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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K


FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2003; or                                         
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|           |  | For the Transition period
    from           to           .                                 

Commission File Number 000-27212



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Endocare, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                       |  |                                         
|---------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                               |  | 33-0618093                              
|(State of
    incorporation)                                           |  | (I.R.S. Employer
    Identification No.)
|                                                                      
|201 Technology, Irvine, CA(Address of
    principal executive offices) |  | 92618(Zip
    Code)                     

Registrants telephone number, including
area code: (949) 450-5400

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $.001 par value

Rights to Purchase Shares of Series A
Junior Participating Preferred Stock

(Title of Class)




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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.    (1) Yes o    No þ    (2) Yes þ    No o

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

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

The aggregate market value of the common stock of
the Registrant held by non-affiliates as of June 30, 2003,
was approximately $84,468,749 (based on the last sale price for
shares of the Registrants common stock as reported in the
Pink Sheets for that date). Shares of common stock held by each
executive officer, director and holder of 10% or more of the
outstanding common stock have been excluded in that such persons
may be deemed affiliates. Exclusion of shares held by any person
should not be construed to indicate that such person possesses
the power, direct or indirect, to direct or cause the direction
of management or policies of the Registrant, or that such person
is controlled by or under common control with the Registrant.

There were 24,139,504 shares of the
Registrants common stock issued and outstanding as of
March 1, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the Definitive Proxy
Statement related to the Registrants 2004 Annual Meeting
of Stockholders, which Definitive Proxy Statement is to be filed
under the Securities Exchange Act of 1934, as amended, within
120 days of the end of the Registrants fiscal year
ended December 31, 2003, are incorporated by reference into
Part III of this Annual Report on Form 10-K.

Certain exhibits filed with our prior
registration statements and Forms 10-K, 8-K and 10-Q are
incorporated herein by reference into Part IV of this
Annual Report on Form 10-K.



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Endocare, Inc.

Form 10-K

For the Fiscal Year Ended December 31,
2003

TABLE OF CONTENTS

|              |  |                                                                                                        |  |      |     | 
|------------- |  | ------------------------------------------------------------------------------------------------------ |  | ---- | --- | 
|              |  |                                                                                                        |  | Page
|              |  |                                                                                                        |  |     
|Part I       
|Item 1.       |  | Business                                                                                               |  |      | 1   | 
|Item 2.       |  | Properties                                                                                             |  |      | 32  | 
|Item 3.       |  | Legal Proceedings                                                                                      |  |      | 33  | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                                |  |      | 34  | 
|Part II      
|Item 5.       |  | Market for Our Common Equity
    and Related Stockholder Matters                                       |  |      | 35  | 
|Item 6.       |  | Selected Consolidated
    Financial Data                                                               |  |      | 36  | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |  |      | 37  | 
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risk                                         |  |      | 52  | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                                        |  |      | 52  | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure               |  |      | 52  | 
|Item 9A.      |  | Controls and Procedures                                                                                |  |      | 52  | 
|Part III     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                                 |  |      | 53  | 
|Item 11.      |  | Executive Compensation                                                                                 |  |      | 53  | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |  |      | 53  | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                                     |  |      | 54  | 
|Item 14.      |  | Principal Accounting Fees
    and Services                                                             |  |      | 54  | 
|Part IV      
|Item 15.      |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                                    |  |      | 54  | 
|              |  | Signatures                                                                                             |  |      | 58  | 
|              |  | Financial Statements                                                                                   |  |      | F-1 | 
|EXHIBIT 3.4  
|EXHIBIT 10.25
|EXHIBIT 10.26
|EXHIBIT 10.27
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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PART I

This Annual Report on Form 10-K may contain
forward-looking statements that involve risks and uncertainties.
Such statements typically include, but are not limited to,
statements containing the words believes,
intends, anticipates,
expects, estimates, should,
could, may, plans,
planned and words of similar import. Our actual
results could differ materially from any such forward-looking
statements as a result of the risks and uncertainties, including
but not limited to those set forth below in Risks Related
to Our Business and in other documents we file from time
to time with the Securities and Exchange Commission, including
our Quarterly Reports on Form 10-Q. Any such
forward-looking statements reflect our managements
opinions only as of the date of this Annual Report on
Form 10-K, and we undertake no obligation to revise or
publicly release the results of any revisions to these
forward-looking statements. Readers should carefully review the
risk factors set forth below in Risks Related to Our
Business and in other documents we file from time to time
with the Securities and Exchange Commission, including our
Quarterly Reports on Form 10-Q.

You are further cautioned that we have determined
that in certain cases we misinterpreted or misapplied GAAP in
our 2001 and 2000 consolidated financial statements and,
accordingly, we have restated our consolidated financial
statements as of December 31, 2001, and for the years ended
December 31, 2000 and 2001. Furthermore, because these
restatements also impacted our 2002 results, the information
previously filed in our quarterly reports on Form 10-Q for
the quarters ended March 31, 2002 and June 30, 2002,
and in our prior periodic reports, should not be relied upon.
Detailed information regarding these restatements is disclosed
in notes 3 and 16 to our consolidated financial statements
filed in our annual report on Form 10-K for the year ended
December 31, 2002.

AutoFreezeTM, CGCTM,
Cryocare®, Cryocare CSTM, Cryocare Surgical
System®, CryoDisc®, CryoGridTM,
Cryoguide®, Direct AccessTM, Endocare®,
ErecAid®, Esteem®, FastTrac®, Horizon Prostatic
Stent®, Integrated UltrasoundTM,
RigiScan®, SmartTempTM, SnapGaugeTM,
SurErecTM, Targeted AblationTM, Targeted
Ablation of the Prostate TAP®, Targeted Ablation Therapy
TAT®, Targeted Cryoablation of the Prostate TCAP®,
Targeted Cryoablation Therapy TCAT®, TEMPprobe®,
ThermaStentTM, and Urethral WarmerTM are
trademarks of ours or our wholly-owned subsidiary, Timm Medical
Technologies, Inc., or Timm Medical. This Annual Report on
Form 10-K may also include trademarks and trade names owned
by other parties, and all other trademarks and trade names
mentioned in this Annual Report on Form 10-K are the
property of their respective owners.






|        |         
|------- | --------
|Item 1. | Business

Overview

We are a specialty medical device company focused
on improving patients lives through the development,
manufacturing and distribution of health care products related
to our core competencies in the areas of cryoablation and vacuum
technology. Our strategy is to achieve a dominant position in
the prostate cancer market while achieving penetration across
horizontal markets with our proprietary cryosurgical technology
and maintaining our dominant position in vacuum technology for
erectile dysfunction.

We were formed in 1990 as a research and
development division of Medstone International, Inc. a
manufacturer of shockwave lythotripsy equipment for the
treatment of kidney stones. Medstone, formerly a public company
traded on Nasdaq under the trading symbol MEDS, was acquired on
February 20, 2004, by Prime Medical Services, Inc. We
were incorporated under the laws of the State of Delaware in May
1994. On January 1, 1996, we became an independent,
publicly owned corporation upon Medstones distribution of
our stock to its existing stockholders.

Between 1996 and 1998, we concentrated on
developing and establishing a market for devices used in
cryosurgical treatment of prostate cancer. We began selling our
Cryocare Surgical System in July 1999 following Medicares
initiation of national reimbursement coverage of cryosurgery for
the primary treatment of localized prostate cancer. Effective
July 2001, Medicare approved reimbursement of secondary
cryosurgical treatment for men who have been unsuccessfully
treated with radiation therapy.

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Today, our FDA-cleared Cryocare Surgical System
occupies a growing position in the urological market for
treatment of prostate cancer. Because of our initial
concentration on prostate and renal cancer, the majority of our
sales and marketing resources are directed towards the promotion
of our technology to urologists. In addition, we contract
directly with hospitals and health care payors to perform
cryoablation procedures using our proprietary device and
disposable products on a fee-for-service basis. We believe our
proprietary cryosurgical technologies have broad applications
across a number of surgical markets, including for the treatment
of tumors in the lung, liver and bone. In November 2003, we
formed a dedicated sales and marketing team focused on marketing
percutaneous cryoablation procedures related to kidney, liver,
lung and bone cancer to radiology physicians throughout the
United States. We intend to continue to identify and develop new
markets for our cryosurgical products and technologies,
particularly in the area of tumor ablation.

Through our acquisition of Timm Medical in
February 2002, we acquired several products used in the
treatment and diagnosis of erectile dysfunction. We have a
dedicated sales, customer service and marketing team focused on
our ErecAid line of vacuum therapy systems, which include the
ErecAid Classic system and the ErecAid Esteem system 
leading non-pharmaceutical treatment devices for erectile
dysfunction. Our ErecAid devices are marketed directly to
consumers, as prescription devices, and to durable medical
equipment providers, physicians and pharmacies. Our principal
diagnostic tool is the RigiScan, an ambulatory device marketed
to physicians that measures the frequency, rigidity and duration
of both nocturnal and provocative erections.

Primarily through our acquisition of Timm
Medical, we significantly expanded the ranks of our urology
sales force. We have deployed these employees in both sales of
our cryosurgical products and sales of our ErecAid products. We
believe this sales force will be a valuable asset as we pursue
building our business in the areas of tumor ablation and vacuum
therapy treatment of erectile dysfunction.

We acquired or obtained marketing rights to a
number of other urological products in the Timm Medical
purchase, many of which we have divested or may divest in the
future. In April 2003, we sold the Dura II penile implant
devices to American Medical Systems, Inc., or AMS. In
October 2003, we sold our products used in the diagnosis and
management of urinary incontinence to SRS Medical, Inc.

We maintain our executive offices at 201
Technology, Irvine, California 92618, and our telephone
number at that address is (949) 450-5400. Financial
information regarding our financial condition and results of
operations can be found in a separate section of this Annual
Report on Form 10-K, beginning on page F-1.

Recent Developments

Internal Review.In
October 2002, our Audit Committee retained legal and financial
experts to conduct an internal review of various accounting and
other matters. In July 2003, our Audit Committee engaged
independent counsel to review and evaluate the results of the
initial investigation. The investigation and review process
resulted in our undertaking certain modifications to our
internal controls, accounting policies and procedures,
disclosure controls and procedures and corporate governance
policies and procedures in order to, among other things, enhance
the quality and consistency of our financial information and
reporting. We also determined to make, and subsequently did
make, certain changes to our senior management team and Board of
Directors. Detailed information regarding these statements is
disclosed in notes 3 and 16 of our consolidated financial
statements filed in our annual report for the year ended
December 31, 2002 filed on Form 10-K.

Legal Proceedings.Beginning in November 2002, we, together with certain former
officers and certain current and former board members, became
parties to various shareholder class-action and derivative
lawsuits and other legal proceedings. We, as well as certain of
our current and former directors and officers, are also under
investigation by the Securities and Exchange Commission, or SEC,
and Department of Justice, or DOJ, to determine whether we have
violated any federal securities laws, and we are fully
cooperating with those investigations. For a further description
of the nature and status of these legal proceedings see below
under Item 3  Legal Proceedings.

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Nasdaq Delisting.Effective January 16, 2003, our common stock was delisted
from The Nasdaq Stock Market. One result of this action is a
limited public market for our common stock. Trading is now
conducted in the over-the-counter market in the Pink
Sheets. We are working towards compliance with all listing
requirements of The Nasdaq Stock Market, and we will seek to be
relisted once we are in full compliance with our obligations as
a reporting company pursuant to the Securities Exchange Act of
1934, as amended.

New Independent Accountants and Restatements
of Financials.In March of 2003, we
dismissed KPMG LLP as our independent accounting firm. We then
engaged Ernst & Young LLP as our new independent
accounting firm to audit certain of our historical consolidated
annual financial statements and to review our historical
consolidated unaudited interim financial statements. As a result
of this audit and our internal review, we have made various
restatement adjustments to our historical financial statements.
Detailed information regarding these restatements is disclosed
in notes 3 and 16 of our consolidated financial statements
filed in our annual report on Form 10-K for the year ended
December 31, 2002.

Management Changes.In December 2003, we appointed Craig T. Davenport as our new
Chief Executive Officer. In March 2003, we appointed a new
President and Chief Operating Officer, William J. Nydam, and a
new Chief Financial Officer, Katherine Greenberg. In March 2003,
Paul W. Mikus vacated his position as our Chief Executive
Officer and in September 2003 he vacated his position as our
Chairman. In March 2003, John V. Cracchiolo vacated his
positions as our Chief Financial Officer and Chief Operating
Officer, and in July 2003 he vacated his position as President
of our Interventional Radiology business group.

Board Changes.Over
the past year, the membership of our Board of Directors has
changed significantly: Thomas R. Testman joined our Board in May
2003 to fill a then-existing vacancy; Terrence A. Noonan joined
our Board in September 2003, filling a vacancy created by
Mr. Mikus resignation; and Mr. Davenport and
John R. Daniels joined our Board in January 2004, filling
vacancies created by the resignations of Peter F. Bernardoni and
Benjamin Gerson, M.D.

Strategic Divestures and Product
Abandonments.We are narrowing the
focus of our business on the development of minimally invasive
technologies for tissue and tumor ablation and vacuum
technology. As part of this strategy, we have begun divesting
certain non-core product lines. Our first significant
divestiture occurred on April 7, 2003, when our
wholly-owned subsidiary, Timm Medical sold its Dura-II
positionable urological prosthesis product line to AMS. Under
the terms of the agreement, the transaction, valued at
approximately $2.2 million, included, among other things,
the intellectual property, customer lists and production
equipment related to the product as well as the then current
Dura-II inventory. Our second significant divestiture occurred
on April 14, 2003, when we sold our cardiac-related product
manufacturing operations and licensed the related intellectual
property to CryoCath Technologies Inc., or CryoCath. Under the
terms of the agreement, we transferred all of our manufacturing
assets and inventory related to the cardiac product line to
CryoCath and are exclusively licensing to CryoCath for
cardiovascular uses our proprietary argon gas based technology
associated with the SurgiFrost system  a cryoablation
system designed to treat cardiac arrhythmias. Terms of the
agreement also include the payment by CryoCath to us of
$10 million during 2003. The agreement also calls for the
payment by CryoCath to us of a nine-year descending royalty
stream based on net sales of products incorporating the licensed
technology. We believe CryoCaths leadership position in
the field of cardiovascular cryotherapy puts them in strong
position to exploit the opportunities for our technology in this
highly competitive arena. Our most recent divestiture occurred
on October 15, 2003, when Timm Medical sold its urodynamics
and incontinence product lines to SRS Medical Corp, or SRS.
Under the terms of the agreement, the transaction, valued at
approximately $2.7 million to be paid over a number of
years, included, among other things, the transfer of the
intellectual property, customer lists and production equipment
related to the EasyPro, EasyFlo, C3, StepFree and Profilometer
products, as well as the then current inventory relating to
those products.

Prior to 2003, we had devoted significant
resources to the development of a proprietary urological stent,
the Horizon Prostatic Stent, to provide temporary and immediate
relief for patients who undergo thermal therapy or other
procedures to treat benign prostatic hyperplasia, or BPH, also
known as prostate enlargement. We had also explored the
development of another stent, the ThermaStent that physicians
could use to deliver

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heat to destroy excess prostate tissue in
patients with moderate to severe BPH. During 2003, in view of
the significant investment needed to bring the Horizon Prostatic
Stent to market and the fact that it is outside of our strategic
focus on cancer treatment, we have decided to abandon further
efforts to obtain FDA approval of our Horizon Prostatic Stent
and have also ceased development of our ThermaStent. We are
actively looking for a buyer for the patent and product
portfolio related to our stent products.


Additionally, in connection with our divestiture
strategy, we have terminated or allowed to lapse our rights to
certain other product offerings including the FastPack®
System, a proprietary prostate cancer test developed by
Qualigen, Inc., the Thermoflex® System, an
office-based thermal therapy for BPH developed by
ArgoMed, Inc., the NMP22TM POC Test, a bladder
cancer detection test developed by Matritech, Inc., and the
urodynamic products, including the Andromeda Ellipse Monitor,
developed by Andromeda Medizinische Systeme, GmbH of Munich,
Germany. Also, we are in the process of dissolving one of our
BPH treatment partnerships. Furthermore, we no longer market our
StayErec product line and intend to discontinue our SnapGauge
diagnostic tool for erectile dysfunction product line once
current inventory levels are exhausted. As part of our strategy
to focus our business on our core technology-cryoablation of
cancer-we may divest additional product lines in the future.

Introduction of New Cryocare CS
System.We recently introduced the
next generation of our Cryocare Surgical System, the
Cryocare CS. The Cryocare CS is a fully integrated
cryosurgical planning, placement and treatment system designed
to simplify our FDA-cleared Targeted Cryoablation of the
Prostate, or TCAP, procedure. We shipped the first Cryocare
CS System in December 2003 and it was in clinical use by
the end of the year. See below under Our Solution: The
Cryocare Surgical Systems.

Prostate Cancer/ Urology Market
Background

The prostate is a walnut-size gland surrounding
the male urethra, located below the bladder and adjacent to the
rectum. Prostate cancer is one or more malignant tumors that
begin most often in the periphery of the gland and, like other
forms of cancer, may spread beyond the prostate to other parts
of the body. If left untreated, prostate cancer can metastasize
to the lung or bone and potentially other sites, resulting in
death.

The number of men diagnosed with prostate cancer
has risen steadily since 1980 and it is now the second most
common cause of cancer-related deaths among men. Prostate cancer
is most prominent in North America and northwestern Europe and
less common in Asia, Africa, Central America, and South America.
The American Cancer Society estimates there will be
approximately 230,855 new cases of prostate cancer diagnosed and
approximately 29,089 deaths associated with the disease in
the United States during 2004. Prostate cancer incidence and
mortality increase with age. Prostate cancer is found most often
in men who are over the age of 50. According to the American
Cancer Society, more than 70% of men diagnosed with prostate
cancer are over the age of 65. In addition to age, other risk
factors are linked to prostate cancer, such as genetics and diet.

The dramatic increase in prostate cancer
diagnoses has led to heightened awareness of the disease, which,
in turn, has led to increased rates of testing and improved
diagnostic methods. The American Cancer Society recommends that
men without symptoms, risk factors and a life expectancy of at
least 10 years should begin regular annual medical exams at
the age of 50, and believes that physicians should offer as a
part of the exam, the prostate-specific antigen, or PSA, blood
test and a digital rectal examination in which the physician
places a gloved finger into the rectum and examines the prostate
for lumps. The PSA blood test determines the amount of prostate
specific antigen present in the blood. PSA is found in a protein
secreted by the prostate, and elevated levels of PSA can be
associated with, among other things, prostatitis, a
non-cancerous inflammatory condition, or a proliferation of
cancer cells in the prostate. Transrectal ultrasound tests and
biopsies are typically performed on patients with elevated PSA
readings to confirm the existence of cancer.

We believe that over 85% of prostate cancer
patients are eligible for our cryosurgical treatment. The
U.S. market for prostate cancer treatment for newly
diagnosed patients is estimated to be approximately
$1.3 billion in 2001 and is expected to grow to
$2 billion by 2006. We also believe the market for
secondary cryosurgical treatment of patients with recurring
prostate cancer is significant.

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| |                                   
| | ----------------------------------
| | Non-Cryosurgical Treatment Options

Therapeutic alternatives for patients with
prostate cancer have been both limited and unattractive. Current
treatment options include radical surgery, radiation therapy,
hormone or other therapies, watchful waiting, and
cryotherapy. These options are evaluated using a number of
criteria, including the patients age, physical condition
and stage of the disease. Due to the slow progression of the
disease, however, the decision for treatment is typically based
upon the severity of the condition and the resulting quality of
life.

Radical prostatectomy has been used for over
30 years and is most often the therapy of choice due to the
surgeons high degree of confidence in surgically removing
the cancerous tissue. The procedure is dependent on the skill of
the surgeon and is often associated with relatively high
incidence of post-operative impotence and incontinence and can
even result in operative mortality.

Radiation therapy for prostate cancer includes
both external radiation beam and interstitial radioactive seed
therapies. External beam radiation therapy emerged as one of the
first alternatives to radical prostatectomy; however, studies
have shown that the success rate of this procedure is not
comparable to that of radical prostatectomy. Interstitial
radioactive seed therapy, also referred to as brachytherapy, is
the permanent placement of radioactive seeds in the prostate.
Brachytherapy has been shown to be most effective for localized
tumors caught in the early stage of disease development.

Other therapies, primarily consisting of hormone
therapy and chemotherapy, are used to slow the growth of cancer
and reduce tumor size, but are generally not intended to be
curative. These therapies are often used during advanced stages
of the disease to extend life and to relieve symptoms. Side
effects of hormonal drug therapy include increased development
of breasts and other feminine physical characteristics, hot
flashes, impotence and decreased libido. In addition, many
hormone pharmaceuticals artificially lower PSA levels in
patients, which can interfere with the staging of the disease
and monitoring its progress. Side effects of chemotherapy
include nausea, hair loss and fatigue. Drug therapy and
chemotherapy require long-term, repeated administration of
medication on an outpatient basis.

Watchful waiting is recommended by
physicians in certain circumstances based upon the severity and
growth rate of the disease, as well as the age and life
expectancy of the patient. The aim of watchful waiting is to
monitor the patient, treat some of the attendant symptoms and
determine when more active intervention is required. Watchful
waiting has gained popularity among those patients refusing
treatment due to side effects associated with radical
prostatectomy. Watchful waiting requires periodic physician
visits and PSA monitoring.



| |                           
| | --------------------------
| | The History of Cryosurgery

Cryosurgery, freezing tissue to destroy tumor
cells, was first developed in the 1960s. During this
period, the use of cold probes, or cryoprobes, was
explored as a method to kill prostate tissue without resorting
to radical surgery. Although effective in killing cancer cells,
the inability to control the amount of tissue frozen during the
procedure prevented broad use and development of cryotherapy for
prostate cancer. These initial limitations in the application of
cryosurgery continue to contribute to a lack of widespread
acceptance of the procedure today.

In the late 1980s, progress in ultrasound
imaging allowed for a revival in the use of cryosurgery. Using
ultrasound, the cryoprobe may be guided to the targeted tissue
from outside the body through a small incision. The physician
activates the cryoprobe and uses ultrasound to monitor the
growth of ice in the prostate as it is occurring. When the ice
encompasses the entire prostate, the probe is turned off. This
feedback mechanism of watching the therapy as it is administered
allows the physician more precise control during application.
Published studies suggest that cryosurgery may be able to
deliver disease-free rates comparable to radical surgery and
radiation, but with the benefit of lower rates of incontinence
and mortality, shorter recovery periods and relatively minimal
complications.

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| |                                                
| | -----------------------------------------------
| | Our Solution: The Cryocare Surgical
    Systems

We have developed our proprietary Cryocare
Surgical System to allow the urologist to treat prostate cancer
in a minimally invasive manner. We designed the Cryocare
Surgical System to freeze tissue much faster and with more
control than previous cryosurgical systems.

The Cryocare Surgical System incorporates
enhanced control mechanisms to minimize the risk of unintended
damage to tissue surrounding the prostate. The argon gas-based
cryoprobes stop freezing instantly. During cryosurgical
procedures, six to eight temperature probes are selectively
placed in the prostate near the rectal tissue, sphincter
muscles, which control continence, and neurovascular bundles,
which control potency. These temperature probes enable the
physician to monitor temperatures of tissue adjacent to the
prostate in real time.

A large percentage of our cryosurgical procedures
to date have been performed in medium to high-risk patients. In
these procedures, the urologist intentionally ablates the
neurovascular bundles to prevent the recurrence of cancer,
typically resulting in impotence. We have developed a
nerve-sparing procedure for lower risk patients, which utilizes
a combination of early detection and improved cryosurgical
techniques. Several clinical studies are in process to determine
the disease-free rates that are attainable with this procedure.

Our Cryoguide, a software-controlled ultrasound
planning and mapping system is a significant advancement in
targeted cryoablation of the prostate We sell the Cryoguide as
an accessory to the Cryocare Surgical System and as a standard
component in our new CS system. The Cryoguide control unit
consists of a computer console and display screen designed to be
compatible with standard ultrasound equipment. The Cryoguide
allows physicians to visualize the prostate in three dimensions
and uses a grid system to facilitate the precise placement of
our cryoprobes in the optimal position in the prostate. Our
Cryoguide incorporates a visualization and planning process
allowing the surgeon to simulate cryoablation of the prostate.
This simulation allows validation of the positioning of the
cryoprobes prior to initiating treatment and tailoring the ice
ball formation for individual patients, improving patient
outcomes. The Cryoguide creates a standardized repeatable
procedure and decreases procedural time.

Our proprietary cryoprobes are engineered to
consistently produce sculpted ice conforming to the unique
anatomy of the prostate. Our efficient argon gas-based system
delivers lethal ice in a controllable and repeatable fashion. We
have also developed a percutaneous access device, named
FastTrac, which allows a simplified one step insertion of our
cryoprobes to significantly reduce procedure time.

We continue to evaluate, develop and implement
technology that will refine and improve the Cryocare Surgical
System. In April 2003, we unveiled the next generation of our
Cryocare Surgical System, the Cryocare CS. The
Cryocare CS is a fully integrated cryosurgical planning,
placement and treatment system designed to simplify our
FDA-cleared Targeted Cryoablation of the Prostate TCAP
procedure. It consists of the AutoFreeze, a computer-controlled
automated freezing mechanism that utilizes optimal power
settings based upon target endpoint temperatures and continual
feedback from the thermocouple tips. Along with AutoFreeze,
Cryocare CS includes new Integrated Ultrasound technology that
provides an internal view of the prostate gland. It also
features patented CryoGuide planning software that assists
physicians in determining optimal treatment of the entire gland
as well as targeting specific cancerous areas of the prostate.
The new system also includes a new Urethral Warmer, along with
the vacuum-insulated Direct Access CryoProbes and CryoGrid, a
grid similar to that used in brachytherapy, which is affixed to
the ultrasound stepper. The CryoGrid aids the physician with
placement of the cryoprobes ensuring that ice formation and
lethal temperatures occur where necessary to destroy cancerous
tissue but do not affect areas where tissue damage could cause
harm. We believe the Cryocare CS is the most sophisticated
cryotherapy system currently available and it brings a new level
of safety, ease of use and reproducibility to the use of
cryotherapy in the treatment of prostate cancer.

