 2004. We expect our maintenance revenues to continue to increase as the installed base of lasers increases.

Gross margin, as a percentage of total revenues, increased to 53% in the three months ended March 31, 2005 from 41% in the three months ended March 31, 2004. 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 the three months ended March 31, 2005 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 a disposable patient interface 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 a disposable patient interface.

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 $158,000 to $2.5 million in the three months ended March 31, 2005 from $2.4 million in the three months ended March 31, 2004. This increase resulted from $294,000 of higher personnel costs and $37,000 of increased legal fees associated with our intellectual property and licensing agreements, offset by decreased expenses for stock based compensation of $152,000 and decreased expenses of $25,000 for regulatory and quality costs since we obtained our ISO EN 13485 certification and CE mark in the three months ended March 31, 2004. The decrease in stock based compensation results primarily from stock options granted to non-employees subject to remeasurement (variable plan accounting treatment). During the three months ended March 31, 2005 the market price of our stock declined, resulting in the recording of a benefit that offsets previously recognized stock based compensation associated with stock options determined to have been issued with exercise prices less than estimated fair value.

Although we expect research and development expenses to continue to fall as a percentage of our revenues we expect that the dollar amount of our research and development expenses will continue to increase by approximately 10% each year as we continue to develop, enhance and commercialize new and existing products and applications. We also expect to incur increased expenses relating to regulatory compliance associated with new and existing applications and products and for regulatory approval for expansion of our existing product offering into new markets outside of the United States. We also expect to incur increased expenses as we continue to support clinical studies.

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 $3.6 million to $7.2 million in the three months ended March 31, 2005 from $3.6 million in the three months ended March 31, 2004. The increase resulted from higher personnel costs in sales, marketing and general and administrative departments of $1.6 million; higher marketing, advertising, promotion and event costs of $494,000; an increase in facilities and depreciation expense of $741,000; higher legal and consulting fees of $521,000 and an increase in commissions paid to sales representatives on higher sales totaling $282,000. These increases were offset by decreased expenses for stock based compensation of $46,000 due primarily to a benefit in the three months ended March 31, 2005 associated with stock options granted to non-employees subject to remeasurement.

We expect sales and marketing expenses to increase in the future, both absolutely and as a percentage of revenues, as a result of continued growth in our sales infrastructure to support projected growth in revenues and continued international expansion. In addition, we expect general and administrative costs to increase due to the increased costs of being a public company.

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 with exercise prices 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 first quarter of fiscal 2006. 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.”

We require capital principally for operating our business, working capital and capital expenditures for both the fixed assets used in our business and the revenue-generating assets under our operating leases. Our capital expenditures for fixed assets consist primarily of capitalization of our lasers for use in manufacturing and developing our product offering, and information technology infrastructure and equipment used to support the growth of our business. Additionally, in 2005 we will spend approximately $3.9 million for leasehold improvements and other expenditures related to our new rental facility in Irvine, California. Our capital expenditures for revenue-generating assets consist of the capitalization of lasers under operating leases. Working capital is required principally to finance accounts receivable and inventory.

Prior to our initial public offering, our operations were funded primarily with proceeds from the issuance of our preferred stock. Cumulative net proceeds from issuances of our preferred stock totaled $73.1 million as of September 30, 2004. In addition, we received government sponsored research grants from inception through 2002, amounting to $2.2 million, cumulatively. From 2001 through December 31, 2004, we generated cumulative gross profit from sales of our product offering of $38.1 million. We financed purchases of equipment and leasehold improvements through our equipment advance facility.

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 payments of estimated 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. The equipment advance facility described above, representing all of our bank debt, was paid in full subsequent to the completion of our initial public offering.

We believe that our current cash and cash equivalents, together with our marketable securities and investments, cash expected to be generated from sales of our product offering, will be sufficient to meet our projected operating requirements for at least the next 12 months. Our uses of cash include purchases of investment-grade securities with diversification among issuers and maturities. We maintain our cash and cash equivalents, marketable securities and investments with two major financial institutions in the United States.

Cash and cash equivalents decreased by $18.8 million to $7.3 million at March 31, 2005 from $26.0 million at December 31, 2004. This decrease was primarily due to the purchase of marketable securities net of maturities of $16.0 million and cash used in operating activities of $954,000 in the three months ended March 31, 2005, as well as net changes in other cash flow activities.