Cryosurgery is the first minimally invasive
procedure that urologists can perform themselves. With radiation
therapies, urologists must refer the patient for treatment to a
radiation oncologist. Cryosurgery offers the urologist both the
opportunity to maintain continuity of patient care and to
generate additional revenue.

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| |                                                   
| | --------------------------------------------------
| | Key Advantages of Our Cryocare Surgical
    System

Our Cryocare Surgical System provides the
following significant clinical advantages relative to other
principal treatment options for prostate cancer:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Effective for a broad range of low to
    high-risk prostate cancer patients.In
    low risk cases, the success of cryosurgery, including our
    Cryocare Surgical System, is comparable to radiation therapy and
    radical surgery. In medium to high-risk cases, results of
    cryosurgery are at least equivalent and appear to be superior to
    radiation therapy and radical surgery.
|
| |  | High quality of life following
    treatment.Our minimally invasive
    procedure offers patients the shortest recovery period of any
    definitive prostate cancer therapy and may result in a lower
    incidence of certain side effects, including incontinence.                                                                                                                           
|
| |  | Treatment of patients who have failed
    radiation therapy.Patients who have
    failed radiation therapy have limited options. Cryosurgery is a
    potentially curative treatment option that can be used to treat
    these patients effectively with significantly fewer side effects
    than radical surgery.                                                                            
|
| |  | Treatment can be performed more than
    once.Regardless of what therapy is
    chosen there is always a chance that the cancer will recur.
    Unlike radiation therapy or surgery, cryosurgery can be repeated
    without increased morbidity.                                                                                                                                               

Erectile Dysfunction Market
Background

Erectile dysfunction, or impotence, is the
inability to achieve or maintain an erection sufficient for
sexual intercourse. Worldwide sales for erectile dysfunction
products are estimated at $1.2 billion annually.
Approximately 30 million men in the United States suffer
from erectile dysfunction, primarily those over the age of 40. A
variety of physical and psychological conditions can cause
erectile dysfunction, including diabetes, high blood pressure,
high cholesterol, nervous system disorders, complications from
surgery, medication, alcoholism, spinal cord injuries,
depression and other psychological conditions. Erectile
dysfunction is most often caused by physical problems, rather
than psychological problems.

Men suffering from erectile dysfunction generally
have five treatment options: drug therapy, vacuum systems,
needle injection therapy, urethral suppositories and penile
implants. Historically, it is estimated that fewer than 10% of
men afflicted with erectile dysfunction sought treatment for
their condition. The introduction and advertising of oral drug
therapies in 1998, however, significantly increased the
population of patients seeking treatment. This trend is expected
to continue during the next five years as patients become
increasingly comfortable in seeking treatment. Although the
success of oral drug therapies has had a positive impact on the
diagnosis and treatment of patients suffering from erectile
dysfunction, a significant number of patients do not respond,
experience side effects or are not proper candidates for drug
therapies. We believe that these patients will turn to
alternative treatments for erectile dysfunction, including
vacuum systems.



| |                                   
| | ----------------------------------
| | Our Erectile Dysfunction Offerings

Through our acquisition of Timm Medical, we now
have an erectile dysfunction product line consisting of
diagnostic and treatment products.



| |                    
| | -------------------
| | Diagnostic Products

We now market a leading tool for the diagnosis of
erectile dysfunction. The RigiScan Plus Rigidity Assessment
System is an ambulatory diagnostic tool used to measure the
frequency, rigidity and duration of both nocturnal and
provocative erections. It is a non-threatening, non-invasive,
cost-effective method for a physician to differentiate between
organic and psychological erectile dysfunction and support the
treatment program of choice.

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| |                   
| | ------------------
| | Treatment Products

We also offer a leading line of vacuum therapy
systems for the treatment of erectile dysfunction. Even with the
success of oral drug therapies, this product line continues to
appeal to a growing patient population. Target patient
populations include individuals who have not responded to or
have conditions contraindicated for existing drug therapies,
patients who are not eligible for third-party reimbursement
under their present healthcare plans and those patients
concerned with the side-effects of drug therapies.

We hold a leading market position in vacuum
therapy systems. We offer a full line of products, including the
ErecAid Classic system and ErecAid Esteem system. Vacuum therapy
involves the use of a mechanical system that creates a vacuum
around the penis, causing the erectile bodies to fill with
blood. A constriction ring is then placed around the base of the
penis to impede blood drainage and maintain the erection. These
systems are over 90% effective and represent a low cost
treatment for erectile dysfunction.

Marketing and Strategy



| |                      
| | ---------------------
| | Cryosurgical Products

Our objective in urology is to establish
cryosurgery as a primary treatment option for prostate and renal
cancer. Our earlier commercial efforts were focused on direct
and distributor sales of these systems to service entities who
would provide systems and technicians to hospitals where
cryosurgical procedures were performed. Disposable devices used
in cryosurgical procedures (cryoprobes and temperature probes)
were sold in bulk to hospitals and distributors or provided as
part of a procedure fee or kit sold either by us,
our distributors or our service partners to hospitals and other
health care providers.

A cryosurgical procedure kit includes the
necessary disposable devices in addition to a service component.
Transportation and rental of equipment used in the procedure,
plus the services of a technician to assist the urologist with
use and monitoring of this equipment, comprise the service
component of a procedure kit. In addition to the use of a
Cryocare Surgical System, an ultrasound device is needed for
visual monitoring of the prostate and ice formation. Tanks of
argon and helium gas are needed for freezing and warming during
the procedure. Frequently, this equipment is not stored on site
but is mobilized and brought into the hospital for procedures.

In 2003, we re-directed our strategy for
cryosurgical products away from driving acceptance of the
technology through sales of capital equipment into the urology
market toward a focus on development and exploitation of our
core technological competence in the area of tumor ablation. Our
primary objective for the urology portion of our business is now
to grow market share, measured in terms of procedures, through
establishment of cryosurgery as a primary treatment option for
prostate cancer. In fiscal year 2003, we derived a significant
percentage of our revenues from recurring sales of disposable
supplies used with the Cryocare Surgical System.

We continue to sell the disposable devices to
hospitals either in the form of procedure kits or separately,
that is, without the service component. We also continue to sell
our Cryocare Surgical Systems both to hospitals and service
partners, although we will often place a system with a new
customer under our placement program for purposes of
generating additional procedure fees.

Our single greatest challenge in the prostate
cancer market is to overcome initial reluctance on the part of
urologists to embrace cryosurgery. Part of this reluctance is
due to clinical failures experienced during earlier efforts to
introduce the technology by other companies. See above under
The History of Cryosurgery. In addition, we are
competing with other therapies that have proven effective in
treating prostate cancer. Over 30 years of clinical data
exist documenting the safety and efficacy of radical surgery for
prostate cancer. There are 20 years of clinical data
supporting use of various forms of radiation treatment options;
brachytherapy and beam radiation treatments are used to treat
approximately one third of all prostate cancer cases each year
in the United States.

We believe we have clinical advantages for many
patients over both forms of treatment. While there are long-term
clinical data available on radical surgery, this treatment
approach, typical of surgery in general, is

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characterized by a long recovery period combined
with a relatively high incidence of side effects, including
impotence and urinary incontinence. The appeal of radiation as a
treatment alternative, particularly to patients, is that it is
less invasive than surgery. Like radiation, cryosurgery is less
invasive and therefore has potentially fewer side effects than
radical surgery. Unlike radiation treatments, however,
cryosurgical treatments can be repeated on the same patient. In
fact, our initial clinical successes in prostate cancer
treatment were in treating patients who had failed radiation
therapy.


Key elements in our strategy for overcoming the
challenges we face in establishing cryosurgery as a primary
treatment option for prostate cancer are:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increasing awareness in the urological community
    regarding the clinical benefits of cryosurgery through our
    presence at significant technical meetings and trade shows,
    publication of numerous scientific papers and articles on
    cryosurgery and formation of a scientific advisory board to
    provide guidance and counsel to us regarding clinical matters
    and physician education;
|
| |  | Conducting ongoing clinical studies to further
    demonstrate the safety and efficacy of cryosurgery as a primary
    treatment of cancer of the prostate, as well as its value in
    treating prostate cancer patients who have failed radiation;                                                                                                                                                        
|
| |  | Conducting clinical studies to further
    demonstrate the safety and efficacy of cryosurgery as a
    treatment for renal tumors; this is another important component
    of the urology market for cryosurgery;                                                                                                                                                                                           
|
| |  | Creating 50 to 100 new practicing cryosurgeons
    each year through our physician education program;                                                                                                                                                                                                                                                                                                       
|
| |  | Working toward ensuring that reimbursement for
    cryosurgery by Medicare and other payors is appropriate given
    the costs and benefits of the treatment;                                                                                                                                                                                                                                               
|
| |  | Driving patient awareness through our
    direct-to-consumer advertising programs; and                                                                                                                                                                                                                                                                                                                      
|
| |  | Marketing our products to physicians and
    hospitals through our direct sales force.                                                                                                                                                                                                                                                                                                                      

Because of our initial concentration on prostate
cancer, the majority of our sales and marketing resources are
directed towards the promotion of cryoablation technology to
urologists for the treatment of prostate and renal cancer. We
are also, however, expanding the reach of our technology across
a number of other markets, including for ablation of tumors in
the kidney, lung and liver, as well as for managing pain related
to metastatic bone cancer. Procedures for treatment of these
cancers are typically performed percutaneously, using CT
scanning technology, and are done by interventional
radiologists, not urologists. In order to better understand and
address the distinct needs of this new market, we have formed a
dedicated marketing and sales team to work in developing these
opportunities for application of our cryosurgical technology.

Key elements in our strategy to establish new
markets for cryosurgical treatment of tumors, specifically in
the interventional radiology and radiation oncology markets, are:



| |   |                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Conducting numerous clinical studies to
    demonstrate the safety and efficacy of cryosurgery as a primary
    treatment for lung and liver tumors as well as for pain
    management of bone metastases;
|
| |  | Formation of a dedicated sales and marketing
    group focused on the opportunities for cryosurgical treatment
    approaches in these new markets; and                                                   
|
| |  | Continuing to enhance our Cryocare Surgical
    System to improve its ease of use across a broad range of tissue
    ablation applications.                                                               

In line with the renewed focus of our
cryosurgical business on tumor ablation in 2003, we made the
decision to divest or discontinue certain product lines
unrelated to this strategy. In April 2003 we sold the
manufacturing rights to SurgiFrost, a product we had developed
for treatment of cardiac arrhythmia, to CryoCath. Part of this
transaction included licensing our technology and intellectual
property rights related to cryosurgical applications in the
cardiology market. As part of this transaction, we sold all
inventory and fixed assets related to the SurgiFrost line. In
addition, we made the decision in early 2003 to discontinue
development and clinical testing of our Horizon Prostatic Stent,
designed for treatment of BPH also known as prostate enlargement.

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| |                              
| | -----------------------------
| | Erectile Dysfunction Products

In the first quarter of 2002, we added to our
urology product portfolio through the purchase of Timm Medical.
Among products acquired in the Timm Medical transaction was a
line of vacuum therapy systems, including the ErecAid Esteem and
ErecAid Classic systems, for the non-pharmacological treatment
of erectile dysfunction. These devices hold a dominant market
position among products using vacuum technology in treating this
condition. Our goal for this product line is to maintain our
dominant market position and to identify opportunities to
leverage sales of our vacuum pump devices through our
cryosurgery customer base.

Regardless of the treatment method, temporary or
long-term impotence frequently occurs following treatment for
prostate cancer. Accordingly, there is an obvious link between
sales of our cryosurgical products and sales of our erectile
dysfunction products. In addition, we are currently
investigating the potential therapeutic benefits of our ErecAid
products in restoring potency following treatment for prostate
disease, including prostate cancer. We are currently planning to
undertake clinical studies designed to establish whether a
connection exists between use of our vacuum technology following
treatment for prostate cancer and faster or more frequent
restoration of potency. Depending on the outcome of these
studies, we may have an even greater opportunity to channel
sales of ErecAid devices through our existing cryosurgical
customer base. Another product acquired in the Timm Medical
transaction is the RigiScan Monitor, a device used in the
diagnosis of erectile dysfunction. This product continues to be
marketed to physicians, clinics and hospitals.

Also purchased with Timm Medical were the
Dura IITM positionable penile prosthesis
(implant) for treatment of erectile dysfunction, the
ProDynamicTMMonitor, the UroBreeze TM
Urodynamics Monitor and the EasyFloTM Urometry System
for diagnosis and treatment of urinary incontinence in both men
and women. Consistent with our emphasis on developing the market
for our ErecAid products and exploiting available synergies with
our cryosurgical products, we made the decision to divest
certain of these other product lines acquired from Timm. In
April of 2003, we sold the intangibles and inventory associated
with the Dura IITM to American Medical
Systems, Inc. and in October 2003 we sold the intangibles
and inventory related to the line of urinary incontinence and
urodynamics products to SRS Medical Corp. See the discussion of
strategic divestitures above under Recent
Developments.

Strategic Alliances and other
Arrangements

We have used and will continue to use marketing
collaborations, distribution alliances and licensing
arrangements to exploit the market for our Cryocare Surgical
System in areas outside our sales and marketing focus of urology
and radiology, as well as to expand our distribution channels
within our target markets.



| |                                                                       
| | ----------------------------------------------------------------------
| | Arrangement with U.S. Medical
    Development, Inc. and its Affiliates

On June 30, 2001, we issued
213,010 shares of our common stock with a fair market value
of $2,837,293 as consideration for a membership interest in the
form of Class A Units of U.S. Medical
Development, Inc., formerly U.S. Therapies, LLC, equal
to approximately 9% of the total issued and outstanding
Class A Units of U.S. Medical Development, Inc.
and approximately 5% of the Class A Units on a
fully-diluted basis. U.S. Medical Development, Inc. is
a national urology group representing more than 150 urologists
across the nation. We simultaneously entered into a distribution
agreement with U.S.M.D., Ltd., formerly U.S. Medical
Devices, Ltd., a subsidiary of U.S. Medical
Development, Inc., under which U.S.M.D., Ltd. received
exclusive sales rights to our Cryocare Surgical System and
associated disposable products in 16 states. U.S.M.D., Ltd.
also had the exclusive right to distribute the Cryocare Surgical
System to HealthTronics Surgical Services, Inc. (Nasdaq:
HTRN) and its affiliates, a company that provides urologic and
orthopedic services to patients in 35 states through
physician partnerships.

In September 2002, we terminated our distribution
agreement with U.S.M.D., Ltd. and acquired the mobile prostate
treatment businesses owned by U.S. Medical
Development, Inc., and its affiliates, U.S.M.D., Ltd. and
U.S.M.D. I, L.L.C., collectively referred to as
USMD. The transaction allowed us to sell directly to
the large base of USMD customers via an experienced sales force
with established physician relationships. We purchased the
mobile prostate treatment businesses in exchange for a total
consideration of approximately

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$11.2 million in the form of cash,
assumption of debt and forgiveness of debt. The debt forgiveness
component of the purchase consideration is structured in the
form of an earn-out. According to the terms of the Purchase
Agreement executed in August and September 2002, the balance of
$7.7 million owed to us by USMD at the purchase date was to
be forgiven, pro-rata, upon the achievement of $12 million
in gross revenues by the businesses purchased from USMD during
the period between October 1, 2002 and December 31,
2005. The earn-out provision of the 2002 Purchase Agreement has
now been restructured. In February 2004 we and USMD executed an
amendment to the 2002 Purchase Agreement which provides that we
will extend the forgiveness period for the unearned balance of
$7.7 million until December 31, 2008.




| |                                                        
| | -------------------------------------------------------
| | Distribution Arrangement with Sanarus
    Medical, Inc.

In October 1999, we entered into a strategic
alliance with Sanarus Medical, Inc., a privately held
medical device company, to commercialize our proprietary
cryosurgical technology in the treatment of breast cancer,
benign breast tumors and gynecological diseases. The terms of
the related agreements included an equity investment by us in
Sanarus totaling $300,000, which represented 6.8% of all
outstanding voting securities on the investment date. We also
received a warrant to acquire at that time approximately 52.0%
of Sanarus voting stock on an as-converted, fully-diluted
basis, in consideration for entering into a manufacturing,
supply and license agreement. In June 2001, we provided a bridge
loan to Sanarus in the principal amount of $250,000, which
accrued interest at the rate of 8% per annum, compounded
annually. This amount was subsequently repaid in July 2001 upon
Sanarus receipt of additional equity financing. This
financing along with other financings by Sanarus reduced our
ownership percentage to approximately 1.8% of Sanarus
voting stock on an as-converted basis and reduced our maximum
potential ownership percentage in Sanarus to approximately 20%
on an as-converted, fully-diluted basis. In April 2003, we and
other investors entered into a bridge loan financing with
Sanarus in which Sanarus issued to us a convertible promissory
note in the aggregate amount of $600,000 and a related stock
purchase warrant with an aggregate exercise price of up to
$300,000. In October 2003, we and other investors participated
in an equity financing with Sanarus in which Sanarus issued to
us shares of preferred stock in exchange for our cancellation of
the indebtedness evidenced by our convertible promissory note.
This financing along with other financings by Sanarus increased
our percentage ownership to approximately 2.7% of Sanarus
voting stock on an as-converted basis and reduced our maximum
potential ownership percentage in Sanarus to approximately 7.9%
on an as-converted, fully-diluted basis.



| |                                    
| | -----------------------------------
| | Licensing Arrangement with CryoCath

In September 2001, we entered into an exclusive
market access and supply agreement with CryoCath, a publicly
traded company listed on the Toronto Stock Exchange focused on
developing minimally invasive, catheter-based, cryotherapy
products to treat cardiovascular disease. Under this agreement,
CryoCath obtained an exclusive, worldwide right to market, sell
and distribute our cryosurgical technologies for the targeted
treatment of cardiac arrhythmias. The agreement required
CryoCath to pay license fees and to make minimum product
purchases. We were obligated under the agreement to undertake
product development projects, maintain regulatory approval for
the products in the United States and Europe and indemnify
CryoCath in the event of some third-party claims. We had the
right to reduce CryoCaths rights to a non-exclusive
license if CryoCath failed to meet certain minimum purchase
requirements. In February 2002, we received FDA clearance for
use of our cryosurgical technologies for the treatment of
cardiac arrhythmias. CryoCath marketed the system as the
SurgiFrost system.

On April 14, 2003, we sold our
cardiac-related product manufacturing operations and licensed
the related intellectual property to CryoCath. In connection
with this sale and license, we terminated our exclusive market
access and supply agreement with CryoCath. Under the terms of
the sale and license agreement, we transferred all of our
manufacturing assets and inventory related to the cardiac
product line to CryoCath and will exclusively license to
CryoCath for cardiovascular uses our proprietary technology
associated with the SurgiFrost system  a cryoablation
system designed to treat cardiac arrhythmias. Terms of the
agreement also include the payment by CryoCath to us of
$10 million during 2003. The agreement also calls for the

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payment by CryoCath to us of a nine-year
descending royalty stream based on net sales of products
incorporating the licensed technology. We believe
CryoCaths leadership position in the field of
cardiovascular cryotherapy puts them in a strong position to
exploit the opportunities for our technology in this highly
competitive arena.


Products

We currently market the following products:

|                                              |  |                                                                                  |  | 
|--------------------------------------------- |  | -------------------------------------------------------------------------------- |  | 
|Product Name                                  |  | Function                                                                        
|                                              |  |                                                                                 
|Prostate Cancer                               |  |                                                                                  |  | 
|Cryocare Surgical System  8 Probe
    System |  | Cryosurgical system with eight cryoprobe capability                             
|Cryocare CS System                            |  | Cryosurgical system with onboard ultrasound                                     
|CryoGuide                                     |  | Computerized cryoprobe placement, simulation and guidance system for cryosurgery
|Cryoprobes                                    |  | Disposable probes used with the Cryocare Surgical System                        
|FastTrac                                      |  | Percutaneous access device that allows one step insertion of cryoprobes         
|Additional Cryosurgical Markets               |  |                                                                                  |  | 
|Cryocare  4 Probe System                     |  | Cryosurgical system with 4 probe capability for general surgery                 
|Erectile Dysfunction                          |  |                                                                                  |  | 
|RigiScan Monitor                              |  | Diagnostic tool for erectile dysfunction                                        
|ErecAid Esteem System                         |  | Vacuum therapy system                                                           
|ErecAid Classic System                        |  | Vacuum therapy system                                                           

Raw Materials

We rely on third-party suppliers to provide
certain critical components for all of our product lines. In a
number of cases, these suppliers are our sole source of supply
for these components. Our policy is to enter into long-term
supply agreements that require suppliers to maintain adequate
inventory levels and that contain other terms and conditions
protecting us against unforeseen interruptions in their
production. In addition, we maintain buffer stock at our own
locations to ensure an uninterrupted source of supply. Wherever
possible, we actively seek to establish secondary sources of
supply or other manufacturing alternatives. Nevertheless,
despite these efforts, it is possible that we may experience an
interruption in supply of one or more of our critical components
resulting in backorders to our customers. If such a supply
interruption proves lengthy or should no manufacturing
alternative be quickly identified, we could experience a
significant reduction in revenues, net income and cash flows.

Patents and Intellectual Property

As of the end of December 2003, we have rights to
33 issued U.S. patents relating to cryosurgical ablative
technology. Included within these 33 issued U.S. patents
are 5 patents in which we have licensed-in rights. The remainder
of the patents is assigned to us. Most of these patents relate
to our cryoprobe technology for creating the freeze zone and
precisely controlling the shape of the freeze zone produced by
the cryoprobes. Additionally, our patents relate to our computer
guided system for assisting surgeons in properly placing
cryoprobes in a patient, a computer controlled cryosurgery
apparatus and method, a cryosurgical integrated control and
monitoring system and urethral warming technology. We also have
13 pending U.S. patent applications relative to
cryosurgical ablative technology. Additionally, we have 25
foreign patents and pending foreign patent applications in this
technology area. The earliest of our patents do not expire until
2011. Most of the earliest patents in our core technology area
do not expire until about 2016.

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We have rights to 15 issued U.S. patents
relating to our stent product line. Included within these 15
patents are 3 licensed-in patents. The remainder is assigned to
us. We also have 2 pending U.S. patent applications
relative to the stent product line. Additionally, we have rights
to 7 foreign patents and pending foreign patent applications in
this technology area. The earliest of our stent patents do not
expire until about 2016.

We own 22 issued U.S. patents relating to
our erectile dysfunction product line. We also have 1 pending
U.S. patent application relative to this product line.
Additionally, we have 14 foreign patents and pending foreign
patent applications in this technology area. Some of these
patents will expire within the next few years.

Our policy is to secure and protect intellectual
property rights relating to our technology through patenting
inventions and licensing others when necessary. While we believe
that the protection of patents and licenses is important to our
business, we also rely on trade secrets, know-how and continuing
technological innovation to maintain our competitive position.
Given our technology and patent portfolio, we do not consider
the operation of our business to be materially dependent upon
any one patent, group of patents or single technological
innovation.

Our policy is to sell our products under
trademarks and to secure trademark protection in the United
States and worldwide where possible. We believe the protection
of our trademarks is important to our business.

No assurance can be given that our processes or
products will not infringe patents or other intellectual
property rights of others or that any license required would be
made available under any such patents or intellectual property
rights, on terms acceptable to us or at all. From time to time,
we have received correspondence alleging infringement of
intellectual property rights of third parties. No assurance can
be given that any relevant claims of third parties would not be
upheld as valid and enforceable, and therefore we could be
prevented from practicing the subject matter claimed or could be
required to obtain licenses from the owners of any such
intellectual property rights to avoid infringement.

In December 2000, we settled a patent lawsuit
against Cryomedical Sciences, Inc., now known as BioLife
Solutions, Inc., or BioLife, and in March 2001 we settled
two patent lawsuits against Israel-based Galil Medical, Ltd. and
its U.S. affiliate, Galil Medical (USA), Inc. The
lawsuits against BioLife and Galil concerned the infringement of
our patent for an integrated cryosurgical system. The
settlements resulted in cross-licensing agreements between Galil
and us and BioLife and us.

We seek to preserve the confidentiality of our
technology by entering into confidentiality agreements with our
employees, consultants, customers and key vendors and by other
means. No assurance can be given, however, that these measures
will prevent the unauthorized disclosure or use of such
technology.

Research Strategy

Our research goal is to develop innovative
cryoablation technology, which dramatically improves patient
outcomes. Our primary focus is on developing devices for the
treatment of prostate, kidney, lung, liver and bone tumors. To
that end, we plan to develop innovations, which improve the
speed and efficacy of our Cryocare Surgical System.

We spent approximately $2.5 million,
$2.9 million and $1.3 million for the years ended
2001, 2002 and 2003 respectively, on research and development
activities.

Sales

We sell our products primarily to physicians and
hospitals and have both domestic and international customers. In
April 2003, we sold our cardiac-related product manufacturing
operations and the licensed the related intellectual property to
CryoCath. In connection with this sale and license, we
terminated the original supply arrangement with CryoCath. None
of our customers accounted for in excess of 10% of our net
revenues

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in 2003. The following products and services
account for 15% or more of total revenues for each of the years
ended December 31:


|                                      |                                        |      |  |      |   |      |  |    |   |  |  |    |  
|------------------------------------- | -------------------------------------- | ---- |  | ---- | - | ---- |  | -- | - |  |  | -- | -
|                                      |                                        | 2001 |  | 2002 |   | 2003
|                                      |                                        |      |  |      |   |     
|Cryoablation and urological products: |                                        |      |  |      |   |      |  |    |   |  |  |   
|                                      | Cryocare Surgical Systems              |      |  | 56   | % |      |  | *  |   |  |  | *  |  
|                                      | Cryoprobes, disposables and procedures |      |  | 44   | % |      |  | 41 | % |  |  | 59 | %
|                                      | Cardiac products (CryoCath)            |      |  | *    |   |      |  | *  |   |  |  | *  |  
|                                      | Urological products (Timm Medical)     |      |  | *    |   |      |  | 41 | % |  |  | 36 | %



---



|  |                                                                
|- | ---------------------------------------------------------------
|* | These products account for less than 15% of total
    revenues.

We currently sell our cryosurgical products
domestically through our direct sales force, which, as of
December 31, 2003 consisted of 48 people, including
32 sales representatives and sales managers and
16 cryosurgical field technicians. Our strategy is to focus
marketing and sales efforts and generating physician access to
and awareness of the Cryocare Surgical System. We also intend to
create patient demand by providing education regarding the
benefits of cryosurgical therapy versus alternative treatment
options and by further expanding our national advertising and
other programs targeted directly at prostate disease patients.

In December 2002, we began to test market direct
consumer response via 800 number call-in
advertisements placed on televised segments of CNN Headline
News. Based on initial call volume and consumer interest, we
expanded direct-to-consumer advertising throughout 2003. Due to
the continued success of this strategy, we plan to invest
additional resources in 2004 in building this program.

Internationally, our cryosurgical products are
sold primarily through independent distributors. Our
international sales represented approximately 8%, 14.7% and
10.6% of our consolidated revenue in 2001, 2002 and 2003,
respectively.

Our ErecAid products are sold through a dedicated
sales force for our vacuum therapy line. We have one national
sales manager in charge of this sales organization, which
consisted of 15 sales representatives as of
December 31, 2003. The devices are primarily sold by
prescription directly to end users. We also distribute the
product through durable medical equipment manufacturers,
pharmacies, physician offices and through our contract with the
Veterans Administration.

We derive our revenues from the following
geographic regions for each of the years ended December 31
(in thousands):

|                    |        |                |        |      |  |      |        |       |  |   |        |       | 
|------------------- | ------ | -------------- | ------ | ---- |  | ---- | ------ | ----- |  | - | ------ | ----- | 
|                    |        | 2001           |        | 2002 |  | 2003
|                    |        |                |        |      |  |     
|                    |        |               
|                    |        | (In thousands)
|United States       |        | $              | 11,988 |      |  | $    | 26,369 |       |  | $ | 27,257 |      
|International:      |        |                |        |      |  |      |        |       |  |   |        |      
|                    | China  |                |        | 593  |  |      |        | 402   |  |   |        | 469   | 
|                    | Canada |                |        |     |  |      |        | 2,104 |  |   |        | 331   | 
|                    | Other  |                |        | 456  |  |      |        | 2,041 |  |   |        | 2,440 | 
|                    |        |                |        |      |  |      |        |       |  |   |        |      
|Total international |        |                | 1,049  |      |  |      | 4,547  |       |  |   | 3,240  |      
|                    |        |                |        |      |  |      |        |       |  |   |        |      
|Total revenues      |        | $              | 13,037 |      |  | $    | 30,916 |       |  | $ | 30,497 |      
|                    |        |                |        |      |  |      |        |       |  |   |        |      

Reimbursement

We sell our Cryocare Surgical System and related
disposable temperature probes and cryoprobes to hospitals and
other entities that provide services to hospitals. Most
procedures involving the Cryocare Surgical System are performed
in hospitals on an inpatient basis. While patients occasionally
pay for cryosurgical procedures directly, virtually all patients
depend upon third-party payors, including Medicare, Medicaid,
Tricare and other federal health care programs, as well as
private insurers to pay for their procedures.

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Accordingly, our revenue is dependent upon
third-party reimbursement, particularly Medicare, since an
estimated 70% of patients receiving cryosurgical treatments
using our proprietary technology are Medicare beneficiaries.


Medicare reimbursement for cryosurgical
procedures using our products as a primary treatment alternative
for localized prostate cancer began in July 1999. Effective July
2001, Medicare coverage was approved for secondary cryosurgical
treatment of prostate cancer patients who have failed radiation
therapy.

When Medicare-reimbursed services are provided on
an inpatient basis, the hospital is reimbursed under the
Medicare prospective payment system, based on the applicable
diagnosis related group, or DRG. A single payment covers all
facility services.

Outpatient reimbursement for cryosurgical
procedures for Medicare beneficiaries is in accordance with the
Hospital Outpatient Prospective Payment System, or HOPPS. Under
HOPPS, the hospital is paid on a per procedure basis, based on
the ambulatory payment classification, APC, for the procedure.
The payment to the hospital includes the per procedure share of
the cost for any depreciable equipment, such as our Cryocare
Surgical System unit, and the provision of disposable devices,
such as our temperature probes and cryoprobes.

Medicare makes additional payments to hospitals
under HOPPS when certain qualifying new medical devices are used
to perform a procedure or service on a program beneficiary on an
outpatient basis. These pass-through payments help
to compensate hospitals for the additional costs of utilizing
new technology in treating Medicare beneficiaries on an
outpatient basis. Our temperature probes and cryoprobes were
previously paid on a pass-through basis, but these payments
ended on December 31, 2003.

Items qualifying for pass-through payment
continue to be eligible for at least two, but not more than
three, years. After the pass-through status of an item expires,
the relevant APC groupings, weights and payments are updated to
include costs associated with former pass-through items.
Effective January 1, 2004, cryosurgery of the prostate is
reimbursed under APC 674 as a single payment, including the
cryoprobes and temperature probes previously reimbursed on a
pass-through basis. This integrated payment for outpatient
procedures for Medicare patients is a reduction of approximately
15 percent from previous HOPPS reimbursement rates to
hospitals for prostate cryosurgery. Many hospitals, however, did
not routinely or accurately bill Medicare for the disposables.
In these cases, the effect of reduced reimbursement will not be
as great. Nevertheless, we can provide no assurance that the new
HOPPS payment levels will not adversely impact our revenues, net
income and cash flows.

We are exploring percutaneous ablation of
cancerous tissue in bone, kidney, lung and liver. Clinical
studies are underway and as soon as studies are complete
coverage decisions and unique reimbursement codes will be sought
from Medicare and private payors.

Our ErecAid Esteem and ErecAid Classic Systems,
which we sell through Timm Medical, are also reimbursed by
Medicare and other federal health care programs, as well as
private insurers. Timm Medical provides certain items to
patients on a prescription basis and bills the patient or
third-party payor directly, including Medicare and private
insurers. Consequently, Timm Medicals business would be
directly impacted by any changes in either coverage policies or
reimbursement amounts adopted by Medicare or other third-party
payors.

Approval of a new device or technology by the FDA
does not guarantee payment by Medicare or other payors. Future
devices and technology that we develop would have to be approved
for coverage by Medicare after we obtain FDA approval or
clearance. The Medicare approval process is lengthy and there is
no assurance that Medicare approval would be granted. Each
private insurer makes its own determination whether to cover a
device or procedure and sets its own reimbursement rate.

Backlog

As of December 31, 2003, we had minimal
backlog for either our cryosurgical products or our vacuum
therapy products. Our policy is to carry enough inventory to be
able to ship most orders within a few days of

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receipt of order. Historically, most of our
orders have been for shipment within 30 days of the
placement of the order. Therefore, we rely on orders placed
during a given period for sales during that period. Backlog
information as of the end of a particular period is not
necessarily indicative of future levels of our revenue.


Government Contracts

Timm Medical has entered into a contract with the
Department of Veterans Affairs Prosthetics and Sensory Aids
Service pursuant to which Timm Medical became the national
mandatory source for vacuum erection devices for the Veterans
Affairs network of hospitals and clinics through March 31,
2005. In 2003, Timm Medical recognized approximately
$1.4 million in revenues under this contract. The
Department of Veterans Affairs can terminate this contract on
30 days notice.

Manufacturing

We manufacture our Cryocare Surgical System and
related disposables internally at our facilities in Irvine,
California. We moved our executive offices and transferred our
manufacturing activities to our existing facility in Irvine,
California in April 2002. The new facility has been inspected by
the California Department of Health Services and has been issued
a Device Manufacturing License.

Our current manufacturing facility was subjected
to Quality System Regulation compliance inspections by the FDA
in September 2002 and again in February and March 2003. Both
audits have been successfully closed by the FDA. We have
received ISO 9001, ISO 13485, and CE Marking
certifications, indicating compliance with European standards
for quality assurance and manufacturing process control.

The erectile dysfunction products we acquired
through our acquisition of Timm Medical are assembled, packaged
and shipped in our Minneapolis facility. Injection molding of
the devices as well as manufacturing of certain other components
is outsourced to third-party suppliers.

Government Regulation

Governmental regulation in the United States and
other countries is a significant factor affecting the research
and development, manufacture and marketing of medical devices,
including our products. In the United States, the FDA has broad
authority under the federal Food, Drug and Cosmetic Act, the FDC
Act, to regulate the distribution, manufacture, marketing and
sale of medical devices. Foreign sales of medical devices are
subject to foreign governmental regulation and restrictions that
vary from country to country.

We are also required to register as a medical
device manufacturer with state agencies, such as the State of
California Department of Health Services, or CDHS. As such, we
will be inspected by such regulatory agencies and authorities
for compliance with applicable regulations. These regulations
require that we manufacture our products and maintain our
documents in a prescribed manner.

Noncompliance with applicable requirements can
result in, among other things, warning letters, proceedings to
detain imported products, fines, injunctions, civil and criminal
penalties against us, our officers and our employees, recall or
seizure of products, total or partial suspension of production,
refusal of the government to grant premarket clearance or
premarket approval for devices, withdrawal of marketing
approvals and a recommendation by the FDA that we not be
permitted to enter into government contracts.

Medical devices intended for human use in the
United States are classified into one of three categories,
depending upon the degree of regulatory control to which they
will be subject. Such devices are classified by regulation into
either Class I general controls, Class II special
standards or Class III pre-market approval depending upon
the level of regulatory control required to provide reasonable
assurance of the safety and effectiveness of the device.

Most Class I devices are exempt from
premarket notification or approval. Class II devices are
subject to the premarket notification requirements under
Section 510(k) of the FDC Act. For a 510(k) to be cleared
by the FDA, the manufacturer must demonstrate to the FDA that a
device is substantially equivalent to another legally marketed
device that was either cleared through the 510(k) process or on
the market prior to 1976. It

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generally takes four to twelve months from the
date of submission to obtain 510(k) clearance although it may
take longer, in particular if clinical trials are required.
Class III devices generally include the most risky devices
as well as devices that are not substantially equivalent to
other legally marketed devices. To obtain approval to market a
Class III device, a manufacturer must obtain FDA approval
of a premarket approval application, or PMA. The
PMA process requires more data, takes longer and is more
expensive than the 510(k) procedure.


Our Cryocare Surgical System, RigiScan and
ErecAid products have been cleared for marketing through the
510(k) process.

We can provide no assurance that we will be able
to obtain clearances or approvals for clinical testing or for
manufacturing and sales of our existing products for all
applications in all targeted markets, or that we will be able to
obtain clearances or approvals needed to introduce new products
and technologies. After a device is placed on the market,
numerous regulatory requirements apply. These include:



| |   |                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | quality system regulation, which requires
    manufacturers to follow design, testing, control, documentation
    and other quality assurance procedures during the manufacturing
    process;                                                                                                        
|
| |  | labeling regulations, which prohibit the
    promotion of products for unapproved or off-label
    uses and impose other restrictions on labeling; and                                                                                                                                              
|
| |  | medical device reporting regulations, which
    require that manufacturers report to the FDA if their device may
    have caused or contributed to a death or serious injury or
    malfunctioned in a way that would likely cause or contribute to
    a death or serious injury if it were to recur.

Failure to comply with applicable regulatory
requirements can result in enforcement action by the FDA, which
may include any of the following sanctions:



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | fines, injunctions, and civil penalties;                                             
|
| |  | recall or seizure of our products;                                                   
|
| |  | operating restrictions, partial suspension or
    total shutdown of production;      
|
| |  | refusing our request for 510(k) clearance or
    premarket approval of new products; 
|
| |  | withdrawing 510(k) clearance or premarket
    approvals that are already granted; and
|
| |  | criminal prosecution.                                                                

Medical device laws are also in effect in many of
the countries outside of the United States in which we do
business. These laws range from comprehensive device approval
and quality system requirements for some or all of our medical
device products to simple requests for product data or
certifications. The number and scope of these requirements are
increasing. In June 1998, the European Union Medical Device
Directive became effective, and all medical devices must meet
the Medical Device Directive standards and receive CE mark
certification. CE mark certification involves a
comprehensive Quality System program, and submission of data on
a product to the Notified Body in Europe.

We have obtained CE Mark for distribution of
our Cryocare Surgical System and our Horizon Prostatic Stent in
Europe and product registration for distribution of our Cryocare
Surgical System in Canada, Australia and New Zealand. The
ErecAid and RigiScan are both CE Marked for distribution in
Europe and registered for distribution in Canada and Australia.
In addition, RigiScan is sold in Asia.

Health Care Regulatory Issues

The health care industry is highly regulated and
the regulatory environment in which we operate may change
significantly in the future. In general, regulation of health
care-related companies is increasing. We anticipate that
Congress and state legislatures will continue to review and
assess alternative health care delivery and payment systems. We
cannot predict what impact the adoption of any federal or state
health care reform measures may have on our business.

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We regularly monitor developments in statutes and
regulations relating to our business. We may be required to
modify our agreements, operations, marketing and expansion
strategies from time to time in response to changes in the
statutory and regulatory environment. We plan to structure all
of our agreements, operations, marketing and strategies in
accordance with applicable law, although we can provide no
assurance that our arrangements will not be challenged
successfully or that required changes may not have a material
adverse effect on our business, financial condition, results of
operations and cash flows.

The following discussion briefly summarizes some,
but not all, of the current regulatory schemes that could be
applicable to our business. Complying with these regulatory
schemes may involve expense to us, delay in our operations,
and/or restructuring of our business relationships. Violations
could potentially result in the imposition upon us of civil
and/or criminal penalties.



| |                   
| | ------------------
| | Anti-Kickback Laws

The federal health care program
anti-kickback law prohibits the knowing and willful
offer, payment, solicitation or receipt of any form of
remuneration in return for, or in order to induce, (i) the
referral of a person for services, (ii) the furnishing or
arranging for the furnishing of items or services or
(iii) the purchase, lease, or order or arranging or
recommending purchasing, leasing or ordering any item or
service, in each case, reimbursable under any federal health
care program. Because our products are reimbursable under
Medicare, Medicaid and other federal health care programs, the
anti-kickback law applies. Many states have similar
anti-kickback laws, and in many cases these laws apply to all
patients, not just federal health care program beneficiaries.
Noncompliance with, or violation of, the federal anti-kickback
law can result in exclusion from federal health care programs
and civil and criminal penalties. Similar penalties are provided
for violation of state anti-kickback laws. Several federal
courts have held that the anti-kickback law is violated if just
one purpose of payment is to induce the referral of patients. To
the extent that we are deemed to be subject to these federal or
similar state laws, we believe that our activities and
contemplated activities will comply in all material respects
with such statutes and regulations.

Regulations to the federal anti-kickback law
specify payment practices that will not be subject to
prosecution under the anti-kickback law. These are known as the
safe-harbors. Failure to comply fully with a
safe-harbor does not mean the practice is per se illegal.
Rather, if a practice does not fit within a safe
harbor, no guarantee can be given that the practice will
be exempt from prosecution; it will be viewed under the totality
of the facts and circumstances.

We believe that our current structure and
business and our contemplated future operations comply and will
comply with the federal anti-kickback law. It does not appear,
however, that certain of our business practices fit or will fit
within a safe harbor and there is no assurance that
if viewed under the totality of the facts and circumstances, our
structure and business would not be challenged, perhaps even
successfully, as a violation of the anti-kickback law. Mere
challenge, even if we ultimately prevail, could have a
substantial adverse effect on us.



| |                      
| | ---------------------
| | Patient Referral Laws

The Stark law prohibits a physician from
referring a Medicare patient for a designated health
service to an entity with which the physician has a direct
or indirect financial relationship, whether in the nature of an
ownership interest or a compensation arrangement, subject only
to limited exceptions. The Stark law also prohibits the
recipient of a prohibited referral from billing for the
designated health services provided pursuant thereto.
Designated Health Services include inpatient and
outpatient hospital services, durable medical equipment and
prosthetic devices. The entity that bills Medicare for the
designated health service is considered to be the provider of
the designated health service for Stark law purposes. Therefore,
we are not (except with respect to certain Timm Medical
products) providers of designated health services, nor are the
physician-owned entities that purchase or lease our equipment.
Rather the hospitals where the procedures are performed are the
providers of designated health services, because they bill
Medicare for the procedures, and inpatient and outpatient
hospital services are designated health services. Physicians who
have an ownership or compensation relationship with the entities
(such as mobile vendors) that furnish our equipment to hospitals,

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and the hospitals that obtain equipment and
services directly or indirectly from such entities, are
considered to have an indirect compensation relationship, and
are thus subject to the Stark law prohibitions.


We believe that the arrangements we have
established with physician-owned entities and hospitals comply
with applicable Stark law exceptions. However, if any of the
relationships between physicians and hospitals involving our
services, or, in the case of Timm Medical, any of our financial
relationships with referring physicians, do not meet a Stark law
exception, neither the hospital nor we would be able to bill for
any procedure resulting from a referral that violated the Stark
law. Although, in most cases we are not the direct provider and
do not bill Medicare for the designated health services, any
Stark law problem with our business arrangements with physicians
and hospitals would adversely affect us as well as the referring
physician and the hospital receiving the referral.

Many states also have patient referral laws, some
of which are more restrictive than the Stark law and regulate
referrals by all licensed health care practitioners for any
health care service to an entity with which the licensee has a
financial relationship unless an exception applies. Such laws in
particular states may prohibit us from entering into
relationships with physicians and physician-owned entities,
which may limit business development.

We believe that our business practices comply
with the Stark law and applicable state referral laws. No
assurance can be made, however, that these practices would not
be successfully challenged and penalties, such as civil money
penalties and exclusion from Medicare and Medicaid, and or state
penalties, imposed. And, again, mere challenge, even if we
ultimately prevail, could have a substantial adverse effect on
us.



| |                             
| | ----------------------------
| | HIPAA and Other Privacy Laws

As of April 14, 2003, the privacy
regulations developed under the Health Insurance Portability and
Accountability Act of 1996, referred to as HIPAA,
took effect. The privacy regulations place limitations on the
use and disclosure of identifiable patient information,
including research data. We have adopted policies and procedures
governing our status as a covered entity (in the
case of Timm Medical) or as a business associate (in
the case of certain other activities). We believe that we have
implemented appropriate measures to ensure compliance with
HIPAA. However there are many uncertainties remaining about how
HIPAA applies to the medical device business, and no assurance
can be made that HIPAA will not be interpreted in a manner that
will hamper our ability to conduct medical research and detail
medical information for other purposes as well.



| |                                                
| | -----------------------------------------------
| | Other United States Regulatory
    Requirements

In addition to the regulatory framework for
product approvals, we are and may be subject to regulation under
federal and state laws, including requirements regarding
occupational health and safety, laboratory practices and the
use, handling, and disposing of toxic or hazardous substances.
We may also be subject to other present and future local, state,
federal and foreign regulations.

Seasonality

We believe that holidays, major medical
conventions and vacations taken by physicians, patients and
patient families may have a seasonal impact on our sales of
cryosurgical products since cryosurgical procedures can be
scheduled in advance. We are continuing to monitor and assess
the impact seasonality may have on demand for our products.

Competition

The medical device industry is subject to intense
competition. Significant competitors in the area of prostate
cancer therapies include ONCURA, Theragenics Corporation and
North American Scientific, Inc. Significant competitors in
the area of erectile dysfunction include American Medical
Systems Holdings, Inc., Mentor Corporation, Augusta Medical
Systems, LLC and Pfizer, Inc. In addition, other companies
are

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developing urological products that could compete
with our Cryocare Surgical System and other urological products.
Many of these competitors have significantly greater financial
and human resources than we do.


We believe the principal competitive factors in
the cryoablation product market include:



| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | the safety and efficacy of treatment alternatives;                    
|
| |  | acceptance of a procedure by physicians and
    patients;             
|
| |  | technology leadership and superiority;                                
|
| |  | price;                                                                
|
| |  | availability of government or private insurance
    reimbursement; and
|
| |  | speed to market.                                                      

Employees

As of December 31, 2003, we had a total of
163 employees. Of these employees, 7 are engaged
directly in research and development activities, 11 in
regulatory affairs/quality assurance, 28 in manufacturing,
87 in sales, marketing and customer service (including
16 clinical technicians) and 30 in general and
administrative positions. We expect to increase employment in
sales and marketing to grow market share, measured in terms of
procedures. In addition, we will build the infrastructure needed
to support more robust internal controls and improved financial
reporting processes and systems. We have never experienced a
work stoppage, none of our employees are represented by a labor
organization, and we consider our employee relations to be good.

Although we conduct most of our research and
development using our own employees, we occasionally have funded
and plan to continue to fund research using consultants.
Consultants provide services under written agreements and
typically are paid based on the amount of time spent on our
matters. Under their consulting agreements, such consultants are
required to disclose and assign to us any ideas, discoveries and
inventions created or developed by them in the course of
providing consulting services.

Available Information

Our website address is www.endocare.com. All
filings we make with the SEC, including our annual report on
Form 10-K, our quarterly reports on Form 10-Q, and our
current reports on Form 8-K, and any amendments thereto,
are available at no charge through links displayed on our
website as soon as reasonably practicable after they are filed
or furnished to the SEC. Please note that we do not currently
intend to amend prior filings based on the restatements to our
historical financial statements. Detailed information regarding
these restatements is disclosed in Notes 3 and 16 to our
consolidated financial statements filed in our annual report on
Form 10-K for the year ended December 31, 2002. The
reference to our website address does not constitute
incorporation by reference of the information contained on the
website, and the information contained on the website is not
part of this document.

Risks Related to Our Business

The risks and uncertainties described below
are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently
deem immaterial may also impair our operations. The occurrence
of any of the following risks could harm our business. In that
case, the trading price of our common stock could decline, and
you may lose all or part of your investment.

Our success will depend on our ability to
attract and retain key personnel.

In order to execute our business plan, we need to
attract, retain and motivate a significant number of highly
qualified managerial, technical, financial and sales personnel.
If we fail to attract and retain skilled scientific and
marketing personnel, our research and development and sales and
marketing efforts will be hindered. Our future success depends
to a significant degree upon the continued services of key
management personnel, including Craig T. Davenport, our
Chief Executive Officer, William J. Nydam, our President and

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Chief Operating Officer, and Katherine Greenberg,
our Senior Vice President and Chief Financial Officer. None of
our key management personnel is covered by an insurance policy
of which we are the beneficiary.


Our management members have spent considerable
time and effort dealing with internal and external
investigations and re-auditing of financial
statements.

In addition to the challenges of the SEC
investigation, the DOJ investigation, a shareholder
class-action and a derivative lawsuit and other legal
proceedings described below, our new management members have
spent considerable time and effort dealing with internal and
external investigations involving our previous internal
controls, accounting policies and procedures, disclosure
controls and procedures and corporate governance policies and
procedures. The significant time and effort spent has adversely
affected our operations and may continue to do so in the future.

We face risks relating to our
liquidity.

Over the past 16 months we have incurred
significant costs related to, among other things, legal,
accounting and other professional fees associated with our
internal review of various accounting and other matters, the
ongoing investigation of us by the SEC and DOJ, various
shareholder class-action and derivative lawsuits and other legal
proceedings described below. In addition we are making
significant investments in the development and implementation of
sound internal controls and corporate governance policies and
procedures designed to enhance the accuracy, quality and
consistency of our financial information and reporting. We will
continue to incur significant related expenses in the future.

If we are not able to significantly grow market
share, improve our gross margins and reduce our operating
expenses, or if we become subject to significant judgments or
settlements in connection with the legal proceedings described
in Item 3 of this Annual Report on Form 10-K, we will
require additional financing. Additional equity or debt
financing may not be available on acceptable terms, or at all,
in part because our common stock was delisted from The Nasdaq
Stock Market. If we are unable to obtain additional capital, we
may be required to reduce our sales and marketing activities,
reduce the scope of or eliminate our research and development
programs, relinquish rights to technologies that we might
otherwise seek to develop or commercialize, or sell certain
assets.

We recently made several significant payments
that have reduced our cash reserves. On March 8, 2004, we
paid to our former Chief Executive Officer an aggregate of
$750,000, which we owed to him under a separation agreement and
consulting agreement that we previously executed. Also on
March 8, 2004, we paid to our former Chief Financial
Officer an aggregate of $616,000, which we owed to him under an
employment agreement we previously executed. At the request of
the SEC, these payments were deposited into escrow accounts
during the fourth quarter of 2003 and released upon termination
of the related escrow agreements. Additionally, on
February 20, 2004, we paid approximately $1.5 million
in directors and officers liability insurance
premiums. Furthermore, as described below in Item 3 of this
Annual Report on Form 10-K, in February 2004 we paid
approximately $1.9 million to BioLife to settle litigation.