Net cash used in operating activities increased to $954,000 in the three months ended March 31, 2005 from $607,000 in the three months ended March 31, 2004. The increase of $347,000 was primarily due to an increase in accounts receivable of $4.1 million, an increase in prepaid expenses and other assets of $1.8 million, partially offset by a $4.1 million increase due to the improvement to net income in the three months ended March 31, 2005 from a net loss in the three months ended March 31,

2004, a reduction in the cash used for inventories of $557,000 and an increase in accrued expenses of $477,000 as well as changes in other assets and liabilities. The increase in accounts receivable was primarily due to the increased sales of per procedure fees inclusive of a disposable patient interface, which are typically sold with longer payment terms than lasers and the increase in laser accounts receivable, primarily for sales to leasing companies and international distributors. The increase in prepaid expenses and other assets was primarily due to a receivable for a leasehold improvement allowance from the landlord of our new building.

Net cash used by investing activities was $18.2 million in the three months ended March 31, 2005 as compared to $2.2 million used in the three months ended March 31, 2004. This increase of $16.0 million was primarily due to an increase in the purchase of marketable securities of $25.0 million, and an increase in the purchase of property, plant and equipment of $1.2 million partially offset by an increase in the proceeds from maturities of marketable securities of $10.0 million.

Net cash flows provided by financing activities was $395,000 in the three months ended March 31, 2005 as compared to $386,000 in the three months ended March 31, 2004.

Our accounts receivable days sales outstanding were 48 days at March 31, 2005 and 34 days at December 31, 2004. Our laser sales are typically on the basis of cash in advance, however, we will extend terms, which are typically net 30, to third party financing companies under irrevocable letters of credit, institutions or well established corporate customers, primarily to adhere to the customer’s internal payment processes, and our per procedure fees inclusive of a disposable patient interface are typically sold for terms net 30 days from shipment. We review our accounts receivable balances and customers regularly to establish and maintain an appropriate allowance for doubtful accounts. We take into account the customer’s payment history, the number of days an account is overdue and any specific knowledge about an account’s financial status. On that basis, allowance for doubtful accounts as a percentage of gross accounts receivable was 1.5% and 2.1% at March 31, 2005 and December 31, 2004, respectively. The reserve requirements are based on our review of every account and we place particular emphasis on analyzing each account with an accounts receivable balance more than 90 days old and on that account’s specific payment history and financial risk. As revenues from our per procedure fee inclusive of a disposable patient interface increase as a percentage of total revenues, we expect days sales outstanding to increase as we grant payment terms of a longer duration on these revenues than we do on our laser sales. As per procedure fees inclusive of a disposable patient interface revenues increase, we will be exposed to an increased risk of not receiving payment on time for a portion of our sales. In addition, as the percentage of our revenues with longer credit terms increase, we will use more capital resources to fund the increase in accounts receivable outstanding. Payment terms for our sales outside the United States are currently cash in advance or irrevocable letter of credit, resulting in limited exposure to international receivables, which typically take longer to collect. However, on occasion, we have offered limited terms to customers outside the United States and irrevocable letters of credit with payment terms. In the future, were we to offer credit terms internationally similar to those in the United States, our days sales outstanding would likely increase.

Our revolving line of credit and equipment advance facility expired at December 31, 2004, and at March 31, 2005 we did not have a credit facility. We plan to enter into new credit agreements in the future consistent with our business requirements.

The following summarizes our long-term contractual obligations as of March 31, 2005:

We have not engaged in any off-balance sheet arrangements within the meaning of Item 303(a)(4)(ii) of Regulation S-K under the Securities Act of 1933.

Realization of our deferred tax assets is dependent upon the timing and amount of our future earnings, if any. Accordingly, we have established full deferred tax asset valuation allowances as of March 31, 2005 and December 31, 2004 to reflect these uncertainties.

As of December 31, 2004, we had federal and state net operating loss carryforwards of approximately $55.6 million and $38.8 million, respectively, and federal and state tax credit carryforwards of approximately $1.6 million and $1.7 million, respectively. Federal tax credit carryforwards will begin to expire in 2005 unless previously utilized. The state credit carryforwards do not expire. Pursuant to Section 382 of the Internal Revenue Code, use of our net operating loss and credit carryforwards may be limited if we experience a cumulative change in ownership of greater than 50% in a moving three-year period. Ownership changes could impact our ability to utilize net operating losses and credit carryforwards remaining at the ownership change date. See “Risk Factors—Risks Related to our Business—Our ability to use net operating loss carryforwards may be limited.”