If we fail to adequately address our liquidity
concerns, then our independent auditors may issue a qualified
opinion, to the effect that there is substantial doubt about our
ability to continue as a going concern. A qualified opinion
could itself have a material adverse effect on our business,
financial condition, results of operations and cash flows.

For a further description of the nature of the
risks relating to our liquidity see,
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

We have limited operating experience and a
history of net losses, and we may never reach or maintain
profitability.

We have limited experience in manufacturing,
marketing and selling our Cryocare Surgical System in commercial
quantities. In addition, during 2002, we completed our
acquisitions of Timm Medical, the

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cryosurgical assets of BioLife, and our
acquisition of the mobile prostate treatment businesses owned by
USMD. As a result, we have a short history in marketing and
selling the products we acquired or have rights to commercialize
through these acquisitions or to market our products on the
scale required by these acquisitions. In addition, we have
limited experience in managing the complex demands of a business
with multiple entities and locations, a large workforce and
diverse information technology systems.


We have incurred annual operating losses each
year since our inception. For the fiscal years ended
December 31, 2001, 2002 and 2003, we had losses from
operations of approximately $11.4 million,
$42.5 million and $34.0 million, respectively. As of
December 31, 2003, our accumulated deficit was
approximately $114.4 million. It is possible that we will
not generate sufficient revenues from product sales and service
revenues to achieve or sustain profitability. Even if we do
achieve significant revenues from our product sales and service
revenues, we expect that increased operating expenses will
result in significant operating losses over the next several
quarters, as we, among other things:



| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | expand our infrastructure to support more robust
    internal controls, including policies and procedures related to
    our accounting practices, disclosure controls and corporate
    governance;
|
| |  | incur costs related to legal proceedings,
    including ongoing government investigations;                                                                                                          
|
| |  | expand our sales and marketing activities as we
    attempt to gain market share for our Cryocare Surgical
    System; and                                                                          
|
| |  | continue our research and development efforts to
    improve our existing products and develop new products.                                                                                        

We will need to significantly increase the
revenues we receive from sales of our products and services as a
result of these increased operating expenses. We may be unable
to do so, and therefore, may not achieve profitability. Even if
we do achieve profitability, we cannot be certain that we will
be able to sustain or increase profitability on a quarterly or
annual basis.

If we require future capital, we may not be
able to secure additional funding in order to expand our
operations and develop new products.

If we fail to achieve and maintain profitability
and positive cash flow, or if we undertake or accelerate
significant research and development projects for new products
or pursue corporate acquisitions, we may need additional outside
financing. We may raise these additional funds by selling one or
more lines of business or products, selling our equity
securities, incurring debt or entering into collaborative
arrangements. Any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve
interest expense and restrictive covenants. Collaborative
arrangements, if necessary to raise additional funds, may
require us to relinquish rights to some of our technologies,
products or marketing territories. Our failure to raise capital
when needed could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.

We cannot assure you that we will not discover
additional instances of historical breakdowns in controls,
policies and procedures affecting our previously issued
financial statements.

We have made significant changes in our internal
controls, accounting policies and procedures, disclosure
controls and procedures and corporate governance policies and
procedures. While we believe that our newly implemented
controls, policies and procedures will help to prevent the
occurrence of financial reporting problems in the future, it is
possible that we may discover additional instances of historical
breakdowns in our internal controls, policies and procedures of
the types that led to restatements of our financial statements
for the years 2000 and 2001 and for the first two quarters of
2002. In the event such breakdowns are discovered they could
impact both historical financial statements and future reported
results.

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We face risks related to investigations by the
SEC and DOJ and related to other legal proceedings.

The SEC and the DOJ are conducting investigations
into allegations that we and certain of our current and former
officers and directors issued or caused to be issued false and
misleading statements regarding our revenues and expenses in
press releases and SEC filings. Although we have fully
cooperated with these governmental agencies in these matters and
intend to continue to fully cooperate, these agencies may
determine we have violated federal securities laws. We cannot
predict when these investigations will be completed or their
outcomes. If it is determined that we have violated federal
securities laws or other laws or regulations, we may face
sanctions, including, but not limited to, significant monetary
penalties and injunctive relief.

In addition, we and certain former officers and
certain current and former board members have been named
defendants in a class action and a derivative lawsuit. The
findings and outcome of the investigations described above may
affect the class action and the derivative lawsuit that are
pending. We are generally obliged, to the extent permitted by
law, to indemnify our directors and officers who are named
defendants in some of these lawsuits. We are unable to estimate
what our liability in these matters may be, and we may be
required to pay judgments or settlements and incur expenses in
aggregate amounts that could have a material adverse effect on
our business, financial condition, results of operations and
cash flows.

We have $20 million of directors and
officers liability insurance coverage. The coverage is
provided in four $5 million policies issued by a primary
insurance carrier and three excess insurance carriers. For
claims asserted during the period from June 10, 2002
through June 10, 2003, one of the excess carriers has
reserved the rights to disclaim coverage and to rescind the
policy if it is determined that, at the time they signed the
policy application, our former management was aware of facts
that might have resulted in future claims under the policy. The
other two excess carriers have declined coverage on the same
ground. A claim in excess of our insurance coverage would have
to be paid out of cash reserves, which could have a material
adverse effect on our business, financial condition, results of
operations and cash flows.

Our investors, customers, vendors and
suppliers may react adversely to the restatement of our
historical financial statements and our inability to timely file
all of our SEC filings.

Our future success depends in large part on the
support of our investors, customers, vendors, and suppliers. The
restatement of our historical financial statements and our
inability to timely file all of our SEC filings has resulted in
negative publicity about us and has, and may continue to have, a
negative impact on the market price of our common stock. The
restatement of our historical financial statements and our
inability to timely file all of our SEC filings also could cause
some of our customers or potential customers to refrain from
purchasing or to defer or cancel purchases of our products.
Additionally, our current and potential vendors and suppliers
may re-examine their willingness to do business with us, to
develop critical interfaces for us or to supply products and
services if they lose confidence in our ability to fulfill our
commitments.

Our common stock was delisted from the Nasdaq
Stock Market and, as a result, trading of our common stock has
become more difficult.

Our common stock was delisted from The Nasdaq
Stock Market on January 16, 2003. One result of this action
is a limited public market for our common stock. Trading is now
conducted in the over-the-counter market in the so-called
Pink Sheets. Consequently, selling our common stock
is more difficult because smaller quantities of shares can be
bought and sold, transactions can be delayed and security
analyst and news media coverage of us may be reduced. These
factors could result in lower prices and larger spreads in the
bid and ask prices for shares of our common stock as well as
lower trading volume. Although we will seek to have our common
stock relisted on The Nasdaq Stock Market once we are in full
compliance with our obligations as a reporting company, we can
provide no assurance that we will be relisted.

As a result of the delisting of our common stock
from The Nasdaq Stock Market, our common stock has become
subject to the penny stock regulations, including
Rule 15g-9 under the Securities Exchange Act of 1934. That
rule imposes additional sales practice requirements on
broker-dealers that sell low-priced securities

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to persons other than established customers and
institutional accredited investors. For transactions covered by
this rule, a broker-dealer must make a special suitability
determination for the purchaser and have received the
purchasers written consent to the transaction prior to
sale. Consequently, the rule may affect the ability of
broker-dealers to sell our common stock and affect the ability
of holders to sell their shares of our common stock in the
secondary market. To the extent our common stock remains subject
to the penny stock regulations, the market liquidity for the
shares will be adversely affected.


We expect to derive a significant portion of
our future revenues from our cryosurgical products, which could
fail to achieve market acceptance or generate significant
revenue.

We introduced our Cryocare Surgical System to the
market in July 1999. We derived a significant portion of our
revenues in 2001, and 2002 from sales of Cryocare Surgical
Systems and related disposable cryoprobes and temperature
probes, as well as from per-procedure fees. In 2003, we shifted
our business model to focus on sales of procedures and
disposable devices rather than on sales of Cryocare Surgical
Systems. We expect sales of cryosurgical products and the
related procedure fees will constitute a significant portion of
our revenues for the foreseeable future, although we expect
revenue from system sales to fluctuate from quarter to quarter
and decrease, over time, as a percentage of our revenue.

Our success is reliant on the acceptance by
doctors and patients of the Cryocare Surgical System as a
preferred treatment for tumor ablation. Cryosurgery has existed
for many years, but has not been widely accepted primarily due
to concerns regarding safety and efficacy and widespread use of
alternative therapies. Because the technology previously lacked
precise monitoring capabilities, cryosurgical procedures
performed in the 1970s resulted in high cancer recurrence and
negative side effects, such as rectal fistulae and incontinence,
and gave cryosurgical treatment negative publicity. To overcome
these negative side effects, we have developed ultrasound
guidance and temperature sensing to enable more precise
monitoring in our Cryocare Surgical System. Nevertheless, we
will need to overcome the earlier negative publicity associated
with cryosurgery in order to obtain market acceptance for our
products. In addition, use of our Cryocare Surgical System
requires significant physician education and training. As a
result, we may have difficulty obtaining recommendations and
endorsements of physicians and patients for our Cryocare
Surgical System. We may also have difficulty raising the brand
awareness necessary to generate interest in our Cryocare
Surgical System. Any adverse side effects, including impotence
or incontinence, recurrence of cancer or future reported adverse
events or other unfavorable publicity involving patient outcomes
from the use of cryosurgery, whether from our products or the
products of our competitors, could adversely affect acceptance
of cryosurgery. In addition, emerging new technologies and
procedures to treat cancer, prostate enlargement and other
prostate disorders may negatively affect the market acceptance
of cryosurgery. If our Cryocare Surgical System does not achieve
broad market acceptance, we will likely remain unprofitable.

If we are unable to continue to develop and
enhance our Cryocare Surgical System, our business will
suffer.

Our growth depends in part on continued ability
to successfully develop enhancements to our Cryocare Surgical
System. We may experience difficulties that could delay or
prevent the successful development and commercialization of
these products. Our products in development may not prove safe
and effective in clinical trials. Clinical trials may identify
significant technical or other obstacles that must be overcome
before obtaining necessary regulatory or reimbursement
approvals. In addition, our competitors may succeed in
developing commercially viable products that render our products
obsolete or less attractive. Failure to successfully develop and
commercialize new products and enhancements would likely have a
significant negative effect on our financial prospects.

Our strategy of divesting non-core product
lines may not be successful.

We are refocusing our business on the development
of minimally invasive technologies for tissue and tumor
ablation. As part of this strategy, we have begun divesting
certain non-core product lines, as evidenced by our sale of our
Dura II Penile Prosthesis product line, our sale of our
urodynamics and urinary incontinence product lines and our
licensing of our cardiac technology and sale of related assets.
We can provide no

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assurance that our strategy of focusing on our
core technologies for tumor ablation applications and our
divestitures of non-core technologies and product lines will be
successful.


There is uncertainty relating to third-party
reimbursement, which is critical to market acceptance of our
products.

Hospitals and other health care providers in the
United States generally rely on third-party payors, principally
federal Medicare, state Medicaid and private health insurance
plans, to reimburse all or part of the cost of medical
procedures involving our products. While private health insurers
in some areas of the United States provide reimbursement for
procedures in which our products are used, we can provide no
assurance that private insurance reimbursement will be adopted
nationally or by additional insurers. Furthermore, those private
insurance companies currently paying for procedures in which our
products are used may terminate such coverage. If reimbursement
levels from Medicare, Medicaid, other governmental health care
programs or private insurers are not sufficient, physicians may
choose not to recommend, and patients may not choose, procedures
utilizing our products.

Previously, reimbursement under Medicare for our
cryosurgical disposable products used in outpatient procedures
was provided on a so-called pass-through basis. This
enabled the hospital or other health care provider to obtain
separate reimbursement for our disposable devices in addition to
reimbursement for the procedure fee. Pass-through status was
terminated on December 31, 2003. As a result, the cost of
our disposable products now is incorporated into HOPPS and there
will be no separate reimbursement for the disposables.

Given the end to pass-through status for our
disposable cryoprobes and temperature probes, we expect total
Medicare reimbursement for our products used in outpatient
settings to decrease by approximately 15%. This may influence
reimbursement rates for our products by private insurers as
well. We can provide no assurance that this change in outpatient
reimbursement rates will not affect our ability to negotiate
favorable charges for our products to hospitals.

International market acceptance of our products
may depend, in part, upon the availability of reimbursement
within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary
significantly by country, and include both government sponsored
health care and private insurance. We may not obtain
international reimbursement approvals in a timely manner, if at
all. Our failure to receive international reimbursement
approvals may negatively impact market acceptance of our
products in the international markets in which those approvals
are sought.

Furthermore, from time to time significant
attention has been focused on reforming the health care system
in the United States and other countries. Any changes in
Medicare, Medicaid or third-party medical expense reimbursement,
which may arise from health care reform, may have a material
adverse effect on reimbursement for our products or procedures
in which our products are used and may reduce the price we are
able to charge for our products. In addition, changes to the
health care system may also affect the commercial acceptance of
products we are currently developing and products we may develop
in the future. Potential approaches that have been considered
include controls on health care spending and price controls.
Several proposals have been made in the United States Congress
and various state legislatures recently that, if adopted, would
potentially reduce health care spending, which may result in a
material adverse effect on our business, financial condition,
results of operations and cash flows.

We have limited sales and marketing experience
with our Cryocare Surgical System and any failure to
significantly expand sales of this product will negatively
impact future revenue.

We primarily handle the marketing, distribution
and sales of our Cryocare Surgical Systems through our own work
force. We have limited experience marketing and selling our
Cryocare Surgical System in commercial quantities or on a
nationwide basis. We will face significant challenges and risks
in training, managing and retaining our sales and marketing
teams, including managing geographically dispersed efforts and
adequately training our people in the use and benefits of our
Cryocare Surgical System. We may not be able to hire significant
additional personnel or deploy sufficient other resources needed
to create increased

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demand for our Cryocare Surgical System. In
addition, we have distribution arrangements, some of which are
exclusive, for the sale of our Cryocare Surgical System both
domestically and internationally, and we are dependent upon the
sales and marketing efforts of our third-party distributors.
These distributors may not commit the necessary resources to
effectively market and sell our Cryocare Surgical System. If we
are unable to expand our sales and marketing capabilities or if
our senior sales and marketing personnel are not retained, we
may not be able to effectively commercialize our Cryocare
Surgical System.


We recently acquired Timm Medical, the
cryosurgical assets of BioLife and the mobile prostate treatment
businesses of USMD and face risks associated with integrating
these businesses into our existing business
operations.

We continue to face numerous risks and expenses
related to integration of the businesses we acquired from Timm
Medical, BioLife and USMD. In addition, the acquired businesses
have suffered because managements resources have been
consumed by, among other things, the internal and external
investigations involving various accounting and related matters
as well as the work involved in re-auditing and restating our
consolidated financial statements for the years ended
December 31, 2000 and 2001 and for the first 2 quarters of
2002. The businesses acquired from Timm Medical have suffered
because resources have been diverted in divesting certain
non-core product lines and in downsizing our Eden Prairie
operations. The businesses we acquired from USMD have suffered
for many of the same reasons in addition to the fact that we
recently assumed administrative responsibility for management of
these complex businesses. If we do not successfully integrate
and grow the acquired businesses, our business will suffer.

Introduction of alternative therapies may
affect our revenues.

We sell medical devices for the treatment of
certain urological disorders. If physicians and patients do not
accept our products, our sales will decline. Patient acceptance
of our products depends on a number of factors, including the
failure of other therapies, the degree of invasiveness involved,
the rate and severity of complications from the procedures, and
other adverse side effects. Patients are more likely first to
consider non-invasive alternatives to treat their urological
disorders. The introduction of new oral medications or other
less-invasive therapies may cause our sales to decline in the
future.

We could be difficult to acquire due to
anti-takeover provisions in our charter, our stockholders rights
plan and Delaware law.

Provisions of our certificate of incorporation
and bylaws may have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from
attempting to acquire, control of us. In addition, in April
1999, our Board of Directors adopted a stockholder rights plan
in which preferred stock purchase rights were distributed as a
dividend. These provisions may make it more difficult for
stockholders to take corporate actions and may have the effect
of delaying or preventing a change in control. We are subject to
the anti-takeover provisions of Section 203 of the Delaware
General Corporation Law. Subject to specified exceptions, this
section provides that a corporation may not engage in any
business combination with any interested stockholder during the
three-year period following the time that such stockholder
becomes an interested stockholder. This provision could have the
effect of delaying or preventing a change of control of us. The
foregoing factors could limit the price that investors or an
acquiror might be willing to pay in the future for shares of our
common stock.

If we fail to protect our intellectual
property rights, our competitors may take advantage of our ideas
and compete directly against us.

Our success will depend to a significant degree
on our ability to secure and protect intellectual property
rights and to enforce patent and trademark protections relating
to our technology. From time to time, litigation may be
advisable to protect our intellectual property position.
However, these legal means afford only limited protection and
may not adequately protect our rights or permit us to gain or
keep any competitive advantage. Any litigation in this regard
could be costly, and it is possible that we will not have
sufficient resources to fully pursue this litigation or to
protect our other intellectual property rights. It could result
in the rejection or

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invalidation of our existing and future patents.
Any adverse outcome in litigation relating to the validity of
our patents, or any failure to pursue litigation or otherwise to
protect our patent position, could have a material adverse
effect on our business, financial condition, results of
operations and cash flows. Also, even if we prevail in
litigation, the litigation would be costly in terms of
management distraction as well as in money. In addition,
confidentiality agreements with our employees, consultants,
customers, and key vendors may not prevent the unauthorized
disclosure or use of our technology. It is possible that these
agreements will be breached or that they will not be enforceable
in every instance, and that we will not have adequate remedies
for any such breach. Enforcement of these agreements may be
costly and time consuming. Furthermore, the laws of foreign
countries may not protect our intellectual property rights to
the same extent as the laws of the United States.


Because the medical device industry is
litigious, we may be sued for allegedly violating the
intellectual property rights of others.

The medical technology industry has in the past
been characterized by a substantial amount of litigation and
related administrative proceedings regarding patents and
intellectual property rights. In addition, major medical device
companies have used litigation against emerging growth companies
as a means of gaining or preserving a competitive advantage.

Should third parties file patent applications or
be issued patents claiming technology also claimed by us in
pending applications, we may be required to participate in
interference proceedings in the U.S. Patent and Trademark
Office to determine the relative priorities of our inventions
and the third parties inventions. We could also be
required to participate in interference proceedings involving
our issued patents and pending applications of another entity.
An adverse outcome in an interference proceeding could require
us to cease using the technology or to license rights from
prevailing third parties.

Third parties may claim we are using their
patented inventions and may go to court to stop us from engaging
in our normal operations and activities. These lawsuits are
expensive to defend and conduct and would also consume and
divert the time and attention of our management. A court may
decide that we are infringing a third partys patents and
may order us to cease the infringing activity. A court could
also order us to pay damages for the infringement. These damages
could be substantial and could have a material adverse effect on
our business, financial condition, results of operations and
cash flows.

If we are unable to obtain any necessary license
following an adverse determination in litigation or in
interference or other administrative proceedings, we would have
to redesign our products to avoid infringing a third
partys patent and could temporarily or permanently have to
discontinue manufacturing and selling some of our products. If
this were to occur, it would negatively impact future sales and,
in turn, our business, financial condition, results of
operations and cash flows.

We have limited experience manufacturing our
products and if we are unable to meet customer demand, we may
not become profitable.

We use internal manufacturing capacity and
expertise to manufacture our products. We have limited
experience in producing our products in commercial quantities.
We may encounter difficulties in scaling up production of new
products, including problems involving production yields,
quality control and assurance, component supply and shortages of
qualified personnel. Our failure to overcome these manufacturing
problems could have a material adverse effect on our business,
financial condition, results of operations and cash flows.

Our success will depend in part upon our ability
to manufacture our products in compliance with the FDAs
Quality System regulations and other regulatory requirements in
sufficient quantities and on a timely basis, while maintaining
product quality and acceptable manufacturing costs.

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We are dependent upon a number of third-party
suppliers to manufacture our products and the loss of any of
these suppliers could harm our business.

We depend upon a number of unaffiliated
third-party suppliers for components and materials used in the
manufacture of our products and, as such, our business would be
seriously harmed if we were unable to develop and maintain
relationships with suppliers that allow us to obtain sufficient
quantities and quality materials and components on acceptable
terms. If our principal suppliers cease to supply the materials
and components we need to manufacture our products, the
qualification of additional or replacement suppliers could be a
lengthy process and there may not be adequate alternatives to
meet our needs, which will have a material adverse effect on our
business, financial condition, results of operations and cash
flows. We may not be able to obtain the necessary components and
materials used in our products in the future on a timely basis,
if at all.

If we fail to obtain or maintain necessary
regulatory clearances or approvals for products, or if approvals
are delayed or withdrawn, we will be unable to commercially
distribute and market our products or any product
modifications.

Government regulation has a significant impact on
our business. Government regulation in the United States and
other countries is a significant factor affecting the research
and development, manufacture and marketing of our products. In
the United States, the FDA has broad authority under the federal
Food, Drug and Cosmetic Act to regulate the distribution,
manufacture and sale of medical devices. Foreign sales of drugs
and medical devices are subject to foreign governmental
regulation and restrictions, which vary from country to country.
The process of obtaining FDA and other required regulatory
clearances and approvals is lengthy and expensive. We may not be
able to obtain or maintain necessary approvals for clinical
testing or for the manufacturing or marketing of our products.
Failure to comply with applicable regulatory approvals can,
among other things, result in fines, suspension or withdrawal of
regulatory approvals, product recalls, operating restrictions,
and criminal prosecution. In addition, governmental regulations
may be established which could prevent, delay, modify or rescind
regulatory approval of our products. Any of these actions by the
FDA, or change in FDA regulations, could have a material adverse
effect on our business, financial condition, results of
operations and cash flows.

Regulatory approvals, if granted, may include
significant limitations on the indicated uses for which our
products may be marketed. In addition, to obtain such approvals,
the FDA and foreign regulatory authorities may impose numerous
other requirements on us. FDA enforcement policy prohibits the
marketing of approved medical devices for unapproved uses. In
addition, product approvals can be withdrawn for failure to
comply with regulatory standards or unforeseen problems
following initial marketing. We may not be able to obtain or
maintain regulatory approvals for our products on a timely
basis, or at all, and delays in receipt of or failure to receive
such approvals, the loss of previously obtained approvals, or
failure to comply with existing or future regulatory
requirements could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.

Our products may be subject to product recalls
even after receiving FDA clearance or approval, which would harm
our reputation and our business.

The FDA and similar governmental authorities in
other countries have the authority to request and, in some
cases, require the recall of our products in the event of
material deficiencies or defects in design or manufacture. A
governmental mandated or voluntary recall by us could occur as a
result of component failures, manufacturing errors or design
defects. Any recall of product would divert managerial and
financial resources and harm our reputation with customers and
our business.

We could be negatively impacted by future
interpretation or implementation of the federal Stark law and
other federal and state anti-referral laws.

The federal Stark law prohibits a physician from
referring medical patients for certain services to an entity
with which the physician has a financial relationship. A
financial relationship includes both investment

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interests in an entity and compensation
arrangements with an entity. Many states have similar and often
broader laws prohibiting referrals by any licensed health care
provider to entities with which they have a financial
relationship. These state laws generally apply to services
reimbursed by both governmental and private payors. Violation of
these federal and state laws may result in prohibition of
payment for services rendered, loss of licenses, fines, criminal
penalties and exclusion from governmental and private payor
programs, among other things. We have financial relationships
with physicians and physician-owned entities, which in turn have
financial relationships with hospitals and other providers of
designated health services. Although we believe that our
financial relationships with physicians and physician-owned
entities, as well as the relationships between physician-owned
entities that purchase or lease our products and hospitals, are
not in violation of applicable laws and regulations,
governmental authorities might take a contrary position. If our
financial relationships with physicians or physician-owned
entities or the relationships between those entities and
hospitals were found to be illegal, we and/or the affected
physicians and hospitals could be subject to civil and criminal
penalties, including fines, exclusion from participation in
government and private payor programs and requirements to refund
amounts previously received from government and private payors.
In addition, expansion of our operations to new jurisdictions,
or new interpretations of laws in our existing jurisdictions,
could require structural and organizational modifications of our
relationships with physicians, physician-owned entities and
others to comply with that jurisdictions laws. For a
further description of the federal Stark law see above under
Item 1  Health Care Regulatory
Issues.


If we become subject to claims, we may be
required to pay damages that exceed our insurance
coverage.

Our business exposes us to potential product
liability claims that are inherent in the testing, production,
marketing and sale of medical devices. We are also subject to
various other claims as described below in
Item 3  Legal Proceedings. While we
believe that we are reasonably insured against these risks, we
may not be able to maintain insurance in amounts or scope
sufficient to provide us with adequate coverage against all
potential liabilities. A claim in excess of our insurance
coverage would have to be paid out of cash reserves, which could
have a material adverse effect on our business, financial
condition, results of operations and cash flows. In addition,
any product liability claim likely would harm our reputation in
the industry and our business.