We do not believe that inflation has had a material effect on our business, financial condition or results of operations during the periods presented, and we do not anticipate that it will have a material effect in the future.

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates including those related to bad debts, inventories and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be

reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 2 to our financial statements appearing elsewhere within this Form 10-Q, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.

We recognize revenues in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by SAB 101A and 101B (“SAB 101”). SAB 101 requires that four basic criteria must be met before revenues can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenues recognized for any reporting period could be adversely impacted.

For arrangements with multiple deliverables, we allocate the total revenues to each deliverable based on its relative fair value in accordance with the provisions of Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” and recognize revenues for each separate element as the above criteria are met.

Reserves for Doubtful Accounts, Billing Adjustments and Contractual Allowances

At the end of each fiscal quarter, we estimate the reserve necessary for doubtful accounts to ensure that we have established an appropriate allowance for accounts receivable that may not ultimately be collectible. To develop this estimate we review all accounts and identify those with overdue balances, particularly those with balances 90 days, or more, overdue. For these accounts we estimate individual specific reserves based on our analysis of the amount overdue, the customer’s payment history, operations and finances of each account. For all other accounts, we review historical bad debt trends, general and industry-specific economic trends, and current payments along with the reasonable probability that payment will occur in the future. On that basis, the allowance for doubtful accounts as a percentage of gross accounts receivable was 1.5% and 2.1% at March 31, 2005 and December 31, 2004, respectively as the percentage of accounts receivable determined to be uncollectible decreased. To date, our estimates of our doubtful accounts have been materially accurate. Subject to any major changes in our business model, our operating environment or the economy in general, and taking into consideration our typical customer, we do not expect either our methodology or the accuracy of our estimates to change significantly in the future.

Adjustments to the carrying value of inventory for excess and obsolete items are based, in part, on our estimate of usage of component parts in the assembly of our lasers and the timing of design changes. This estimate, though based on our product design plans and other relevant factors, such as the current economic climate, is subject to some uncertainty. Amounts charged to income for excess and obsolete inventories and as a percentage of total revenues, were $319,500 or 1.5% of total revenues in the three months ended March 31, 2005 as compared to $187,500 or 2.0% of total revenues in the three months ended March 31, 2005. Additions to the inventory reserve have diminished as the product has matured and fewer changes are made to the product to make it easier to manufacture, assemble or otherwise produce. To date, our estimates of excess and obsolete inventory have been materially accurate. Subject to any major changes in our business model, our operating environment or the economy in general, and taking into consideration the ongoing development of our technology we do not expect either our methodology or the accuracy of our estimates to change significantly in the future.

We account for employee and director stock options and restricted stock using the intrinsic-value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and have adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Stock options issued to non-employees, principally individuals who provide clinical support studies, are recorded at their fair value as determined in accordance with SFAS No. 123 and Emerging Issues Task Force

(EITF) No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and amortized over the service period.

Stock compensation expense, which is a noncash charge, results from stock option grants made to employees at exercise prices below the deemed fair value of the underlying common stock, and from stock option grants made to non-employees at the fair value of the option granted as determined using the Black-Scholes valuation model. Stock compensation expense for grants made to employees below the fair value of the underlying common stock is amortized on a straight line basis over the vesting period of the underlying option, generally four years. Unearned deferred compensation for non-employees is periodically remeasured through the vesting date. We have recorded deferred stock-based compensation representing the difference between the option exercise price and the fair value of our common stock on the grant date for financial reporting purposes. Prior to issuing our stock publicly, we determined the deemed fair value of our common stock based upon several factors, including operating performance, liquidation preferences of the preferred stock, an independent valuation analysis, the market capitalization of peer companies and the expected valuation we would obtain in an initial public offering. Had different assumptions or criteria been used to determine the deemed fair value of our common stock, different amounts of stock-based compensation could have been reported.

We recorded a stock-based compensation benefit of $58,785 in the three months ended March 31, 2005. From inception through March 31, 2005, we recorded amortization of deferred stock compensation of $5.2 million. At March 31, 2005, we had a total of $2.6 million remaining to be amortized over the vesting period of the stock options, of which $1.3 million is subject to periodic remeasurement.

The amount of stock based compensation expense to be recorded in future periods may decrease if unvested options for which we have recorded deferred compensation are subsequently cancelled or expire or if the fair value of our stock decreases; or may increase if the fair market value of our stock increases or we make additional grants of non-qualified stock options to members of our medical advisory board or other non-employee consultants.

Pro forma information regarding net loss applicable to common stockholders and net loss per share applicable to common stockholders is required in order to show our net loss as if we had accounted for employee stock options under the fair value method of SFAS No. 123, as amended by SFAS No. 148. This information is contained in Note 2 to our financial statements contained elsewhere within this Form 10-Q. The fair values of options and shares issued pursuant to our option plan at each grant date were estimated using the Black-Scholes option-pricing model.

We currently are not required to record stock-based compensation charges if the employee stock option exercise price or restricted stock purchase price equals or exceeds the deemed fair value of our common stock at the date of grant. In December 2004, the FASB issued SFAS No. 123 (Revised 2004) Share Based Payment, which is a revision to SFAS 123 and supersedes APB 25 and SFAS 148. This statement requires that the estimated fair value resulting from all share-based payment transactions be recognized in the financial statements. If we had estimated the fair value of the options or restricted stock on the date of grant in our financial statements, and then amortized this estimated fair value over the vesting period of the options or restricted stock, our net loss would have been adversely affected. See Note 2 to our financial statements contained elsewhere within this Form 10-Q for a discussion of how our net loss would have been adversely affected.

We account for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under this method, we determine deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of assets and income. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of March 31, 2005 and December 31, 2004, due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future. These deferred tax assets primarily consist of net operating loss carryforwards and research and development tax credits.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This statement replaces SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives

employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB 25, Accounting for Stock Issued to Employees, and requires instead that such transactions be accounted for using a fair-value-based method. 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 first quarter of fiscal 2006. 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.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets – An amendment of APB 29, Accounting for Nonmonetary Transactions. This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. We will evaluate the effect, if any, of adopting SFAS No. 153.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) to be expensed as incurred and not included in overhead. Further, SFAS No. 151 requires that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Our current accounting policies are consistent with the accounting required by SFAS No. 151 and, as such, the adoption of this statement will have no effect on our financial statements.

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 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.

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 March 31, 2005, we captured approximately 17% 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 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 a 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.

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.

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 have been involved in litigation with Escalon Medical Corp. concerning a license agreement with Escalon under which we license certain intellectual property. The litigation arose as a result of Escalon’s attempt to terminate the license agreement based on alleged underpayment of royalties (see Part II, Item 1, Legal Proceedings). We believe that Escalon will persist in its attempts to terminate the license agreement, and intend to defend against such efforts vigorously. Termination of the Escalon license agreement could have a material adverse effect on our 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 the three months ended March 31, 2005 we sold or leased 39 lasers and sold 75,188 per procedures fees inclusive of a disposable patient interface. In 2004 we sold or leased 111 lasers and sold 191,861 per procedure fees inclusive of a disposable patient interface; and in 2003, we sold or leased 67 lasers and sold 84,230 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.

As we continued to grow, we determined that our current facilities were 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.

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 41% of our total revenues in the three months ended March 31, 2005 and 19% of our total revenues in the three months ended March 31, 2004. 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.

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.

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.

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.

Although we were profitable for the three months ended March 31, 2005, we have incurred significant operating losses in each previous full year since our inception in 1997. We incurred net losses applicable to common stockholders of $10.2 million in 2004 and $12.0 million in 2003. As of March 31, 2005, we had an accumulated deficit of approximately $61.4 million. In order to maintain 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 maintain 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.

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 $55.6 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 income from operations would have decreased by approximately $575,000 in the three months ended March 31, 2005 and our loss from operations would have increased by $57,000 in the three months ended March 31, 2004. 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 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.

The primary objective of our investment activities is to preserve principal while maximizing the income we receive from our investments without significantly increasing the risk of loss. Some of the securities in which we may invest in the future may be subject to market risk for changes in interest rates. To mitigate this risk, we plan to maintain a portfolio of cash equivalents and short-term investments in a variety of marketable securities, which may include commercial paper, money market funds, government and non-government debt securities. Currently, we are exposed to minimal market risks. We manage the sensitivity of our results of operations to these risks by maintaining a conservative portfolio, which is comprised solely of highly rated, short-term investments. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes.