We have $20 million of directors and
officers liability insurance coverage. The coverage is
provided in four $5 million policies issued by a primary
insurance carrier and three excess insurance carriers. For
claims asserted during the period from June 10, 2002
through June 10, 2003, one of the excess carriers has
reserved the rights to disclaim coverage and to rescind the
policy if it is determined that, at the time they signed the
policy application, our former management was aware of facts
that might have resulted in future claims under the policy. The
other two excess carriers have declined coverage on the same
ground. A claim in excess of our insurance coverage would have
to be paid out of cash reserves, which could have a material
adverse effect on our business, financial condition, results of
operations and cash flows.

We are faced with intense competition and
rapid technological and industry change, which may make it more
difficult for us to achieve significant market
penetration.

The medical device industry generally, and the
urological disease treatment market in particular, are
characterized by rapid technological change, changing customer
needs, and frequent new product introductions. If our
competitors existing products or new products are more
effective than or considered superior to our products, the
commercial opportunity for our products will be reduced or
eliminated. We face intense competition from companies in the
cryosurgical marketplace as well as companies offering other
treatment options, including radical surgery, radiation therapy
and hormone therapy. If we are successful in penetrating the
market for treatment of prostate cancer with our cryosurgical
treatment, other medical device companies may be attracted to
the marketplace. Many of our potential competitors are
significantly larger than we are and have greater financial,
technical, research, marketing, sales, distribution and other
resources than we do. We believe there will be intense price
competition for products developed in our markets. Our
competitors may develop or market technologies and products,
including drug-based treatments, that are more effective or
commercially attractive than any that we are developing or
marketing. Our competitors may obtain regulatory approval, and
introduce and commercialize products before we do. These
developments could have a material

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adverse effect on our business, financial
condition, results of operations and cash flows. Even if we are
able to compete successfully, we may not be able to do so in a
profitable manner.


Fluctuations in our future operating results
may negatively impact the market price of our common
stock.

Our operating results have fluctuated in the past
and can be expected to fluctuate from time to time in the
future. Some of the factors that may cause these fluctuations
include the following:



| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | impact of legal proceedings;                                                                                                                 
|
| |  | costs of expanding our infrastructure to support
    more robust internal controls, including more effective policies
    and procedures;    
|
| |  | related to our accounting practices, disclosure
    controls and corporate governance;                                                       
|
| |  | market acceptance of our existing products, as
    well as products in development;                                                          
|
| |  | timing of payments received and the recognition
    of such payments as revenue under collaborative arrangements and
    strategic alliances;
|
| |  | ability to manufacture products efficiently;                                                                                                 
|
| |  | timing of our research and development
    expenditures;                                                                                     
|
| |  | timing of customer orders;                                                                                                                   
|
| |  | changes in reimbursement rates for our products
    and procedures by Medicare and other third-party payors;                                 
|
| |  | potential impact of acquisitions;                                                                                                            
|
| |  | timing of regulatory approvals for new products;                                                                                             
|
| |  | outcomes of clinical studies by us or our
    competitors;                                                                                   
|
| |  | competition from other treatment
    modalities; and                                                                                         
|
| |  | physician and patient acceptance of cryosurgery.                                                                                             

If our operating results are below the
expectations of securities analysts or investors, the market
price of our common stock may fall abruptly and significantly.

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

We may acquire one or more businesses or lines of
business. We cannot assure you that we will be able to identify
suitable acquisition opportunities in the future. In addition,
even if we do identify acquisition opportunities, we may not be
able to effectively integrate our business with any other
business we may acquire or merge with or effectively utilize the
business acquired to develop and market our products. We have
limited experience in acquiring businesses or managing
facilities or operations in geographically distant areas. The
failure to successfully integrate an acquired company or
acquired assets into our operations may cause a drain on our
financial and managerial resources, and have a significant
negative effect on our business and financial results. In
addition, our cash flow and operating results may suffer because
of acquisition-related costs, amortization costs, restructuring
or impairment of acquired goodwill and other intangible assets.
There is also a risk of loss of key employees, customers and
vendors of recently acquired businesses. Finally, in connection
with any future acquisitions, we may incur debt or issue equity
securities as part or all of the consideration for the acquired
companys assets or capital stock. We may be unable to
obtain sufficient additional acquisition financing on favorable
terms or at all. In addition, any equity issuances may be
dilutive to our existing stockholders.

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Our stock price may be volatile and your
investment could decline in value.

Our stock price has fluctuated significantly in
the past and is likely to continue to fluctuate significantly,
making it difficult to resell shares when investors want to at
prices they find attractive. The market prices for securities of
emerging companies have historically been highly volatile.
Future events concerning us or our competitors could cause such
volatility including:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | actual or anticipated variations in our operating
    results;                                                             
|
| |  | developments regarding government and third-party
    reimbursement;                                                       
|
| |  | changes in government regulation of our products
    and business practices;                                               
|
| |  | developments concerning government investigation
    of us;                                                                
|
| |  | developments concerning proprietary rights;                                                                                
|
| |  | developments concerning litigation or public
    concern as to the safety of our products or our
    competitors products;
|
| |  | technological innovations or introduction of new
    products by us or our competitors;                                    
|
| |  | investor and analyst perception of us and our
    industry;                                                                
|
| |  | general economic and market conditions; and                                                                                
|
| |  | physician and patient acceptance of cryosurgery.                                                                           

In addition, the stock market is subject to price
and volume fluctuations that affect the market prices for
companies in general, and small-capitalization, high technology
companies in particular, which are often unrelated to the
operating performance of these companies.

Future sales of shares of our common stock may
negatively affect our stock price.

Future sales of our common stock, including
shares issued upon the exercise of outstanding options and
warrants or hedging or other derivative transactions with
respect to our stock, could have a significant negative effect
on the market price of our common stock. These sales also might
make it more difficult for us to sell equity securities or
equity-related securities in the future at a time and price that
we would deem appropriate.

Our intangible assets and goodwill could
become impaired.

Intangible assets acquired in a purchase, such as
intellectual property or developed technology, are generally
amortized over various periods depending on their anticipated
economic benefits or useful lives. Long-lived assets, including
amortizable intangibles, are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to
be generated by the asset. Following a review, if such assets
are considered to be impaired, the impairment to be recognized
is measured by the amount by which the carrying value of the
assets exceeds the fair value of the assets.

We had no reported goodwill prior to
January 1, 2002. With the adoption of Statement of
Financial Accounting Standards No. 142 Goodwill and
Intangible Assets, goodwill can no longer be amortized
against earnings. Goodwill balances are subject to an impairment
review on an annual basis or sooner if indicators of potential
impairment exist. The test for impairment requires us to first
compare the fair value of the net assets of each reporting unit
to their carrying value, including goodwill. If the fair value
of the reporting unit is less than the carrying value, goodwill
of the reporting unit is potentially impaired and we next
calculate the implied fair value of goodwill by deducting the
fair value of all tangible and intangible net assets of the
reporting unit from the fair value of the reporting unit. If the
implied fair value of goodwill is less then the carrying amount
of goodwill, an impairment loss is recognized equal to the
difference. We completed our annual goodwill impairment test as
of October 1, 2002 and 2003 for all of our reporting units.
We utilized an independent

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third-party appraiser to assess the fair values
of each reporting unit and compared the fair values of the
reporting units to their carrying values. Based on our
evaluation we recognized an impairment charge of
$18 million in the fourth quarter of 2002 to reduce the
carrying value of the goodwill acquired in the Timm Medical
acquisition. We determined that a charge for goodwill impairment
was not required in 2003. Significant estimates, including
assumptions regarding future events and circumstances that
cannot be easily predicted are required to perform an analysis
of the value of goodwill. These estimates and assumptions may
differ materially from actual outcomes and occurrences.
Furthermore, no assurance can be given that we will not have
further impairment charges related to Timm Medical or other
acquisitions.


In the fourth quarter of 2002, we also recorded a
$2.3 million other-than-temporary loss in the value of our
investment in U.S. Medical Development, Inc. acquired
in June 2001. The loss was based on our assessment that the
investee is unable to sustain an earnings capacity sufficient to
justify the carrying amount of the investment. We can give no
assurance that we will not incur further impairment charges
related to our goodwill or other intangible assets.

Negative economic conditions in the United
States may negatively impact our ability to achieve
profitability.

During 2001, 2002 and into 2003, the United
States and other international markets experienced a significant
economic downturn. In addition, the United States and other
countries suffered significant acts of hostility, terror and
war. Such acts may increase or prolong such negative economic
conditions. The economic downturn may impact our ability to
maintain or increase profitability by negatively affecting
growth in demand for our products. There can be no certainty as
to the degree or severity of the duration of this downturn. We
also cannot predict the extent and timing of the impact of the
economic downturn in the United States and in other countries
and geographic regions in which we conduct our business.

Our facilities and systems are vulnerable to
natural disasters or other catastrophic events.

Our headquarters, cryosurgical products
manufacturing facilities, research facilities and much of our
infrastructure, including computer servers, are located in
California, an area that is susceptible to earthquakes and other
natural disasters. Our erectile dysfunction products are
assembled, packaged and shipped in our Minneapolis facility. A
natural disaster or other catastrophic event, such as an
earthquake, fire, flood, severe storm, break-in, terrorist
attack or other comparable problems could cause interruptions or
delays in our business and loss of data or render us unable to
accept and fulfill customer orders in a timely manner, or at
all. In addition, as our Minneapolis facility is located in an
area that is susceptible to harsh weather, a major storm, heavy
snowfall or other similar event could prevent us from delivering
products in a timely manner. We have no formal disaster recovery
plan and our business interruption insurance may not adequately
compensate us for losses that may occur. In the event that an
earthquake, natural disaster or other catastrophic event were to
destroy any part of our facilities or interrupt our operations
for any extended period of time, or if harsh weather conditions
prevent us from delivering products in a timely manner, our
business, financial condition and operating results would be
seriously harmed.






|        |           
|------- | ----------
|Item 2. | Properties

In April 2002, we moved our executive offices, as
well as our principal manufacturing and research facilities for
our Cryocare Surgical System, to a 28,000 square foot
facility in Irvine, California. The lease for this facility
expires in 2007, with an option to extend the lease for an
additional five years.

Through our acquisition of Timm Medical in
February 2002, we obtained offices, manufacturing and research
facilities for our erectile dysfunction products in a
28,066 square foot building in Eden Prairie, MN. During
2003, we divested several non-core product lines acquired when
we purchased Timm Medical. In June 2003, we transferred certain
manufacturing operations and administrative functions previously
performed at this location to our Irvine, California
manufacturing facility and outsourced certain other operations.
At the end of 2003, we revisited the decision to outsource the
assembly and packaging of our vacuum therapy line and returned
theses operations to our Minnesota facility. The lease on the
Eden Prairie

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facility expires in April 2004. As a result of
the net downsizing of our Minnesota operations, we do not intend
to renew this lease. Rather, we will continue to rent this space
on a temporary basis until we complete negotiations on the lease
of a smaller facility to handle all remaining Eden Prairie
operations.


We believe that our property and equipment are
generally well maintained, in good operating condition and are
sufficient to meet our current needs.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

We are a party to lawsuits in the normal course
of our business. Litigation and governmental investigation can
be expensive and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult
to predict. We can provide no assurance that significant
judgments or settlements in connection with the legal
proceedings described below will not have a material adverse
effect on our business, financial condition, results of
operations and cash flows. See Item 7 
Managements Discussion and Analysis of Financial Condition
and Results of Operations. Other than as described below,
we are not a party to any material legal proceedings.

In November 2002, we were named as a defendant,
together with certain former officers, one of whom is also a
former board member, in a class-action lawsuit filed in the
United States District Court for the Central District of
California. On February 2, 2003, the court issued an order
consolidating this action with various other similar complaints
and ordering plaintiffs to file a consolidated complaint, which
was filed on October 31, 2003. The consolidated complaint
asserts two claims for relief, alleging that the defendants
violated sections of the Securities Exchange Act of 1934 by
purportedly issuing false and misleading statements regarding
our revenues and expenses in press releases and SEC filings.
Plaintiffs seek class certification and unspecified damages from
us, as well as forfeiture and reimbursement of bonus
compensation received by two of the individual defendants. We
intend to defend the case vigorously and have filed a currently
pending motion to dismiss the consolidated complaint, but cannot
assure you that it will be resolved in our favor.

On November 26, 2002, BioLife filed an
action against us in the Delaware Court of Chancery seeking
damages for alleged breaches of contract stemming from our
acquisition, pursuant to an asset purchase agreement dated
May 28, 2002, of the tangible and intangible assets related
to BioLifes cryosurgical business. In the action, styled
as BioLife Solutions, Inc. v. Endocare, Inc.,
Del. Ch., C.A. No. 20057-NC, BioLife alleged that we failed
to timely register 120,022 shares of our common stock that
were provided to BioLife in connection with the asset purchase
agreement, in violation of a registration rights agreement
relating to the shares that was executed in conjunction with the
asset purchase agreement. BioLife sought damages of
approximately $1.6 million. We defended the action on the
grounds that our obligation to register the shares was excused
for various reasons, including as a consequence of
BioLifes failure to transfer assets in accordance with the
asset purchase agreement. Trial on all but one of the claims in
the action was held during the week of March 31, 2003. On
October 1, 2003, the Delaware Court ruled in favor of
BioLife, awarding BioLife $1,648,000, plus pre-judgment interest
and costs (including legal fees), and requiring BioLife to
surrender the 120,022 shares of our common stock to us.
That ruling became an appealable final order and judgment on
October 10, 2003. On February 20, 2004, we agreed with
BioLife to settle all claims. As part of the settlement: we paid
to BioLife $1,887,474, which represented a discount of $150,000
from the total judgment amount (including accrued interest and
costs); BioLife returned to us the 120,022 shares of our
common stock referred to above; and we agreed to abandon our
appeal.

On December 6, 2002, Frederick Venables
filed a purported derivative action against us and certain
former officers and certain current and former board members in
the California Superior Court for the County of Orange alleging
breach of fiduciary duty, abuse of control, gross mismanagement,
waste of corporate assets and unjust enrichment. On
April 17, 2003 the court issued an order staying the action
until resolution of the anticipated motion to dismiss the
consolidated complaint in the federal securities action pending
in the Central District of California. Pursuant to this order,
no deadline is currently set for our response to the complaint.
The complaint seeks unspecified monetary damages, equitable
relief and injunctive relief based upon allegations that the
defendants issued false and misleading statements regarding our
revenues and

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expenses in press releases and SEC filings. We
intend to defend the case vigorously, but cannot assure you that
it will be resolved in our favor.


On December 19, 2002, we filed a demand for
arbitration before the American Arbitration Association in
Minnesota against Joseph Hafermann, the former General Manager
of our Minnesota subsidiary. Our complaint included various
claims in response to which Mr. Hafermann made several
counterclaims. On December 30, 2003, we agreed with
Mr. Hafermann to a confidential settlement of all claims on
mutually acceptable terms without the admission of liability by
any party.

On March 17, 2003, we were notified by the
United States Department of Labor that a letter of complaint had
been presented against us; our former Chairman and Chief
Executive Officer, Paul Mikus; and our former Chief Financial
Officer, John Cracchiolo, by counsel for Mr. Hafermann. The
letter from Mr. Hafermanns counsel alleged that we,
Mr. Mikus and Mr. Cracchiolo had violated
18 U.S.C. §1514A by improperly retaliating against
Mr. Hafermann. Pursuant to our settlement with
Mr. Hafermann described above, Mr. Hafermann withdrew
his letter of complaint, and the Department of Labor has
indicated that it considers this matter closed.

The SEC is currently conducting an investigation
to determine whether any federal securities laws were violated
in connection with the filing of our financial statements for
2001 and the first two quarters of 2002, including investigation
into allegations that we and certain of our current and former
officers and directors issued or caused to be issued false and
misleading statements regarding our revenues and expenses in
those SEC filings. We are cooperating fully with this
investigation. We cannot assure you that this matter will be
resolved in our favor.

The DOJ is currently conducting an investigation
into allegations that we and certain of our current and former
officers and directors intentionally issued or caused to be
issued false and misleading statements regarding our revenues
and expenses in SEC filings. We are cooperating fully with this
investigation. We cannot assure you that this matter will be
resolved in our favor.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

We held our Annual Meeting of Stockholders on
Tuesday, December 30, 2003. Our stockholders adopted the
following matters at the Annual Meeting by the votes indicated:

1. The stockholders elected the following
seven directors to our Board of Directors to serve during the
ensuing year or until their respective successors are duly
elected and qualified:

|                         |  |                  |            |          |  |  |         | 
|------------------------ |  | ---------------- | ---------- | -------- |  |  | ------- | 
|                         |  |                 
|                         |  | Number of Shares
|                         |  |                 
|                         |  | For              |            | Withheld
|                         |  |                  |            |         
|Peter F. Bernardoni      |  |                  | 21,115,788 |          |  |  | 409,843 | 
|Robert F. Byrnes         |  |                  | 21,117,988 |          |  |  | 407,643 | 
|Benjamin Gerson, M.D.    |  |                  | 21,119,188 |          |  |  | 406,443 | 
|Ronald A. Matricaria     |  |                  | 21,149,580 |          |  |  | 376,051 | 
|Terrence A. Noonan       |  |                  | 21,146,080 |          |  |  | 379,551 | 
|Michael J. Strauss, M.D. |  |                  | 21,141,680 |          |  |  | 383,951 | 
|Thomas R. Testman        |  |                  | 21,149,080 |          |  |  | 376,551 | 

2. The stockholders approved an amendment
and restatement of our 1995 Stock Plan to increase the maximum
number of shares with respect to which options and stock
purchase rights may be granted to any participant in the 1995
Stock Plan in any fiscal year from 100,000 to
1,500,000 shares:

|        |  |                  |           | 
|------- |  | ---------------- | --------- | 
|        |  | Number of Shares
|        |  |                 
|For     |  |                  | 8,066,347 | 
|Against |  |                  | 5,477,742 | 
|Abstain |  |                  | 65,593    | 

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3. The stockholders ratified the selection
of Ernst & Young LLP as our independent auditors for
the fiscal year ended December 31, 2003:

|        |  |                  |            | 
|------- |  | ---------------- | ---------- | 
|        |  | Number of Shares
|        |  |                 
|For     |  |                  | 21,404,646 | 
|Against |  |                  | 105,740    | 
|Abstain |  |                  | 15,245     | 




PART II






|        |                                                                 
|------- | ----------------------------------------------------------------
|Item 5. | Market for Our Common Equity and Related
    Stockholder Matters

Market Information

On January 16, 2003, our common stock was
delisted from The Nasdaq Stock Market. The symbol under which we
trade in the Pink Sheets is ENDO.PK. Accordingly,
there is no established public trading market for our common
stock. From January 1, 1999 to May 22, 2000, our
common stock was traded on The Nasdaq SmallCap Market and from
May 23, 2000 to December 12, 2002, our common stock
was traded on The Nasdaq National Market. From December 12,
2002 through January 15, 2003, trading of our common stock
was halted by The Nasdaq Stock Market.

The following table sets forth for the fiscal
quarters indicated, the high and low sales prices for our common
stock as quoted on The Nasdaq National Market, or the high and
low bid prices as reflected in the Pink Sheets, as
applicable. Such prices represent inter-dealer prices without
retail mark up, mark down or commission and may not necessarily
represent actual transactions.

|                             |                |      |   |       |  |  |   |       | 
|---------------------------- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|                             |                | High |   | Low  
|                             |                |      |   |      
|Year Ended December 31, 2003 |                |      |   |       |  |  |   |      
|                             | First Quarter  |      | $ | 3.10  |  |  | $ | 0.35  | 
|                             | Second Quarter |      |   | 6.35  |  |  |   | 2.42  | 
|                             | Third Quarter  |      |   | 5.70  |  |  |   | 3.50  | 
|                             | Fourth Quarter |      |   | 5.22  |  |  |   | 3.80  | 
|Year Ended December 31, 2002 |                |      |   |       |  |  |   |      
|                             | First Quarter  |      | $ | 20.00 |  |  | $ | 13.42 | 
|                             | Second Quarter |      |   | 21.05 |  |  |   | 11.30 | 
|                             | Third Quarter  |      |   | 14.31 |  |  |   | 9.78  | 
|                             | Fourth Quarter |      |   | 14.29 |  |  |   | 2.58  | 

Holders

As of March 1, 2004, there were
287 holders of record of our common stock. This number was
derived from our stockholder records and does not include
beneficial owners of our common stock whose shares are held in
the names of various dealers, clearing agencies, banks, brokers,
and other fiduciaries.

Dividends

We have never paid any cash dividends on our
capital stock. We anticipate that we will retain any future
earnings to support operations and to finance the growth and
development of our business. Therefore, we do not expect to pay
cash dividends in the foreseeable future. Any determination to
pay dividends in the future will be at the discretion of the
Board of Directors and will depend on existing conditions,
including our financial condition, contractual restrictions,
capital requirements and business prospects.

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Recent Sales of Unregistered
Securities

Pursuant to a consulting agreement dated
May 21, 2003, we issued to Peter Littrup, M.D.,
5,000 shares of common stock for services rendered in
connection with radiology training and product development. This
issuance was deemed to be exempt from registration under the
Securities Act in reliance on Section 4(2) of the
Securities Act in that the issuance did not involve a public
offering.

In addition, in 2003 we issued an aggregate of
35,000 shares of common stock to four current and former
employees and consultants upon their exercise of options. These
issuances were deemed to be exempt from registration under the
Securities Act in reliance on Section 4(2) of the
Securities Act in that these issuances did not involve a public
offering.






|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

The selected financial data set forth below
should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of
Operation and our consolidated financial statements and
related notes included elsewhere in this Annual Report on
Form 10-K. The selected financial data as of and for the
years ended December 31, 1999, 2000 and 2001, has been
restated. Detailed information regarding these restatements is
disclosed in Notes 3 and 16 to our consolidated financial
statements filed in our annual report on Form 10-K for the
year ended December 31, 2002. Our historical results are
not necessarily indicative of operating results to be expected
in the future.

|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |        |        | 
|---------------------------------------------------------- | ------------------------------------- | ------------------------------------- | ------- | ----- | ------ | ---- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                           |                                       | 1999                                  |         | 2000  |        | 2001 |         | 2002   |        | 2003
|                                                           |                                       |                                       |         |       |        |      |         |        |        |     
|                                                           |                                       |                                      
|                                                           |                                       | (In thousands, except per share data)
|Revenues:                                                  |                                       | $                                     | 3,514   |       |        | $    | 6,568   |        |        | $    | 13,037  |        |        | $ | 30,916  |        |        | $ | 30,497  |       
|Costs and expenses:                                        |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                           | Cost of revenues                      |                                       |         | 1,790 |        |      |         | 3,757  |        |      |         | 6,208  |        |   |         | 16,484 |        |   |         | 16,058 |       
|                                                           | Research and development              |                                       |         | 2,618 |        |      |         | 2,371  |        |      |         | 2,544  |        |   |         | 2,900  |        |   |         | 1,257  |       
|                                                           | Selling, general and administrative   |                                       |         | 9,231 |        |      |         | 13,436 |        |      |         | 15,728 |        |   |         | 33,770 |        |   |         | 47,189 |       
|                                                           | Goodwill impairment and other charges |                                       |         |      |        |      |         |       |        |      |         |       |        |   |         | 20,311 |        |   |         |       |       
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                           |                                       | Total costs and expenses              |         |       | 13,639 |      |         |        | 19,564 |      |         |        | 24,480 |   |         |        | 73,465 |   |         |        | 64,504 | 
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Loss from operations                                       |                                       |                                       | (10,125 | )     |        |      | (12,996 | )      |        |      | (11,443 | )      |        |   | (42,549 | )      |        |   | (34,007 | )     
|Gain on divestitures, net                                  |                                       |                                       |        |       |        |      |        |        |        |      |        |        |        |   |        |        |        |   | 8,631   |       
|Loss on minority investment                                |                                       |                                       |        |       |        |      |        |        |        |      | (250    | )      |        |   |        |        |        |   |        |       
|Interest income (expense), net                             |                                       |                                       | (541    | )     |        |      | (832    | )      |        |      | 241     |        |        |   | 1,007   |        |        |   | 548     |       
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Loss before minority interests                             |                                       |                                       | (10,666 | )     |        |      | (13,828 | )      |        |      | (11,452 | )      |        |   | (41,542 | )      |        |   | (24,828 | )     
|Minority interests                                         |                                       |                                       |        |       |        |      |        |        |        |      |        |        |        |   | (444    | )      |        |   | (619    | )     
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss                                                   |                                       | $                                     | (10,666 | )     |        | $    | (13,828 | )      |        | $    | (11,452 | )      |        | $ | (41,986 | )      |        | $ | (25,447 | )     
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss per share of common stock 
    basic and diluted |                                       | $                                     | (0.98   | )     |        | $    | (1.08   | )      |        | $    | (0.68   | )      |        | $ | (1.76   | )      |        | $ | (1.05   | )     
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Weighted-average shares of common stock
    outstanding    |                                       |                                       | 10,838  |       |        |      | 12,757  |        |        |      | 16,741  |        |        |   | 23,822  |        |        |   | 24,162  |       
|                                                           |                                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       

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|                                                             |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|------------------------------------------------------------ |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                                             |  | 1999           |        | 2000 |  | 2001 |        | 2002 |  | 2003
|                                                             |  |                |        |      |  |      |        |      |  |     
|                                                             |  |               
|                                                             |  | (In thousands)
|Balance Sheet Data:                                          |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Cash, cash equivalents and available-for-sale
    securities |  | $              | 7,365  |      |  | $    | 22,016 |      |  | $    | 81,887 |  |  | $ | 40,361 |  |  | $ | 23,977 | 
|Working capital                                              |  |                | 6,532  |      |  |      | 20,885 |      |  |      | 84,999 |  |  |   | 37,021 |  |  |   | 19,004 | 
|Total assets                                                 |  |                | 13,394 |      |  |      | 29,183 |      |  |      | 95,094 |  |  |   | 92,628 |  |  |   | 71,997 | 
|Long-term obligations(1)                                     |  |                | 10,153 |      |  |      | 8,574  |      |  |      |       |  |  |   |       |  |  |   |       | 
|Total stockholders equity (deficiency)                      |  |                | (48    | )    |  |      | 15,871 |      |  |      | 90,881 |  |  |   | 78,623 |  |  |   | 55,321 | 



---



|    |                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------
|(1) | Long-term obligations include convertible
    debentures, a note payable and other liabilities, net of current
    balances.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion should be read in
conjunction with Item 1  Business,
Item 6  Selected Consolidated Financial
Data and Item 8  Financial
Statements and Supplementary Data, as well as our
consolidated financial statements and related notes contained
elsewhere in this Annual Report on Form 10-K. This
discussion contains forward-looking statements based on our
current expectations. There are various factors  many
beyond our control  that could cause our actual
results or the occurrence or timing of expected events to differ
materially from those anticipated in these forward-looking
statements. Some of these factors are described below and other
factors are described elsewhere in this Annual Report on
Form 10-K, including above under Risks Related to Our
Business in Item 1 of this Annual Report on
Form 10-K. In addition, there are factors not described in
this Annual Report on Form 10-K that could cause our actual
results or the occurrence or timing of expected events to differ
materially from those anticipated in these forward-looking
statements. All forward-looking statements included in this
Annual Report on Form 10-K are based on information
available to us as of the date hereof, and we assume no
obligation to update any such forward-looking
statements.