The risk associated with fluctuating interest rates is limited to our investment portfolio and our borrowings. We do not believe that a 10% change in interest rates would have a significant effect on our results of operations or cash flows.

All of our sales since inception have been made in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations. We expect to continue to realize our sales in U.S. dollars, regardless of our intended expansion into international markets, although no assurances can be given. As we increase our international sales and support organization, we anticipate some level of exposure to foreign currency risk as a result of compensating these employees in local currencies.

As of March 31, 2005, we have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Securities and Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information related to us that is required to be included in our periodic SEC filings.

There have been no significant changes in our internal control over financial reporting during the most recent fiscal quarter ended March 31, 2005 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

On June 10, 2004, we received notice from Escalon Medical Corp. of its intent to terminate our license agreement unless we paid in full certain royalties which Escalon believed we owed under the license agreement. Escalon sought payment of approximately $645,000 in additional royalties and other expenses, and sought additional royalties for future periods that if Escalon had prevailed on all aspects of their claims, would have represented 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. Escalon subsequently agreed to stipulate to the temporary restraining order. On October 29, 2004, the court accepted a second stipulation by the parties to waive the preliminary injunction hearing. This second stipulation precluded 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 do not believe that the court’s order will have a material adverse effect on our business, financial condition and results of operations, and our financial statements were not affected at December 31, 2004. On April 1, 2005, Escalon again attempted to terminate the license agreement based on its June 10, 2004 notice. We sought and obtained a preliminary injunction against this attempted termination, and on April 25, 2005 the court found the purported termination to be ineffective. On May 5, 2005, the court entered a final judgment which in effect adopted its March 1, 2005 rulings on the parties’ cross-motions for summary judgment and ended the case. We believe that Escalon will persist in its attempts to terminate the license agreement, and intend to defend against such efforts vigorously. Termination of the Escalon license agreement could have a material adverse effect on our business, financial condition and results of operations.

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.

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.

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. There has been no change in the other information set forth in Part II, Item 2(b) of our Quarterly Report on Form 10-Q for the Quarterly Period ended September 30, 2004 and summarized in Part II, Item 5(b) of our 2004 Annual Report on Form 10-K.

*** In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Securities and Exchange Act of 1934 or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

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

INTRALASE CORP.

(Registrant)

/s/ Robert J. Palmisano

Robert J. Palmisano

President and Chief Executive Officer

/s/ Shelley B. Thunen

Shelley B. Thunen

Executive Vice President and Chief Financial Officer


DELAWARE		38-3380954
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

3 Morgan, Irvine, CA		92618
(Address of principal executive offices)		(zip code)


		Page No

PART I	FINANCIAL INFORMATION

Item 1	Financial Statements (unaudited)

	Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004	2

	Condensed Consolidated Statements of Operations – Three Month Periods Ended March 31, 2005 and 2004	3

	Condensed Consolidated Statements of Cash Flows – Three Month Periods Ended March 31, 2005 and 2004	4

	Notes to Condensed Consolidated Financial Statements	5

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3	Quantitative and Qualitative Disclosures about Market Risk	29

Item 4	Controls and Procedures	30

PART II	OTHER INFORMATION

Item 1	Legal Proceedings	30

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	31

Item 6	Exhibits	31

	Signatures	32


	March 31, 2005			December 31, 2004
Assets
Current assets:
Cash and cash equivalents	$	7,261,056		$	26,014,926
Marketable securities		70,000,000			66,000,000
Accounts receivable—Net of allowance for doubtful accounts of $163,725 (March 31, 2005) and $151,604 (December 31, 2004)		10,688,694			7,186,163
Inventories, Net		9,129,126			8,901,684
Prepaid expenses and other current assets		3,573,070			1,868,186

Total current assets		100,651,946			109,970,959

Marketable securities		12,000,000
Property, plant and equipment—Net		5,349,097			4,597,546
Equipment under operating leases—Net of accumulated depreciation of $768,973 (March 31, 2005) and $682,889 (December 31, 2004)		2,780,837			2,224,785
Other assets		1,282,320			1,418,774

Total	$	122,064,200		$	118,212,064

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	5,989,771		$	5,685,565
Accrued expenses		7,186,452			6,030,507
Deferred revenues		3,228,837			3,232,272

Total current liabilities		16,405,060			14,948,344

Deferred revenues-Long-term		1,033,219			970,115

Total liabilities		17,438,279			15,918,459
Commitments and Contingencies (Note 6)
Stockholders’ Equity:
Preferred stock, $0.01 par value — 10,000,000 shares issued and authorized and no shares outstanding at March 31, 2005 and December 31, 2004
Common stock, $0.01 par value—45,000,000 shares authorized; 26,840,082 (March 31, 2005) and 26,769,185 (December 31, 2004) shares issued and outstanding		268,401			267,692
Additional paid-in capital		168,897,834			170,567,316
Deferred stock-based compensation		(2,646,744	)		(4,302,631	)
Receivable from sale of stock to officers and employees		(489,704	)		(838,690	)
Accumulated deficit		(61,403,866	)		(63,400,082	)

Total stockholders’ equity		104,625,921			102,293,605

Total	$	122,064,200		$	118,212,064


	Three Months Ended
	March 31, 2005			March 31, 2004
Revenues – product revenues	$	21,180,973		$	9,484,731
Costs of goods sold (1)		10,022,236			5,621,493

Gross Margin		11,158,737			3,863,238

Operating expenses:
Research and development (1)		2,515,050			2,357,109
Selling, general and administrative (1)		7,248,465			3,610,408

Total operating expenses		9,763,515			5,967,517

Income (loss) from operations		1,395,222			(2,104,279	)
Interest and other income (expense), Net
Interest expense		(91,950	)		(23,893	)
Interest income		599,329			37,979
Other income		160,518			3,225

Interest and other income (expense) , net		667,897			17,311

Income (loss) before provision for income taxes		2,063,119			(2,086,968	)
Provision for income taxes		66,903			7,500

Net income (loss)		1,996,216			(2,094,468	)
Accretion of preferred stock					(14,949	)
Net income (loss) applicable to common stockholders	$	1,996,216		$	(2,109,417	)

Net income (loss) per share applicable to common stockholders – basic	$	0.07		$	(0.97	)

Net income (loss) per share applicable to common stockholders – diluted	$	0.06		$	(0.97	)

Weighted average shares outstanding – basic		26,815,190			2,177,806

Weighted average shares outstanding – diluted		31,126,618			2,177,806


(1) Amounts include stock-based compensation expenses, as follows:

Costs of goods sold	$	34,873		$	1,195
Research and development		(96,715	)		54,861
Selling, general and administrative		3,057			49,503

	$	(58,785	)	$	105,559


	Three Months Ended
	March 31, 2005			March 31, 2004
Cash flows from operating activities:
Net income (loss)	$	1,996,216		$	(2,094,468	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		886,884			695,314
Loss on disposition of property, plant and equipment		—			2,303
Provision for bad debt expense		12,120			21,024
Stock-based compensation		(58,785	)		105,559
Amortization of technology license		72,228			—
Changes in operating assets and liabilities:
Accounts receivable		(3,514,651	)		584,285
Prepaid expenses and other current assets		(1,704,884	)		91,732
Inventories		(227,442	)		(784,714	)
Other assets		64,226			(13,205	)
Accounts payable		304,206			187,229
Accrued expenses		1,155,945			679,397
Deferred revenues		59,669			(81,770	)

Net cash used in operating activities		(954,268	)		(607,314	)

Cash flows from investing activities:
Purchase of property, plant and equipment		(1,552,350	)		(387,770	)
Purchase of equipment under operating leases		(642,137	)		(821,293	)
Purchase of marketable securities		(29,000,000	)		(3,990,892	)
Proceeds from maturities of marketable securities		13,000,000			2,992,765

Net cash used in investing activities		(18,194,487	)		(2,207,190	)

Cash flows from financing activities:
Net proceeds from the exercise of stock options		63,697			51,658
Net proceeds from collection of receivable - sale of stock to officers and employees		348,986			—
Payments for issuance costs associated with 2004 common stock offering		(17,798	)		—
Proceeds from issuance of long-term debt		—			423,498
Principal payments on long-term debt		—			(89,583	)

Net cash provided by financing activities		394,885			385,573

Net decrease in cash and cash equivalents	$	(18,753,870	)	$	(2,428,931	)
Cash and cash equivalents—beginning of year		26,014,926			8,903,715