Overview

We are a medical device company focused on
developing, manufacturing and selling cryosurgical products with
the potential to improve the treatment of cancer and other
tumors and on manufacturing and marketing vacuum technology as a
non-pharmacological option for treatment of erectile dysfunction.

Our cryosurgical product, the Cryocare Surgical
System, employs a computerized device and disposable probes to
freeze cancerous tissue or other tumors through our proprietary
argon gas-based technology. We recently introduced the next
generation of our Cryocare Surgical System, the Cryocare CS. See
above in Item 1 under Our Solution: The Cryocare
Surgical Systems.

Our erectile dysfunction products include the
ErecAid Esteem and the ErecAid Classic for treatment of
impotence as well as the RigiScan for diagnostic evaluation of
this condition.

Currently, our cryosurgical products are sold
chiefly to hospitals for the treatment of prostate cancer. In
addition, we are exploring the application of our cryosurgical
technologies for ablation of other tumors, specifically in the
treatment of tumors of the kidney, lung, liver and for pain
management related to metastatic bone cancer. We sell our vacuum
therapy products for treatment of erectile dysfunction primarily
to individual patients on a prescription basis. Our RigiScan
products are sold to physicians.

We have incurred significant operating losses and
negative cash flows from operations in each full fiscal year
since January 1, 1996. We incurred net losses of
approximately $42.0 million in 2002 and $25.4 million
in 2003. As of December 31, 2003, we had an accumulated
deficit of $114.4 million. We expect to incur additional
losses as we expand our sales and marketing efforts, strengthen
our infrastructure, improve our financial reporting processes
and controls and continue to develop new products.

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Results of Operations

The following table sets forth, for the periods
indicated, financial data as a percentage of revenues.

|                    |                                       |                          |     |      |     |      |     |      |     |  |     |      |     | 
|------------------- | ------------------------------------- | ------------------------ | --- | ---- | --- | ---- | --- | ---- | --- |  | --- | ---- | --- | 
|                    |                                       |                         
|                    |                                       | Year Ended              
|                    |                                       | December 31,            
|                    |                                       |                         
|                    |                                       | 2001                     |     | 2002 |     | 2003
|                    |                                       |                          |     |      |     |     
|Revenues            |                                       |                          | 100 | %    |     |      | 100 | %    |     |  | 100 | %   
|Costs and expenses: |                                       |                          |     |      |     |      |     |      |     |  |     |     
|                    | Cost of revenues                      |                          |     | 48   |     |      |     | 53   |     |  |     | 53   |    
|                    | Research and development              |                          |     | 19   |     |      |     | 9    |     |  |     | 4    |    
|                    | Selling, general and administrative   |                          |     | 121  |     |      |     | 109  |     |  |     | 155  |    
|                    | Goodwill impairment and other charges |                          |     |     |     |      |     | 66   |     |  |     |     |    
|                    |                                       |                          |     |      |     |      |     |      |     |  |     |     
|                    |                                       | Total costs and expenses |     |      | 188 |      |     |      | 237 |  |     |      | 212 | 
|                    |                                       |                          |     |      |     |      |     |      |     |  |     |     
|                    | Loss from operations                  |                          |     | (88  | )   |      |     | (137 | )   |  |     | (112 | )  
|                    | Loss on minority investment           |                          |     | (2   | )   |      |     |     |     |  |     |     |    
|                    | Interest income                       |                          |     | 6    |     |      |     | 3    |     |  |     | 3    |    
|                    | Interest expense                      |                          |     | (4   | )   |      |     |     |     |  |     |     |    
|                    | Gain on divestitures, net             |                          |     |     |     |      |     |     |     |  |     | 28   |    
|                    |                                       |                          |     |      |     |      |     |      |     |  |     |     
|                    | Loss before minority interests        |                          |     | (88  | )   |      |     | (134 | )   |  |     | (81  | )  
|                    | Minority interests                    |                          |     |     |     |      |     | (2   | )   |  |     | (2   | )  
|                    |                                       |                          |     |      |     |      |     |      |     |  |     |     
|                    | Net loss                              |                          |     | (88  | )   |      |     | (136 | )   |  |     | (83  | )  
|                    |                                       |                          |     |      |     |      |     |      |     |  |     |     

Revenues and cost of revenues related to the
following products and services for the three-year period ended
December 31, 2003 are as follows (in thousands):

|                  |                                                    |                |        |       |  |      |        |        |  |   |        |        | 
|----------------- | -------------------------------------------------- | -------------- | ------ | ----- |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                  |                                                    | 2001           |        | 2002  |  | 2003
|                  |                                                    |                |        |       |  |     
|                  |                                                    |               
|                  |                                                    | (In thousands)
|Revenues:         |                                                    |                |        |       |  |      |        |        |  |   |        |       
|                  | Cryocare Surgical Systems                          |                | $      | 7,358 |  |      | $      | 3,422  |  |   | $      | 1,283  | 
|                  | Cryoprobes, disposables and bundled procedure fees |                |        | 5,679 |  |      |        | 12,601 |  |   |        | 17,930 | 
|                  | Cardiac products (CryoCath)                        |                |        |      |  |      |        | 2,104  |  |   |        | 331    | 
|                  | Urological products (Timm Medical)                 |                |        |      |  |      |        | 12,789 |  |   |        | 10,953 | 
|                  |                                                    |                |        |       |  |      |        |        |  |   |        |       
|                  |                                                    | $              | 13,037 |       |  | $    | 30,916 |        |  | $ | 30,497 |       
|                  |                                                    |                |        |       |  |      |        |        |  |   |        |       
|Cost of Revenues: |                                                    |                |        |       |  |      |        |        |  |   |        |       
|                  | Cryocare Surgical Systems                          |                | $      | 2,200 |  |      | $      | 1,480  |  |   | $      | 466    | 
|                  | Cryoprobes, disposables and bundled procedure fees |                |        | 4,008 |  |      |        | 8,111  |  |   |        | 10,626 | 
|                  | Cardiac products (CryoCath)                        |                |        |      |  |      |        | 1,539  |  |   |        | 399    | 
|                  | Urological products (Timm Medical)                 |                |        |      |  |      |        | 5,354  |  |   |        | 4,567  | 
|                  |                                                    |                |        |       |  |      |        |        |  |   |        |       
|                  |                                                    | $              | 6,208  |       |  | $    | 16,484 |        |  | $ | 16,058 |       
|                  |                                                    |                |        |       |  |      |        |        |  |   |        |       



| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2003 Compared to
    Year Ended December 31, 2002

Revenues.We
generate revenues from sales of our Cryocare Surgical Systems,
disposable cryoprobes and other disposable devices used in
cryoablation procedures. We also contract with hospitals and
other health care payors for the use of our Cryocare Surgical
Systems in cryoablation treatments for which we charge a
per-procedure fee.

The procedure fee typically includes a procedure
kit containing cryoprobes and other disposables
needed to perform a cryosurgical procedure, in addition to a
service component. The service component of the

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procedure fee generally consists of rental and
transport of a Cryocare Surgical System as well as the services
of a technician to assist the physician with the set-up, use and
monitoring of the equipment. In certain instances, we will
provide the service component of the procedure to the hospital
as well as the devices. At other times, we will contract with
third parties to perform the service component of the procedures
and will remit a service fee to the third party upon invoicing
the hospital. Approximately 38% of our prostate cancer cases
were serviced by third-party service providers.


Prior to 2003, we concentrated heavily on selling
the capital equipment component of our Cryocare Surgical System,
often referred to as the box, primarily to
distributors and service providers. These distributors and
service providers were often entities in which our trained
cryosurgeons had invested. Since hospitals were frequently
reluctant to invest in capital equipment, trained cryosurgeons
who desired to introduce our technology into a hospital often
had to invest in the equipment themselves.

Due to the significant start-up costs involved in
forming a new cryosurgical service provider, however, this
strategy proved, in some cases, to be a barrier to the adoption
of our technology. In addition to purchasing our Cryocare
Surgical System, a service provider would require a van and an
ultrasound monitor and would need to employ or contract with a
clinical technician. Frequently, there were issues related to
financing of the equipment and the creditworthiness of these new
ventures.

In 2003, we shifted our emphasis for the urology
market from equipment sales to procedure growth. Through our
placement program, we provide equipment to hospitals with
high-volume potential for cryosurgery procedures and charge them
a per-procedure fee for use of the equipment.

There were approximately 190 Cryocare Surgical
Systems in service in the United States as of the end of 2002.
This number grew to 203 as of the end of 2003. These figures
include Cryocare Surgical Systems owned by our customers as well
as Cryocare Surgical Systems that are part of our placement
program. There were approximately 275 United States physicians
trained and using the Cryocare Surgical System as of the end of
2002 and approximately 536 at of the end of 2003. The number of
cryoablation procedures performed domestically was 2,474 in 2002
and increased to 3,504 in 2003. These numbers include estimates
of the number of procedures performed by hospitals who purchase
only probes from us, without the service component. We estimate
the number of procedure equivalents based on our knowledge of
the number of probes normally required to complete a procedure.
Our blended average selling price for those periods was
approximately $4,500 per procedure in 2002 and $4,700 per
procedure in 2003. This average reflects the lower prices we
charge where we sell probes only, without the service component.

We also sell other urological products acquired
when we purchased Timm Medical, a urological device
manufacturer, in the first quarter of 2002. We continue to sell
our ErecAid vacuum therapy systems and RigiScan monitors,
although in 2003 we either divested or discontinued the
remaining product lines acquired from Timm Medical. See above in
Item 1 under Recent Developments. The reduction
in year-over-year sales of our Timm urology products is
primarily attributable to these divestitures.

Revenues for the year ended December 31,
2003 decreased $0.4 million to $30.5 million from
$30.9 million in 2002, representing a reduction of 1.3%.
Significant shifts in product mix, driven by a strategic
re-alignment of our business, including the shift in focus for
our prostaterelated cryosurgery business and divestitures
of several product lines, are significant factors underlying the
year-over-year change in revenues. Divestiture of several Timm
Medical products and sale of the SurgiFrost products to CryoCath
resulted in a $3.4 million reduction in 2003 sales compared
to 2002. Revenues from sales of Cryocare Surgical Systems also
decreased $2.1 million in the same period. Revenues from
ongoing product lines, excluding Cryocare Surgical Systems and
the divested product lines, were up $5.1 million in 2003
over 2002.

Sales of Cryocare Surgical Systems decreased
$2.1 million or 62.5% from $3.4 million in 2002 to
$1.3 million in 2003. We sold 21 Cryocare Surgical Systems
in 2002 compared to 12 in 2003. The principal reason for the
reduction in system sales was a shift in our strategy to focus
on procedural growth rather than driving adoption of
cryosurgical technology through sales of capital equipment as
discussed above.

Growth in sales of cryoprobes, other disposables
and bundled procedure fees increased $5.3 million or 42.3%
from $12.6 million in 2002 to $17.9 million in 2003.
The number of procedures performed domestically

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increased 41.6% from 2,474 in 2002 to 3,504 in
2003. In addition, our blended average selling price per
procedure increased 4.4% from approximately $4,500 per procedure
in 2002 to $4,700 in 2003. We expect that average selling prices
may soften somewhat in 2003 as a result of Medicare
reimbursement of outpatient procedures moving from pass-through
status to an APC code. See above in Item 1 under
Reimbursement. Sales of other urology products
related to our Timm Medical business were 14.4% lower in 2003
than in 2002, falling $1.8 million from $12.8 million
to $11.0 million. Due to our strategy of divesting some of
the smaller urologic product lines, future revenues of Timm
Medical urological products were expected to decrease initially.
The Dura II line of penile implants and the urinary
incontinence and urodynamics lines were divested in April 2003
and October 2003, respectively. Sales of these divested products
accounted for approximately $3.3 million and
$1.6 million in combined revenues during 2002 and 2003
respectively. We expect sales of the remaining RigiScan and
ErecAid products for the diagnosis and treatment of erectile
dysfunction to grow modestly in 2004.


The $1.8 million reduction in sales of
cardiac products in 2003 compared to 2002 is due to the April
2003 agreement to transfer certain rights and assets related to
this product line to CryoCath as discussed above. We sold
SurgiFrost products to CryoCath throughout 2002 under a
pre-existing distribution agreement, whereas we discontinued
sales of this product in 2003 following the divestiture. Under
the terms of our April 2003 agreement with CryoCath, we are
entitled to receive a descending royalty stream from CryoCath of
from 10% to 3% of net sales from the products incorporating the
licensed technology during the period from 2004 to 2012.

Cost of Revenues.Cost of revenues consists of fixed and
variable costs incurred in the manufacture of our products in
addition to depreciation of Cryocare Surgical Systems placed in
the field with customers under our placement program or with our
sales and service personnel. We incur an additional cost of
revenues in the form of a fee for equipment usage and other
services when a procedure is performed on a box owned by an
unrelated service provider. That portion of the procedure fee
remitted to the third-party service provider is charged to cost
of revenues when the procedure is performed and billed. We
retain a larger profit on procedures performed on systems owned
by us where no outside service fees are incurred. In addition,
we have incurred charges for product warranties as well as
excess and obsolete inventory, shrinkage and other inventory
carrying costs. Also included in cost of revenues are costs of
maintaining patents or other intellectual property rights to
processes or technologies related to our products, royalties on
product sales and amortization of developed technology acquired
in connection with our acquisition of Timm Medical.

Cost of revenues decreased $0.4 million or
2.6% from $16.5 million in 2002 to $16.1 million in
2003. Part of the divestiture of several Timm Medical products
and the Surgifrost line sold to CryoCath account for a
$1.4 million reduction in cost of sales, while a reduction
in the number of Cryocare Surgical Systems sold in 2003 compared
to 2002 caused a $1.0 million decrease in this number.
These reductions in cost of revenues were partially offset by an
increase of $2.0 million due to growth in sales of
cryosurgical probes and procedures. Also affecting cost of
revenues is the reduction in Cryocare Surgical Systems sold in
2003 compared to 2002. Cost of revenues for Cryocare Surgical
Systems as a percentage of related revenues decreased from 43.2%
in 2002 to 36.3% in 2003. This was mainly due to the fact that
in 2002 we recorded $0.6 million in cost of sales for which
the corresponding sales could not be recorded under our revenue
recognition policy. Conversely, in 2003, we collected and
recorded $0.6 million of revenue for sales of systems where
approximately $0.1 million in cost of sales had been
recognized in the periods when the systems were originally
shipped.

Cost of revenues for cryoprobes, other
disposables and procedure kits as a percentage of related
revenues decreased from 64.4% in 2002 to 59.2% in 2003. This was
primarily due to an increase in the blended average selling
price per procedure from $4,500 in 2002 to $4,700 in 2003, and a
reduction in write downs of excess and obsolete inventory.

There was also an increase in year-over-year
depreciation and amortization expense due to an increase in
placement of Cryocare Surgical Systems and other inventory
located in the field. The number of placement

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systems grew from 109 at December 31, 2002
to 133 at December 31, 2003. In 2002 we took a charge of
$1.0 million for inventory written down as a result of
excess production and changes in product design.


Gross Margins.Gross
margins on revenues increased from 46.7% for the year ended
December 31, 2002 to 47.3% for the year ended
December 31, 2003. Factors contributing to the improvement
in gross margins are related to the changes in both revenues and
cost of sales that are discussed above.

Research and Development Expenses.Research and development expenses
include expenses associated with the design and development of
new products as well as significant enhancements to existing
products. These expenses consist primarily of salaries and
related benefits and overhead costs for staff engaged in
research and development activities, costs for materials and
supplies used in performing research and development activities,
costs of clinical trials conducted for the purpose of obtaining
regulatory approval of our products, consulting and advisory
fees for outside service providers directly involved in research
and development activities, and depreciation on equipment used
directly for research and development activities. We expense
research and development expenses when incurred. Our research
and development efforts are periodically subject to significant
non-recurring expenses and fees that can cause some variability
in our quarterly research and development expenses.

Research and development expenses for the year
ended December 31, 2003 decreased $1.6 million or
56.6% from $2.9 in 2002 to $1.3 million in 2003.
Development costs were incurred in 2002 but not 2003 for the
Horizon Prostatic Stent and the SurgiFrost system purchased by
CryoCath. In early 2003, we halted development of the Horizon
Prostatic Stent. Also, as discussed above, we sold our
manufacturing assets and inventory associated with the
SurgiFrost system to CryoCath in April 2003. Research and
development expenses in 2003 were primarily related to design,
development and testing of our new CS System for the prostate
cancer market.

Selling, General and Administrative Expenses.Selling, general and administrative
expenses primarily consist of salaries, commissions and related
benefits and other overhead costs for employees and activities
in the areas of sales, marketing, customer service, clinical
services, finance, information technology, human resources and
administration. Fees for attorneys, independent auditors and
certain other outside consultants and suppliers are included
where their services or products are related to selling, general
and administrative activities. Costs of insurance premiums,
including directors and officers liability and
products liability insurance, are also included in this
category. Expenses associated with advertising, trade shows,
promotional and training costs related to marketing our products
are also classified as selling, general and administrative
expenses as are the costs of conducting clinical research
studies for the purpose of collecting clinical data used in
promoting our products.

Selling, general and administrative expenses for
the two year period ended December 31, 2003, by line of
business, are shown below. Costs related to the cryosurgery
component of our business are on the left, while costs related
to products acquired in our February 2002 purchase of Timm
Medical are shown on the right under other urology.
Other urology relates primarily to our erectile dysfunction
products, but also includes the urological prosthesis and
incontinence products through their divestiture in 2003.

|                                          |                             |                              |                                  |         |        |        |       |  |       |       |        |  |        |        | 
|----------------------------------------- | --------------------------- | ---------------------------- | -------------------------------- | ------- | ------ | ------ | ----- |  | ----- | ----- | ------ |  | ------ | ------ | 
|                                          |                             |                             
|                                          |                             | Year Ended December 31, 2003
|                                          |                             |                             
|                                          |                             |                              |                                  | Other   |        |       
|                                          |                             | Cryosurgery                  |                                  | Urology |        | Total 
|                                          |                             |                              |                                  |         |        |       
|                                          |                             |                             
|                                          |                             | (In thousands)              
|Sales and marketing                       |                             | $                            | 16,025                           |         |        | $      | 2,841 |  |       | $     | 18,866 | 
|                                          | General and administrative: |                              |                                  |         |        |        |       |  |       |       |        |  |       
|                                          |                             | Ordinary course of business  |                                  |         | 10,998 |        |       |  | 3,070 |       |        |  | 14,068 |       
|                                          |                             | Non-recurring                |                                  |         | 14,255 |        |       |  |      |       |        |  | 14,255 |       
|                                          |                             |                              |                                  |         |        |        |       |  |       |       |        | 
|                                          |                             |                              | Total general and administrative |         |        | 25,253 |       |  |       | 3,070 |        |  |        | 28,323 | 
|                                          |                             |                              |                                  |         |        |        |       |  |       |       |        | 
|Total selling, general and administrative |                             | $                            | 41,278                           |         |        | $      | 5,911 |  |       | $     | 47,189 | 
|                                          |                             |                              |                                  |         |        |        |       |  |       |       |        | 

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|                                          |                             |                              |                                  |         |        |        |       |       |       |       |        |        |        |        | 
|----------------------------------------- | --------------------------- | ---------------------------- | -------------------------------- | ------- | ------ | ------ | ----- | ----- | ----- | ----- | ------ | ------ | ------ | ------ | 
|                                          |                             |                             
|                                          |                             | Year Ended December 31, 2002
|                                          |                             |                             
|                                          |                             |                              |                                  | Other   |        |       
|                                          |                             | Cryosurgery                  |                                  | Urology |        | Total 
|                                          |                             |                              |                                  |         |        |       
|                                          |                             |                             
|                                          |                             | (In thousands)              
|                                          | Sales and marketing         |                              | $                                | 11,539  |        |        | $     | 4,035 |       |       | $      | 15,574 |       
|                                          | General and administrative: |                              |                                  |         |        |        |       |       |       |       |        |        |       
|                                          |                             | Ordinary course of business  |                                  |         | 13,076 |        |       |       | 2,919 |       |        |        | 15,995 |       
|                                          |                             | Non-recurring                |                                  |         | 2,200  |        |       |       |      |       |        |        | 2,200  |       
|                                          |                             |                              |                                  |         |        |        |       |       |       |       |        |       
|                                          |                             |                              | Total general and administrative |         |        | 15,276 |       |       |       | 2,919 |        |        |        | 18,195 | 
|                                          |                             |                              |                                  |         |        |        |       |       |       |       |        |       
|Total selling, general and administrative |                             | $                            | 26,815                           |         |        | $      | 6,954 |       |       | $     | 33,769 |       
|                                          |                             |                              |                                  |         |        |        |       |       |       |       |        |       

Selling, general and administrative expenses
increased $13.4 million or 39.7% to $47.2 million for
the year ended December 31, 2003 compared to
$33.8 million for the year ended December 31, 2002.
Costs related to the investigations by our audit committee, the
SEC and the DOJ into possible accounting irregularities,
including related legal fees and settlements and audit expenses
and severance payments to former executives, explain most of the
year-over-year increase. Through December 31, 2003 costs
related to these investigations amounted to approximately
$16.5 million of which $14.3 million were expensed in
2003. These costs appear in the above table in the column under
Cryosurgery. Included in the 2003 costs was $3.6 million
related to severance agreements with various executives,
including $3.2 million for our former CEO and CFO.
Approximately $1.8 million of the total severance-related
costs was in the form of cash payments and $1.8 million was
a non-cash charge taken for equity-based compensation for two
former employees.

Non-recurring costs in 2002 included a
$1.5 million charge taken for a judgment entered against
the Company in October 2003 in the matter of Biolife Solutions,
Inc. v. Endocare, Inc. The remaining $0.7 million in
2002 were costs related to investigations into our historical
accounting and financial reporting by our audit committee, the
SEC and the DOJ. We have incurred and expect to incur further
costs related to these investigations in 2004 and perhaps
subsequent periods as we resolve all outstanding legal matters
stemming from these investigations. See above under
Item 3  Legal Proceedings. We
believe that a portion of the legal fees and costs associated
with these legal matters should be reimbursed to us under our
directors and officers liability insurance coverage.
However, we have not received any reimbursement of these fees
and costs to date, and the insurance carriers may dispute all or
a portion of these fees and costs.

Also in 2003, we consolidated a number of general
and administrative functions previously performed in multiple
locations. In early 2003, we made a decision to absorb certain
general and administrative functions duplicated at our Eden
Prairie, MN offices where our Timm Medical business is
headquartered. Certain accounting, human resources, information
technology and other positions were eliminated and their duties
were absorbed by employees in Irvine, CA. This transition was
completed in June 2003. Costs savings related to the downsizing
of our Eden Prairie, MN operations enabled us to keep our
general and administrative expenses constant for the other
urological component of our business. In real terms, our rate of
spending in this area has decreased. The 2002 costs for the
urological portion of our business included only 10 months
of operations following the February 2002 acquisition, while
2003 represented 12 months of expenses. We expect to see
further savings in future periods from this downsizing.

In March 2003, we also transferred the billing
services performed by our Advance Medical Procedures division,
located in Winter Park, FL, to our Irvine, CA office. In
addition, in July 2003 we assumed accounting and administrative
support for the thirteen entities in which we became general
partner or managing member through our purchase of certain
interests in these entities from USMD in 2002. These services
were previously outsourced.

As a result of consolidating various operations
and reducing duplicative overhead, we reduced the total number
of employees from 194 at December 31, 2002 to 163 at
December 31, 2003.

Looking forward at our general and administrative
costs, we anticipate making investments in building an
organization and infrastructure to support improvements in
internal controls, financial reporting and corporate governance.
We also expect to incur expenses associated with satisfying the
listing requirements of The

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Nasdaq Stock Market should our common stock be
relisted and in connection with implementing the requirements of
the Sarbanes-Oxley Act of 2002, in particular, Section 404
thereof, which requires management to report on, and our
independent auditors to attest to, the effectiveness of our
internal controls.


Overall, however we anticipate net reductions in
general and administrative costs due primarily to the winding
down of activities related to various investigations of
accounting and financial reporting matters. In addition, we
expect the full-year benefits from elimination of redundant
functions at our subsidiaries and centralizing them at our
Irvine, CA headquarters.

Sales and marketing expenses increased
$3.3 million or 21.1% to $18.9 million for the year
ended December 31, 2003 compared to $15.6 million for
the year ended December 31, 2002. The primary reason for
this increase is investment in our cryosurgery sales force. The
large sales force we acquired in our purchase of Timm Medical
had to be cross-trained in cryosurgical products and their
applications. In 2003, we incurred approximately
$1.2 million in training workshops, travel, salaries and
other costs related to developing our cryosurgical sales force.

We also incurred $0.7 million in costs
related to forming a dedicated interventional radiology sales
and marketing group, which focuses on application of our
cryosurgical products in treating tumors of the lung and liver
as well as for pain management in patients with metastatic bone
cancer.

Sales and marketing expenses in 2003 included
salaries, benefits and travel for the cryosurgical field
technicians who joined our staff when we purchased interests in
several mobile cryosurgical businesses from USMD in
September 2002. We incurred approximately $0.9 million
of salary and benefits costs and travel expenses for these
technicians in 2003. Additionally, we increased our investment
in training cryosurgeons from $1.8 million in 2002 to
$2.2 million in 2003, in our effort to continue to grow the
market for our cryosurgical products. These increases were
partially offset by a reduction in marketing costs of
$0.9 million in 2003 compared to 2002, primarily related to
reduced expenditures for printed materials such as sales
brochures.

We also incurred a full year of sales and
marketing expenses in 2003 for the erectile dysfunction line,
compared to ten months in 2002, as a result of the Timm Medical
acquisition. This resulted in $0.7 million of additional
sales and marketing expenses in 2003 over 2002.

We have planned new investments in sales and
marketing activities in 2004 to increase market share for our
cryosurgical products and to support our strong position in the
market for non-pharmacological treatment of erectile
dysfunction. Promotions related to our new Cryocare CS
system, and the use of our products in the interventional
radiology arena, in addition to broader national advertising
programs and continued training of new cryosurgeons are among
the strategies we will emphasize for our cryosurgical business
in the current fiscal year. Clinical studies and investments in
field sales are areas in which we plan to invest for our
erectile dysfunction business in 2004.

Goodwill Impairment and Other Charges.We took a charge of approximately
$18 million in October 2002 for impairment in the goodwill
recorded in connection with our purchase of Timm Medical. In
October 2002, we also recorded an other-than-temporary decline
in the value of our minority investment in U.S. Medical
Development, Inc. of approximately $2.3 million. We took no
further write-downs of goodwill nor did we determine that any
additional charges for impairment in other assets were required
during 2003.

Interest Income (Expense), Net.Interest income net of interest
expense was $0.5 million for the year ended
December 31, 2003 compared to $1.0 for the year ended
December 31, 2002. The drop in net interest income in 2003
compared to 2002 resulted from declining cash balances
throughout 2003 combined with lower interests rates, which were
primarily driven by reductions in the Federal Funds Rate in
November 2002 and June 2003 of 50 basis points and
25 basis points, respectively.

Minority Interests.Minority interests represent earnings
attributable to minority investors in the mobile prostate
treatment businesses we acquired from USMD on September 30,
2002. Minority interests increased 39% from $0.4 million in
2002 to $0.6 million in 2003. The increase is due to
results for 2002 including only the 3 post-acquisition
months, while in 2003 minority interest represents
12 months of earnings. This was

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offset by a reduction in earnings from the
entities dedicated to mobile treatment of BPH and the withdrawal
of limited partners from certain other entities.


Gain on Divestitures, Net.In 2003 we recorded a net gain of
$8.6 million related to the divestiture of several product
lines and related assets. As discussed above, in April 2003, we
licensed our intellectual property and manufacturing rights for
the SurgiFrost line, and sold inventory and other assets to
CryoCath for a total gain of $10.0 million. Also in April
2003, we sold the intangibles and inventory related to our Dura
II products to American Medical Systems for $2.2 million
resulting in a $35,000 loss and we sold the inventory and assets
associated with our urinary incontinence products to SRS
Medical, Inc. resulting in a loss of $1.3 million.

Net Loss.Net loss
for the year ended December 31, 2003 was
$25.4 million, or $1.05 per share. For the year ended
December 31, 2002 the net loss was $42.0 million or
$1.76 per share. Reasons for the higher net loss in 2002
included higher cost of revenues combined with
$20.3 million in impairment charges related to goodwill and
investments. In 2003, significant non-recurring costs related to
accounting investigations were partially offset by the net gain
on divestitures.

Year
Ended December 31, 2002 Compared to Year Ended
December 31, 2001

Revenues.We
generate revenues from sales of our Cryocare Surgical Systems as
well as from the recurring sales of our disposable cryoprobes
and other disposable devices used in cryoablation procedures. We
also contract with hospitals and other healthcare payors for the
use of our Cryocare Surgical Systems in cryoablation treatments
for which we charge a per-procedure, or bundled, fee. The
bundled fee typically includes a procedure kit
containing cryoprobes and other disposables needed to perform a
cryosurgical procedure, in addition to a service component. The
service component of the bundled fee generally consists of
rental and transport of a Cryocare Surgical System as well as
the services of a technician to assist the physician with the
set-up, use and monitoring of the equipment. During the fiscal
year ended December 31, 2002, we also sold a number of
other urological products acquired when we purchased Timm
Medical, a urological device manufacturer, in the first quarter
of 2002. While we have divested a number of those urological
product lines acquired from Timm Medical, we continue to sell
our ErecAid vacuum therapy systems and RigiScan monitors. Also
in 2002, we sold cryoablation systems and disposables we
developed for treatment of cardiac arrhythmias to CryoCath, a
company specializing in the sales distribution of these products
into the cardiology market.

Revenues for the year ended December 31,
2002 increased $17.9 million or 137.7% to
$30.9 million from $13.0 million in 2001. Of this
increase, $12.8 million related to Timm Medical and
$2.1 million was from sales to CryoCath. Sales to CryoCath
were not significant in 2001. Excluding Timm Medical and
CryoCath, sales of Cryocare Surgical Systems decreased
$4.0 million or 54.1% from $7.4 million in 2001 to
$3.4 million in 2002. In 2001, 45 Cryocare Surgical
Systems were sold compared to 21 Cryocare Surgical Systems
in 2002. Termination of the exclusive distribution agreement
with U.S.M.D., Ltd. explains part of the year-over-year
reduction in sales of Cryocare Surgical Systems. U.S.M.D., Ltd.
purchased 19 units in 2001 versus five units in 2002, prior
to our acquisition of the mobile prostate treatment businesses
from USMD on September 30, 2002. In connection with this
acquisition, the distribution agreement was terminated and USMD
exited the cryosurgical market.

The reduction in sales of Cryocare Surgical
Systems was offset by growth in sales of cryoprobes, other
disposables and bundled procedure fees, which increased
$6.9 million or 121.1% from $5.7 million to
$12.6 million. The growth is due to an increase in the
number of Cryocare Surgical Systems in operation from 113 in
2001 to 190 in 2002, including both systems purchased by third
parties and systems in our placement program. The number of
procedures performed domestically increased from 1,093 in 2001
to 2,474 in 2002. In addition, our blended average selling price
per procedure increased from approximately $2,900 per
procedure in 2001 to approximately $4,500 per procedure in
2002. This was primarily due to a shift in our business model in
mid-2001 from selling only probes and other disposables used in
a cryosurgical procedure to our customers, without a service
component, to invoicing for a bundled procedure including both
the disposable devices and a service fee for use of the
equipment and technical assistance.

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Due to our divestiture strategy, future revenues
relating to the Timm Medical urological products are initially
expected to decrease. The penile implants product lines and the
urinary incontinence and urodynamics product lines divested in
April and October 2003, respectively, accounted for
approximately $3.4 million in combined revenues during
2002. In addition, we terminated our CryoCath distribution
agreement effective April 2003 upon the sale of our
cardiac-related product manufacturing operations, and our
license for cardiovascular uses of our proprietary argon-based
technology, to CryoCath. Under the sale agreement, we are
entitled to receive a descending royalty stream from CryoCath
from 10% to 3% of net sales from the products incorporating the
licensed technology during the period 2004 to 2012. However, we
cannot estimate the amount of future royalty payments at this
time.

Cost of Revenues.Cost of revenues consists of fixed and variable costs incurred
in the manufacture of our products, depreciation of Cryocare
Surgical Systems placed in the field with customers or with our
sales and service personnel, excess and obsolete inventory,
shrinkage and other inventory carrying costs, royalties on
products sales, and costs of maintaining patents or other
intellectual property rights to processes or technologies
related to our products and product warranties.

Cost of revenues for the year ended
December 31, 2002 increased $10.3 million or 166.1%
from $6.2 million in 2001 to $16.5 million in 2002. Of
this increase, $5.4 million related to Timm Medical and
$1.5 million related to the cardiac-related products sold
to CryoCath. Cost of revenues for Cryocare Surgical Systems as a
percentage of related revenues increased from 29.9% in 2001 to
43.2% in 2002 due to an increase in the number of Cryocare
Surgical Systems shipped to customers in 2002 over 2001, for
which no revenues were recognized as discussed below. Cost of
revenues for cryoprobes, other disposables and bundled
procedures as a percentage of related revenues decreased from
70.6% in 2001 to 64.4% to 2002. This was primarily due to an
increase in the blended average selling price per procedure from
$2,900 in 2001 to $4,500 in 2002 partially offset by increase in
the number of procedures performed on Cryocare Surgical Systems
owned by third parties where we incur an additional cost of
revenues in the form of a fee for equipment usage and other
services. The portion of the procedure fee remitted to the
third-party service provider is charged to cost of revenues when
the procedure is performed and billed. We retain a larger profit
on procedures performed on systems owned by us where no outside
service fees were incurred.

Also included in cost of revenues for 2002 was
approximately $0.6 million in manufacturing costs for
16 Cryocare Surgical Systems shipped to customers, for
which no corresponding sales revenue was recognized pursuant to
our revenue recognition policy. Of the 16 Cryocare Surgical
Systems, 11 were shipped and billed during the first and
second quarters of 2002. Sales of these units, previously
recognized in the quarters when they were invoiced, were
reversed for reasons discussed in note 3 to our
consolidated financial statements. The remaining five systems
were shipped and billed in the third and fourth quarters of
2002, but no revenue has been recognized in accordance with our
revenue recognition policy. The cost of revenues in 2001
included approximately $0.4 million in manufacturing costs
for 10 Cryocare Surgical Systems, the sales revenue of which
were also reversed for reasons discussed in note 3 to our
consolidated financial statements. Although the sales of these
systems have been reversed and excluded from revenues as
discussed above, the manufacturing costs for these systems were
not reversed and remained in 2002 and 2001 cost of revenues
since these units were still held by customers, and had not been
returned to us.

In April 2002, we relocated our headquarters and
manufacturing operations to a new, larger facility in Irvine,
California. A total of $2.1 million was invested in
improvements to the leased space and in furniture and equipment
for the facility. The increase in rent, utilities and other
facilities related costs, as well as additional depreciation and
amortization expenses, are partially reflected in the higher
cost of revenues through increased manufacturing overhead. There
was also an increase in year-over-year depreciation and
amortization expense due to an increase in placement of Cryocare
Surgical Systems and other inventory located in the field. The
number of placement systems grew from 23 at December 31,
2001 to 109 at December 31, 2002. Additionally, there was
an increase in reserves for excess and obsolete inventory taken
in 2002, as compared to 2001, due to excess production and
changes in product design.

Gross Margins.Gross
margins on revenues decreased from 52.4% for the year ended
December 31, 2001 to 46.7% for the year ended
December 31, 2002. This was due to the fact that revenue
growth from 2001

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to 2002 did not keep pace with the increase in
costs of revenues. Factors contributing to the significant
increase in cost of revenue are discussed above.


Research and Development
Expenses.Research and development
expenses include expenses associated with the design and
development of new products as well as significant enhancements
to existing products. These expenses consist primarily of
salaries and related benefits and overhead costs for staff
engaged in research and development activities, costs for
materials and supplies used in performing research and
development activities, costs of clinical trials conducted for
the purpose of obtaining regulatory approval of our products,
consulting and advisory fees for outside service providers
directly involved in research and development activities, and
depreciation on equipment used directly for research and
development activities. We expense research and development
expenses when incurred. Our research and development efforts are
periodically subject to significant non-recurring expenses and
fees that can cause some variability in our quarterly research
and development expenses.

Research and development expenses increased
$.4 million or 16.0% from $2.5 million in 2001 to
$2.9 million in 2002. This increase was primarily due to
development costs for the Horizon Prostatic Stent and the
SurgiFrost system purchased by CryoCath. In early 2003, we
halted development of the Horizon Prostatic Stent. Also in early
2003, we sold our manufacturing assets and inventory associated
with the SurgiFrost system, and licensed the related proprietary
argon gas based technology for cardiac uses, to CryoCath.

Selling, General and Administrative
Expenses.Selling, general and
administrative expenses primarily consist of salaries,
commissions and related benefits and other overhead costs for
employees and activities in the areas of sales, marketing,
customer service, finance, information technology, human
resources and administration. Fees for attorneys, independent
auditors and certain other outside consultants and suppliers are
included where their services or products are related to
selling, general and administrative activities. Expenses
associated with advertising, trade shows, promotional and
training costs related to marketing our products are also
classified as selling, general and administrative expenses as
are the costs of conducting clinical research studies for the
purpose of collecting clinical data used in promoting our
products.

Selling, general and administrative expenses
increased $18.1 million or 115.3% to $33.8 million for
the year ended December 31, 2002 compared to
$15.7 million for the year ended December 31, 2001.
Included in the 2002 expenses was $7.0 million related to
Timm Medical and a $1.5 million charge related to an
adverse verdict in the BioLife litigation as discussed below. A
significant portion of the increase in costs was driven by
staffing. The number of employees grew from 94 at the end of
2001 to 194 at the end of 2002. As a result of the Timm Medical
acquisition, 94 employees were added. The acquisition of Timm
Medical was intended, in part, to provide us with an expanded
sales force and service personnel with experience in the urology
market. Of the 100 new employees in 2002, 71 were added in
selling, general and administrative areas, primarily in sales
and customer service. Sales personnel increased from 18
employees at the end of 2001 to 57 at the end of 2002, while
customer service staff increased from 10 to 25 employees during
the same period.

Another factor in the year-over-year growth of
our selling, general and administrative expenses was the
investment in training new physicians in the use of our
products. The cost of training a doctor through our cryosurgical
program averages between $15,000 and $20,000. In 2002 we trained
an estimated 109 cryosurgeons compared to approximately 47 in
2001.

Also, as discussed above, we moved our
headquarters and manufacturing operations to a new facility in
April 2002. Higher rent, utilities, depreciation and
amortization costs also contributed to the increase in selling,
general and administrative expenses. Other increases in selling,
general and administrative costs included legal, tax, accounting
and facility expenses related to the operations of Timm Medical.

Further, we incurred approximately
$1.1 million in legal and accounting fees associated with
the audit committees internal review of various accounting
and other matters as well as the related legal proceedings.
Additionally, we recorded a charge of $1.5 million in the
fourth quarter of 2002 to reflect the ruling by a Delaware
Chancery court relating to a dispute arising from our agreement
to acquire certain assets from BioLife in May 2002. The ruling
requires us to pay BioLife approximately $1.6 million, plus
pre-judgment interest and costs (including legal fees), and
requires BioLife to surrender to us 120,022 shares of our
common

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stock. The ruling was issued on October 1,
2003. In February 2004 we agreed to settle this case for a
cash payment to BioLife of $1.9 million and return to us by
BioLife of 122,022 shares of our common stock.


Looking forward, we expect to incur significant
additional expenses related to the investigations and legal
proceedings in which we continue to be involved. In addition, we
anticipate making substantial investments in building an
organization and infrastructure to support improvements in
internal controls, financial reporting and corporate governance.
We also expect to incur significant expenses associated with
satisfying the listing requirements of The Nasdaq National
Market should our common stock be relisted and in connection
with implementing the requirements of the Sarbanes-Oxley Act of
2002, in particular, Section 404 thereof, which requires
management to report on, and our independent auditors to attest
to, the effectiveness of our internal controls.

Goodwill Impairment and Other
Charges.We took a charge of
approximately $18 million in October 2002 for impairment in
the goodwill recorded in connection with the purchase of Timm
Medical. In October 2002, we also recorded an
other-than-temporary decline in the value of our minority
interests in U.S. Medical Development, Inc. of
approximately $2.3 million.

Interest Income (Expense),
Net.Interest income net of interest
expense was $1.0 million for the year ended
December 31, 2002 compared to $241,000 for the year ended
December 31, 2001. The net increase was due to an increase
in cash of approximately $72.6 million following our
secondary public equity offering in November 2001. The increase
in cash was partially offset by operating losses and
$24.1 million in cash used for significant business
acquisitions during 2002. In addition, all our significant
borrowings were eliminated in 2001 with the conversion of
$8 million in debentures and repayment of funds drawn under
a credit facility.

Minority Interests.Minority interests represent fourth quarter 2002 earnings
attributable to minority investors in the mobile prostate
treatment businesses we acquired from USMD on September 30,
2002.

Net Loss.Net loss
for the year ended December 31, 2002 was
$42.0 million, or $1.76 per share. For the year ended
December 31, 2001 the net loss was $11.5 million or
$0.68 per share. Reasons for the higher net loss in 2002
included a steep increase in cost of revenues and in selling,
general and administrative expenses, combined with
$20.3 million in impairment charges related to goodwill and
investments. The increases in operating expenses were partially
offset by revenue growth.

Liquidity and Capital Resources

Since inception, we have incurred losses from
operations and have reported negative cash flows. As of
December 31, 2003, we had an accumulated deficit of
$114.4 million and cash and cash equivalents of
$24.0 million. We currently have no long-term debt, and no
long-term financial obligations other than under operating
leases and purchase commitments for raw material used in
manufacturing our products. Although we believe that our
existing cash and cash equivalents will be sufficient to fund
our working capital requirements, capital expenditures and other
obligations through the next 12 months, there are certain
risks and uncertainties that could, in the future, change our
opinion regarding the adequacy of our capital resources.

We recently made several significant payments
that have reduced our cash reserves. On March 8, 2004, we
paid to our former Chief Executive Officer an aggregate of
$750,000, which we owed to him under a separation agreement and
consulting agreement that we previously executed. Also on
March 8, 2004, we paid to our former Chief Financial
Officer an aggregate of $616,000, which we owed to him under an
employment agreement we previously executed. At the request of
the SEC, these payments were deposited into escrow accounts
during the fourth quarter of 2003 and released upon termination
of the related escrow agreements. The escrow of these payments
caused the amount of these payments to be classified as
restricted cash and included in prepaid expenses and other
current assets as of December 31, 2003, instead of being
included in our December 31, 2003 cash and cash equivalents
balance of $24.0 million.

In addition to the payments described in the
prior paragraph, in February 2004 we paid approximately
$1.5 million in directors and officers
liability insurance premiums, and we paid approximately
$1.9 million to BioLife to settle litigation, as described
above in Item 3 of this Annual Report on Form 10-K.

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We face the possibility that there will be
additional material cash payments required in connection with
resolving matters related to the investigations into our
historical accounting and financial reporting. We and certain
former officers and certain current and former board members
have been named defendants in a class action and a derivative
lawsuit. We are generally obliged, to the extent permitted by
law, to indemnify our directors and officers who are named
defendants in these lawsuits. At this point in time we are
unable to provide a reasonable estimate of our potential
liability in these lawsuits.

We may be required to pay judgments or
settlements and to incur expenses in defending against these
claims that could be material. Further, while we carry
$20 million of directors and officers liability
insurance coverage, this coverage may not be adequate to cover
all costs related to these lawsuits, including any resulting
judgments or settlements. As described above under Risks
Related to Our Business, two of our excess carriers have
denied us coverage for these claims, and the third excess
carrier has reserved the right to deny us coverage for these
claims. Any of these unfavorable outcomes could have a material
adverse effect on our business, financial condition, results of
operations and cash flows.

Beyond the factors described above, we expect to
face significant demands on our capital resources related to the
execution of our 2004 operating plan, regaining compliance with
the SEC rules and regulations required of publicly traded
companies, including Section 404 of the Sarbanes-Oxley Act
of 2002, and fulfilling requirements prerequisite to becoming
relisted on The Nasdaq Stock Market. We are currently projecting
an operating loss for fiscal 2004, as well as a net use of cash.

We will continue to use cash reserves to finance
our projected 2004 cash flow deficit. Our 2004 forecast provides
for an increase in revenues and improvement in gross profit as
well as a significant reduction in general and administrative
expenses. The reduction in general and administrative costs is
due primarily to the winding down of activities related to
various investigations of accounting and financial reporting
matters. In addition, we have trimmed general and administrative
costs through the elimination of redundant functions at our
subsidiaries and centralizing them at our Irvine, California
headquarters.

At the same time, however, we have planned new
investments in sales and marketing activities to increase our
market penetration as well as in inventory related to the
introduction of our new Cryocare CS System. Additionally, we
expect to incur additional research and development costs to
improve our existing products and develop new ones. We have also
planned expenditures on staffing and infrastructure improvements
in finance and information technology to ensure that we will be
able to comply with internal control and other SEC requirements.

As part of our overall strategy to improve
operating results and conserve cash, we plan to attempt to
negotiate reduced per-procedure service fees for service
providers with whom we contract to make Cryocare Surgical
Systems and technicians available to hospitals where
cryosurgical procedures are performed. In addition, we are
contemplating several other cost-cutting initiatives for the
current fiscal year. We cannot provide any assurance that these
cost-cutting efforts will be successful, nor that we will
achieve our budgeted results. We may need to implement more
extensive cost-cutting measures in order to ensure that our cash
balances are adequate to fund operations for the next
12 months.

Although we believe that our current cash
balances will be sufficient to fund our operations for at least
the next 12 months, we may require additional financing
sooner than expected if we fail to achieve our operating
objectives. Further, we may identify new opportunities to invest
in our core technology or to accelerate market share and revenue
growth that require external sources of funding.

We fully expect that, to meet our long-term
capital requirements, we will need to raise substantial
additional funds from one or more of the following sources:
leveraging or pledging our assets, selling equity or debt
securities to public or private investors, selling certain of
our products or lines of business, or licensing our technologies
for applications outside our existing target markets. We are
currently exploring various fund-raising alternatives and
strategies. There are risks associated with any of these
fund-raising strategies. In the event that we raise additional
equity financing, our stockholders will be further diluted. In
the event that we incur additional indebtedness to fund our
operations, we may have to grant the lender a security interest
in our assets.

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Additional equity or debt financing may not be
available on acceptable terms, or at all. Our common stock was
delisted from The Nasdaq Stock Market on January 16, 2003.
One result of this action is a limited public market for our
common stock. This reduced liquidity will likely make it
difficult to raise additional capital.

If we are unable to obtain additional capital, we
may be required to divest additional product lines, reduce our
sales and marketing activities, reduce the scope of or eliminate
our research and development programs, or relinquish rights to
technologies or products that we might otherwise seek to develop
or commercialize.

Furthermore, if we fail to adequately address our
liquidity concerns, then our independent auditors may issue a
qualified opinion, to the effect that there is substantial doubt
about our ability to continue as a going concern. A qualified
opinion could itself have a material adverse effect on our
business, financial condition, results of operations and cash
flows.

Contractual Obligations

In the table below, we set forth our contractual
obligations as of December 31, 2003. Some of the figures we
include in this table are based on managements estimates
and assumptions about these obligations, including their
duration, the possibility of renewal, anticipated actions by
third parties, and other factors. Because these estimates and
assumptions are necessarily subjective, the contractual
obligations we will actually pay in future periods may vary from
those reflected in the table.

|                                   |  |                        |       |      |  |           |       |           |  |   |     |  |  |   |    | 
|---------------------------------- |  | ---------------------- | ----- | ---- |  | --------- | ----- | --------- |  | - | --- |  |  | - | -- | 
|                                   |  |                       
|                                   |  | Payments Due by Period
|                                   |  |                       
|                                   |  | Total                  |       | 2004 |  | 2005-2006 |       | 2007-2008
|                                   |  |                        |       |      |  |           |       |          
|                                   |  |                       
|                                   |  | (In thousands)        
|Non-cancelable operating leases(1) |  | $                      | 1,710 |      |  | $         | 663   |           |  | $ | 970 |  |  | $ | 77 | 
|Purchase commitments(2)            |  |                        | 2,483 |      |  |           | 2,483 |           |  |   |    |  |  |   |   | 
|                                   |  |                        |       |      |  |           |       |           |  |   |     |  |  |   |    | 
|                                   |  | $                      | 4,193 |      |  | $         | 3,146 |           |  | $ | 970 |  |  | $ | 77 | 
|                                   |  |                        |       |      |  |           |       |           |  |   |     |  |  |   |    | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We enter into operating leases in the normal
    course of business. We lease office space as well as other
    property and equipment under operating leases. Some lease
    agreements provide us with the option to renew the lease at the
    end of the original term. Our future operating lease obligations
    would change if we exercised these renewal options and if we
    entered into additional operating lease agreements. For more
    information, see note 12 to our consolidated financial
    statements.                                                                                                                                                                                                                   
|   
|(2) | These purchase commitments relate to agreements
    to purchase goods or services to manufacture our products. The
    agreements included in the table include open purchase orders in
    excess of $100,000. These obligations are not recorded in our
    consolidated financial statements until contract payment terms
    take effect. We expect to fund these commitments with cash flows
    from operations and from cash balances on hand. The obligations
    shown in the above table are subject to change based on, among
    other things, our manufacturing operations not operating in the
    normal course of business, the demand for our products, and the
    ability of our suppliers to deliver the products as promised.