Cash and cash equivalents—end of period	$	7,261,056		$	6,474,784

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	91,950		$	22,904

Cash paid during the year for income taxes	$	12,210		$	4,495

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	Three Months Ended March 31,
	2005			2004
Net income (loss) applicable to common stockholders as reported	$	1,996,216		$	(2,109,417	)
Add: Stock—based employee compensation expense included in reported net loss		299,282			12,571
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(874,586	)		(70,008	)

Net income (loss) applicable to common stockholders	$	1,420,912		$	(2,166,854	)

Pro forma net income (loss) per share applicable to common stockholders—basic	$	0.05		$	(0.99	)

Pro forma net income (loss) per share applicable to common stockholders—diluted	$	0.05		$	(0.99	)


	March 31,		December 31,
	2005		2004
Cash and money market funds	$	1,273,058	$	4,074,091
Commercial paper		5,987,998		21,940,835
Agency bonds – short term		70,000,000		66,000,000
Agency bonds – long term		12,000,000		—

	$	89,261,056	$	92,014,926


	March 31, 2005			December 31, 2004
Raw materials	$	3,890,624		$	4,757,720
Work-in-process		4,088,368			3,303,745
Finished goods		2,234,434			1,620,043

		10,213,426			9,681,508
Less reserve for obsolescence		(1,084,300	)		(779,824	)

	$	9,129,126		$	8,901,684


	Shares Under Option		Weighted Average Exercise Price		Exercisable at End of Period	Weighted Average Exercise Price
Outstanding—January 1, 2005	5,439,795		$	3.83	2,418,454	$	1.82
Granted	437,740		$	20.49
Forfeited	(105,683	)	$	8.05
Exercised	(42,313	)	$	1.51

Outstanding—March 31, 2005	5,729,539		$	5.04	2,604,355	$	1.86


Grants Made During Quarter Ended	Number of Options Granted	Weighted Average Exercise Price		Weighted Average Fair Value per Share		Weighted Average Intrinsic Value per Share
March 31, 2004	80,991	$	3.14	$	3.14		—
June 30, 2004	711,147	$	6.37	$	10.07	$	4.85
September 30, 2004	291,390	$	12.73	$	12.73		—
December 31, 2004	235,165	$	18.13	$	18.13		—
March 31, 2005	437,740	$	20.49	$	20.49		—


	2005		2004				2003
	Q1	Q4	Q3	Q2	Q1	Q4	Q3	Q2	Q1
Laser Sales/Leases Per Quarter	39	37	27	30	17	26	14	22	5

Cumulative Lasers Installed (1)	254	217	180	153	123	106	80	66	44

Total Per-procedure Fees, Inclusive of Disposable Patient Interface, Sold	75,188	52,418	49,927	48,422	41,094	27,372	22,164	19,208	15,486


	Three months ended March 31,
	2005			2004
	Units	Revenue		Units	Revenue
INTRALASE^® FS laser	39	$	10,441,562	17	$	3,967,253
Per procedure fees inclusive of a disposable patient interface	75,188		9,027,950	41,094		4,727,907
Product maintenance	—		1,711,461	—		789,571

Total revenues		$	21,180,973		$	9,484,731


	Three Months Ended March 31,
	2005		2004
Revenues:
Total revenues	100.0	%	100.0	%
Costs of goods sold	47.3		59.3

Gross margin	52.7		40.7
Operating expenses:
Research and development	11.9		24.9
Selling, general and administrative	34.2		38.0

Total operating expenses	46.1		62.9

Income (loss) from operations	6.6		(22.2	)
Interest and other income (expense), net	3.1		0.2

Income (loss) before provision for income taxes	9.7		(22.0	)
Provision for income taxes	0.3		0.1

Net income (loss)	9.4		(22.1	)
Accretion of preferred stock	—		(0.1	)

Net income (loss) applicable to common stockholders	9.4	%	(22.2	)%


	Payments due by period
Contractual Obligations	Total		Less than 1 year		1 to 3 years		4 to 5 years		After 5 years
	(in thousands)
Leasehold improvements and other expenditures (1)	$	3,859	$	3,859	$	—	$	—	$	—
Operating leases (1)		18,470		1,953		3,512		3,507		9,498
Royalty payments (2)		688		124		237		218		109
Letter of credit		50		50
Employment agreement with Robert Palmisano, CEO		528		507		21		—		—

Total	$	23,595	$	6,493	$	3,770	$	3,725	$	9,607


Exhibit No.		Description

31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002

31.2		Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002

32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002***

32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002***