Critical Accounting Policies

The following discussion and analysis of our
financial condition and results of operations are based on our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of the financial statements
requires management to make estimates and assumptions in
applying certain critical accounting policies. Certain
accounting estimates are particularly sensitive because of their
significance to our consolidated financial statements and
because of the possibility that future events affecting the
estimates could differ significantly from current expectations.
Factors that could possibly cause actual amounts to differ from
current estimates relate to various risks and uncertainties
inherent in our business, including those set forth under
Risk Related to Our Business in Item 1 of this
Annual Report on Form 10-K. Management believes that the
following are some of the more critical judgment areas in the
application of accounting policies that affect our financial
statements. The

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restatements described in note 3 of our
consolidated financial statements filed in our annual report for
the year ended December 31, 2002 filed on Form 10-K
relate to certain of the critical accounting policies described
below.


Revenue Recognition.We follow the provisions of Staff Accounting Bulletin 101,
Revenue Recognition in Financial Statements
(SAB 101), for revenue recognition. Under
SAB 101, four conditions must be met before revenue can be
recognized: (i) there is persuasive evidence that an
arrangement exists, (ii) delivery has occurred or service
has been rendered, (iii) the price is fixed or determinable
and (iv) collection is reasonably assured.

Revenues for Cryocare Surgical Systems shipped to
company controlled locations for interim storage are deferred
until subsequently shipped and accepted by our customers. We
also reduce our revenues for customer concessions, and defer
revenue recognition for minimum procedure guarantees and
contingent payment arrangements until a future date when the
contingencies are resolved.

Where we own the equipment used in the procedure,
we bill the hospital or other payor and retain the entire
procedure, or bundled, fee. In many instances, however, the
equipment is owned by a third-party who contracts with us to
perform the service component of the procedure. Third-party
service providers are usually entities owned or controlled by
urologists who perform cryosurgical procedures. In the latter
case, we still invoice the payor but we remit a portion of the
procedure fee to the third-party service provider. The procedure
fee is recorded as revenue in the period when the procedure is
performed and, where applicable, the fee paid to a third-party
service provider is included in cost of revenues for the same
period.

Where a third-party service provider is not
involved, we earn the entire procedure fee, both the portion
related to providing the disposable kits and the
portion related to providing mobile or placement
Cryocare Surgical Systems to customers. Providing loaner or
placement equipment to customers is a strategy aimed
at promoting broader acceptance of our technology and driving
sales of disposable components faster than would be possible if
we restricted use of the device only to customers willing to
make a significant capital investment in a Cryocare Surgical
System. In these situations, we either loan a mobile Cryocare
Surgical System to a hospital or consign a stationary Cryocare
Surgical System with the hospital under our placement program
and charge a fee for each procedure in which the equipment is
used. Cost of revenues includes depreciation on the Cryocare
Surgical Systems owned by us over an estimated useful life of
three years.

We routinely assess the financial strength of our
customers and, as a consequence, believe that our accounts
receivable credit risk exposure is limited. Accounts receivable
are carried at original invoice amount less all discounts and
allowances, and less an estimate for doubtful accounts and sales
returns based on a periodic review of outstanding receivables.
Allowances are provided for known and anticipated credit losses
as determined by management in the course of regularly
evaluating individual customer receivables. This evaluation
takes into consideration a customers financial condition
and credit history as well as current economic conditions.
Accounts receivable are written off when deemed uncollectible.
Recoveries of accounts receivable previously written off are
recorded when received.

Purchase Accounting.Our acquisitions of Timm Medical and certain general and limited
equity interests in the mobile prostate cancer and BPH treatment
businesses of U.S.M.D. have been accounted for under the
purchase method of accounting for business combinations. We are
required to allocate the purchase price of acquired companies to
the tangible and intangible assets acquired and liabilities
assumed based on their estimated fair values. The judgments made
in determining the estimated fair value and expected useful
lives assigned to each class of assets and liabilities acquired
can significantly impact periodic amortization expense and net
income.

Determining the fair value of certain assets and
liabilities acquired is judgmental in nature and often involves
the use of significant estimates and assumptions, especially
with respect to intangibles. Critical estimates in valuing
certain intangible assets include: future expected cash flows
from customer contracts, customer lists and distribution
agreements and acquired developed technologies and patents;
brand awareness and market position, as well as assumptions
about the period of time the brand will continue to be used in
our product portfolio; and discount rates. To assist in this
process, we obtained appraisals from independent

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valuation firms for certain significant tangible
and intangible assets and liabilities. While our estimates of
fair value are based upon assumptions believed to be reasonable,
these estimates are inherently uncertain and unpredictable, and
as a result, actual results may differ from estimates. Other
estimates associated with the accounting for acquisitions may
also change as additional information becomes available
regarding the assets acquired and liabilities assumed.


Goodwill Impairment.We test for goodwill impairment in the fourth fiscal quarter of
each year, or sooner if events or changes in circumstances
indicate that the carrying amount may exceed the fair value. The
goodwill impairment test is a two-step process, which requires
management to make judgments in determining what assumptions to
use in the calculation. The first step of the process consists
of estimating the fair value of each reporting unit, which we
base on a weighted combination of the (i) guideline company
method (GCM) that utilizes revenue multiples for comparable
publicly-traded companies, and (ii) a discounted cash flow
(DCF) model that utilizes future net cash flows, the timing of
these cash flows, and a discount rate (or weighted average cost
of capital which considers the cost of equity and cost of debt
financing expected by a typical market participant) representing
the time value of money and the inherent risk and uncertainty of
the future cash flows. If the estimated fair value is less than
the carrying value, a second step is performed to compute the
amount of the impairment by determining an implied fair
value of goodwill. The determination of a reporting
units implied fair value of goodwill requires
us to allocate the estimated fair value of the reporting unit to
the assets and liabilities of the reporting unit. Any
unallocated fair value represents the implied fair
value of goodwill, which is compared to its corresponding
carrying value. Goodwill totaled $17.5 million at December
2002 and 2003, and represented 19% and 24% of our total assets,
respectively. In 2002, we recognized an impairment charge of
$18.0 million to reduce the carrying value of the goodwill
acquired in the Timm Medical acquisitions. The impairment
resulted from the termination or abandonment of three of the
acquired distribution agreements for urological products
following the acquisition. In 2003, we concluded that the
estimated fair value of each reporting unit exceeded the
carrying amount, so goodwill was not impaired. If the exit
market multiples used in the GCM had been reduced by up to 10%,
or the discount rate used in the DCF model were increased by
100 basis points, or both, the fair value would continue to
exceed the carrying value for all of our reporting units.

Impairment of Long-Lived Assets.We have a significant amount of
property, equipment and amortizable intangible assets primarily
consisting of purchased patents and acquired technology. In
accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the Impairment or
Disposal of Long Lived Assets, we review our long-lived
assets and certain identifiable intangibles for impairment
whenever events or changes in circumstances indicate that the
carrying amount of an asset or asset group may not be
recoverable. Recoverability of long-lived and amortizable
intangible assets to be held and used is measured by a
comparison of the carrying amount of an asset to the
undiscounted future operating cash flows expected to be
generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured as the
amount by which the carrying value of the assets exceeds their
fair value. At December 31, 2002 and 2003, we did not
determine that a write down for impairment of any of our
long-lived assets was required.

Legal and Other Loss
Contingencies.In the normal course of
business, we are subject to contingencies, such as legal
proceedings and claims arising out of our business that cover a
wide range of matters, including tax matters, product liability
and workers compensation. In accordance with SFAS
No. 5, Accounting for Contingencies, we record
accruals for such contingencies when it is probable that a
liability will be incurred and the amount of loss can be
reasonably estimated. A significant amount of management
estimation is required in determining when, or if, an accrual
should be recorded for a contingent matter and the amount of
such accrual, if any. Due to the uncertainty of determining the
likelihood of a future event occurring and the potential
financial statement impact of such an event, it is possible that
upon further development or resolution of a contingent matter, a
charge could be recorded in a future period that would be
material to our consolidated results of operations, financial
position or cash flows.

Other Investments.We review our equity investments for impairment based on our
determination of whether the decline in market value of the
investment below our carrying value is other than temporary. In
making this determination, we consider Accounting Principles
Board Opinion (APB) No. 18, The Equity

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Method of Accounting of Investments in Common
Stock , which set forth factors to be
evaluated in determining whether a loss in value should be
recognized. Factors include the investees operational
performance, indictors of continued viability, financing status,
liquidity prospects and cash flow forecasts. We also consider
our ability to hold the investment, the market price and market
price fluctuations of the investments publicly traded
shares and the ability of the investee to sustain an earnings
capacity which would justify the carrying amount of the
investment.


Income Taxes.In the
preparation of our consolidated financial statements, we are
required to estimate income taxes in each of the jurisdictions
in which we operate, including estimating both actual current
tax exposure and assessing temporary differences resulting from
differing treatment of items for tax and accounting purposes.
Assessment of actual current tax exposure includes assessing tax
strategies, the status of tax audits and open audit periods with
the taxing authorities. To the extent that we have deferred tax
assets, we must assess the likelihood that our deferred tax
assets will be recovered from taxable temporary differences, tax
strategies or future taxable income and to the extent that we
believe that recovery is not likely, we must establish a
valuation allowance. As of December 31, 2003 we have
established a valuation allowance of $40.3 million against
our deferred tax assets. In the future, we may adjust our
estimates of the amount of valuation allowance needed and such
adjustment would impact our provision for income taxes in the
period of such change.

Inflation

The impact of inflation on our business has not
been significant to date.




Item 7A.     Quantitative
and Qualitative Disclosures About Market Risk

The primary objective of our investment
activities is to preserve principal while at the same time
maximizing the income we receive from our invested cash without
significantly increasing risk of loss. Our financial instruments
include cash, cash equivalents, accounts and notes receivable,
investments, accounts payable and accrued liabilities. At
December 31, 2003, the carrying values of these financial
instruments approximated their fair values.

Our policy is not to enter into derivative
financial instruments. In addition, we do not enter into any
futures or forward contracts and therefore, we do not have
significant market risk exposure with respect to commodity
prices.

Although we transact our business in
U.S. dollars, future fluctuations in the value of the
U.S. dollar may affect the price competitiveness of our
products. However, we do not believe that we currently have any
significant direct foreign currency exchange rate risk and have
not hedged exposures denominated in foreign currencies or any
other derivative financial instruments.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Our financial statements and schedule, as listed
under Item 15, appear in a separate section of this Annual
Report on Form 10-K beginning on page F-1.




Item 9. Changes in and Disagreements
with Accountants on Accounting and Financial
Disclosure

Effective March 7, 2003, we dismissed KPMG
LLP as our independent auditor. Disclosure with respect to this
Item was included in our Definitive Proxy Statement filed on
December 3, 2003. We are not aware of any transactions or
events similar to those previously reported and described in our
prior disclosure with respect to this Item, which were accounted
for or disclosed in a manner different from that which our
former accountants apparently would have concluded was required.




Item 9A.     Controls
and Procedures

(a) Evaluation of Disclosure Controls and
Procedures. As required by Securities and Exchange
Commission Rule 13a-15(b), our Chief Executive Officer and
our Senior Vice President, Chief Financial

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Officer have evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period
covered by this report. Based on their evaluation, our Chief
Executive Officer and our Senior Vice President, Chief Financial
Officer have concluded our disclosure controls and procedures
are not yet effective because we are not currently able to
timely file all reports required to be filed by us pursuant to
Section 15(d) of the Securities Exchange Act of 1934. Our
inability to timely file the required reports is due to, among
other things, the fact that managements time and attention
have been consumed by the auditing and re-auditing of our
financial statements for the years ended December 31, 2000,
2001, 2002 and 2003, and the resulting restatements, by the
development and implementation of improvements to our internal
controls and financial reporting processes, and by the internal
and external investigations into the accounting and other
matters described in Item 1  Recent
Developments and Item 7 
Managements Discussion and Analysis of Financial Condition
and Results of Operations.


Since March 2003, management has implemented and
continues to implement significant changes in organization,
policies and procedures designed to enhance our disclosure
controls and procedures and the related internal controls. These
include, among other measures: new restrictions and guidelines
governing sales personnel, terms and conditions of sale and
revenue recognition; new and more stringent credit approval
policies; new policies governing approval, review and recording
of expenditures and other legal and financial transactions; new
procedures governing documentation and approval of options and
warrants issued in connection with legal and financial
transactions; and new internal reporting procedures.
Nevertheless, during much of 2003, many of these enhancements to
our disclosure controls and procedures and the related internal
controls were not yet in place, or were only partially in place.
For this reason, management has undertaken an extensive and
substantive review and evaluation of all financial transactions
that, individually or collectively, could have a material impact
on the information contained in this Form 10-K. These
review procedures, in combination with the changes in internal
control that have been implemented as of the end of the period
covered by this report, form the basis for our determination
that the financial statements and other information contained in
this report fairly present, in all material respects, our
financial condition, results of operations and cash flows for
the years ended December 31, 2001, 2002 and 2003.

(b) Changes in Internal Controls.
Except as described above in subsection (a) of this
Item 9A, there was no change in our internal control over
financial reporting during our fourth fiscal quarter for 2003
that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required by this Item 10 is
incorporated by reference to the Definitive Proxy Statement
relating to our 2004 Annual Meeting of Stockholders, which is to
be filed within 120 days after the end of our fiscal year
ended December 31, 2003.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this Item 11 is
incorporated by reference to the Definitive Proxy Statement
relating to our 2004 Annual Meeting of Stockholders, which is to
be filed within 120 days after the end of our fiscal year
ended December 31, 2003.




Item 12.                       Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

The information required by this Item 12 is
incorporated by reference to the Definitive Proxy Statement
relating to our 2004 Annual Meeting of Stockholders, which is to
be filed within 120 days after the end of our fiscal year
ended December 31, 2003.

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|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this Item 13 is
incorporated by reference to the Definitive Proxy Statement
relating to our 2004 Annual Meeting of Stockholders, which is to
be filed within 120 days after the end of our fiscal year
ended December 31, 2003.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

The information required by this Item 14 is
incorporated by reference to the Definitive Proxy Statement
relating to our 2004 Annual Meeting of Stockholders, which is to
be filed within 120 days after the end of our fiscal year
ended December 31, 2003.




PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a)(1) Financial Statements:

The consolidated financial statements of
Endocare, Inc. are included in a separate section of this
Annual Report on Form 10-K commencing on the pages
referenced below:

|                                                                                                         |  |      |             | 
|-------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | 
|                                                                                                         |  | Page
|                                                                                                         |  |     
|Consolidated Financial Statements of
    Endocare, Inc.:                                                 |  |      |             | 
|Report of Ernst & Young LLP, Independent
    Auditors                                                    |  |      | F-1         | 
|Consolidated Statements of Operations for the
    Years Ended December 31, 2001, 2002 and 2003           |  |      | F-2         | 
|Consolidated Balance Sheets as of
    December 31, 2002 and 2003                                         |  |      | F-3         | 
|Consolidated Statements of Stockholders
    Equity for the Years Ended December 31, 2001, 2002 and 2003 |  |      | F-4 to F-5  | 
|Consolidated Statements of Cash Flows for the
    Years Ended December 31, 2001, 2002 and 2003           |  |      | F-6 to F-7  | 
|Notes to the Consolidated Financial Statements                                                           |  |      | F-8 to F-37 | 

(2) Financial Statement Schedules:

Schedule II  Valuation and
Qualifying Accounts for the years ended December 31, 2001,
2002 and 2003 is included in the consolidated financial
statements at page F-38. All other schedules have been
omitted because they are not applicable, not required or the
information is included in the consolidated financial statements
or the notes thereto.

(3) Exhibits:

|            |        |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | ------ | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |        | Description
|            |        |            
|            | 2.1(1) |             |  | Agreement and Plan of Reorganization, dated
    February 21, 2002, by and among the Company, Timm Medical
    Technologies, Inc., TMT Acquisition Corporation and certain
    stockholders of Timm Medical Technologies, Inc. Certain
    schedules and other attachments to this exhibit were omitted. We
    agree to furnish supplementally a copy of any omitted schedules
    or attachments to the Commission upon request.
|            | 2.2(2) |             |  | Agreement and Plan of Merger, dated June 30,
    1999, by and among the Company, Advanced Medical
    Procedures, Inc., Advanced Medical Procedures, LLC, Gary M.
    Onik, M.D., Robert F. Byrnes and Jerry Anderson. Schedules
    and other attachments to this exhibit were omitted. We agree to
    furnish supplementally a copy of any omitted schedules or
    attachments to the Commission upon request.               

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|            |            |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | ---------- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 2.3(3)     |             |  | Asset Purchase Agreement, dated February 6,
    2002, by and between the Company and Gary M. Onik, M.D.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                                          
|            | 2.4(3)     |             |  | Asset Purchase Agreement, dated May 28,
    2002, by and among the Company and Cryomedical
    Sciences, Inc. Certain schedules and other attachments to
    this exhibit were omitted. We agree to furnish supplementally a
    copy of any omitted schedules or attachments to the Commission
    upon request.                                                                                                                    
|            | 2.5(4)     |             |  | Partnership and Limited Liability Company
    Membership Interest Purchase Agreement, dated as of
    August 12, 2002, by and among the Company and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C. Certain schedules and other attachments
    to this exhibit were omitted. We agree to furnish supplementally
    a copy of any omitted schedules or attachments to the Commission
    upon request.
|            | 2.6(5)     |             |  | Amendment No. 1 to Partnership and Limited
    Liability Company Membership Interest Purchase Agreement, dated
    as of September 30, 2002, by and among the
    Company, Inc. and U.S. Medical Development, Inc.,
    U.S.M.D., Ltd. and U.S.M.D. I, L.L.C.                                                                                                                                                                        
|            | 2.7(6)     |             |  | Agreement of Purchase and Sale, dated as of
    April 7, 2003, by and among American Medical
    Systems, Inc., the Company and Timm Medical
    Technologies, Inc.                                                                                                                                                                                                                                                                  
|            | 2.8(7)     |             |  | Asset Purchase and Technology License Agreement,
    dated as of April 29, 2003, by and between the Company and
    CryoCath Technologies Inc.                                                                                                                                                                                                                                                                                       
|            | 2.9(8)     |             |  | Agreement of Purchase and Sale, dated as of
    October 15, 2003, by and between SRS Medical Corp. and Timm
    Medical Technologies, Inc.                                                                                                                                                                                                                                                                                           
|            | 3.1(2)     |             |  | Certificate of Amendment of Restated Certificate
    of Incorporation of the Company.                                                                                                                                                                                                                                                                                                                                                
|            | 3.2(2)     |             |  | Certificate of Designation of Series A
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                                                                                                                                                      
|            | 3.3(2)     |             |  | Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                               
|            | 3.4        |             |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                          
|            | 10.3(2)   |             |  | Promissory Note, dated November 2, 1999, by
    Jerry Anderson in favor of the Company.                                                                                                                                                                                                                                                                                                                                              
|            | 10.10(9)   |             |  | Lease Agreement, dated November 26, 2001 by
    and between the Company and the Irvine Company.                                                                                                                                                                                                                                                                                                                                      
|            | 10.11(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its directors.                                                                                                                                                                                                                                                                                                                                                  
|            | 10.12(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its executive officers.                                                                                                                                                                                                                                                                                                                                         
|            | 10.13(10) |             |  | 1995 Director Option Plan (as amended and
    restated through March 2, 1999).                                                                                                                                                                                                                                                                                                                                                       
|            | 10.14(12) |             |  | 1995 Stock Plan (as amended and restated through
    April 16, 2002).                                                                                                                                                                                                                                                                                                                                                                
|            | 10.15(13) |             |  | 2002 Supplemental Stock Plan.                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 10.16(4)   |             |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                   
|            | 10.17(5)   |             |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical
    Development, Inc. to the Company.                                                                                                                                                                                                                                                                                               
|            | 10.18(11)  |             |  | Registration Rights Agreement, dated as of
    February 21, 2002, by and among the Company and the parties
    listed on Schedule A thereto.                                                                                                                                                                                                                                                                                         
|            | 10.19(13)  |             |  | Registration Rights Agreement, dated as of
    May 28, 2002, by and between the Company and Cryomedical
    Sciences, Inc.                                                                                                                                                                                                                                                                                                           
|            | 10.20(13) |             |  | Letter Agreement, dated June 11, 1999, by
    and between the Company and Jerry Anderson                                                                                                                                                                                                                                                                                                                                             
|            | 10.21(13)  |             |  | Blanket Purchase Agreement, effective
    April 1, 2002, by and between Timm Medical
    Technologies, Inc. and the U.S. Department of Veterans
    Affairs.                                                                                                                                                                                                                                                                         
|            | 10.22(13) |             |  | 2002 Executive Separation Benefits Plan.                                                                                                                                                                                                                                                                                                                                                                                             
|            | 10.23(14) |             |  | Employment Agreement, dated as of March 3,
    2003, by and between the Company and William J. Nydam.                                                                                                                                                                                                                                                                                                                                

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|            |            |             |  |                                                                                                                                     
|----------- | ---------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 10.24(14) |             |  | Employment Agreement, dated as of March 25,
    2003, by and between the Company and Katherine Greenberg.                           
|            | 10.25     |             |  | Employment Agreement, dated as of March 25,
    2003, by and between the Company and Kevin Quilty.                                  
|            | 10.26     |             |  | First Amendment to Employment Agreement, dated as
    of September 14, 2003, by and between the Company and
    Katherine Greenberg.
|            | 10.27      |             |  | Consulting Agreement, dated as of August 27,
    2003, by and between the Company and Craig T. Davenport.                           
|            | 10.28(15) |             |  | Employment Agreement, dated as of
    December 15, 2003, by and between the Company and Craig T.
    Davenport.                     
|            | 21.1       |             |  | Subsidiaries of Registrant.                                                                                                         
|            | 23.1       |             |  | Consent of Ernst & Young
    LLP, Independent Auditors.                                                                             
|            | 24.1       |             |  | Power of Attorney, included on signature pages.                                                                                     
|            | 31.1       |             |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                       
|            | 31.2       |             |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                      
|            | 32.1       |             |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                       
|            | 32.2       |             |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                      



---



| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| | * | We have requested confidential treatment with
    respect to certain portions of these documents.



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | Management contract or compensatory plan or
    arrangement



| |     |                                                                                                                       
| | --- | ----------------------------------------------------------------------------------------------------------------------
| | (1) | Previously filed on Form 8-K on
    March 5, 2002.                                                                    
|
| | (2) | Previously filed with our Registration Statement
    on Form S-3 filed on September 20, 2001 and
    October 31, 2001.
|
| | (3) | Previously filed on Form 10-Q for the
    quarter ended June 30, 2002.                                                
|
| | (4) | Previously filed on Form 8-K on
    August 16, 2002.                                                                  
|
| | (5) | Previously filed on Form 8-K on
    October 15, 2002.                                                                 
|
| | (6) | Previously filed on Form 8-K on
    April 22, 2003.                                                                   
|
| | (7) | Previously filed on Form 8-K on
    April 29, 2003.                                                                   
|
| | (8) | Previously filed on Form 8-K on
    October 20, 2003.                                                                 
|
| | (9) | Previously filed on Form 10-K for the year
    ended December 31, 2001.                                               



|     |                                                                                                                  
|---- | -----------------------------------------------------------------------------------------------------------------
|(10) | Previously filed with our Registration Statement
    on Form S-8 filed on June 2, 1999.                          
|    
|(11) | Previously filed with our Registration Statement
    on Form S-3 filed on May 15, 2002.                          
|    
|(12) | Previously filed with our definitive proxy
    statement for the 2002 annual meeting filed on April 30,
    2002.
|    
|(13) | Previously filed on Form 10-K for the year
    ended December 31, 2002.                                          
|    
|(14) | Previously filed on Form 8-K on
    March 27, 2003.                                                              
|    
|(15) | Previously filed on Form 8-K on
    December 16, 2003.                                                           

(b) Reports on Form 8-K

We filed a Form 8-K under Item 5 on
October 20, 2003, announcing that: (i) we had sold our
urodynamics and urinary incontinence product lines to SRS
Medical Corp; and (ii) a Delaware Court of Chancery had
ruled that we must pay Biolife Solutions, Inc., formerly
Cryomedical Sciences (BioLife), $1.6 million in
damages plus accrued interest and legal fees to settle a dispute
that resulted from our acquisition of the cryosurgical
technology and assets of BioLife.

We filed a Form 8-K under Item 5 on
December 16, 2003, announcing the appointment of Craig T.
Davenport as our new Chief Executive Officer, effective
December 15, 2003.

56



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Supplemental Information

We have not sent an annual report or proxy
materials to our stockholders as of the date of this Annual
Report on Form 10-K. We intend to provide our stockholders
with an annual report and proxy materials after the filing of
this Annual Report on Form 10-K, and we will furnish the
annual report to the SEC at that time.

57



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SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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.

|                     |  |                |  |                                                                                                        
|-------------------- |  | -------------- |  | -------------------------------------------------------------------------------------------------------
|                     |  | ENDOCARE, INC.
|                    
|Date: March 15, 2004 |  | By:            |  | /s/ CRAIG T. DAVENPORT
    ------------------------------
    Craig T. DavenportChief Executive Officer

POWER OF ATTORNEY

Know all men by these present, that each person
whose signature appears below constitutes and appoints Craig T.
Davenport and Katherine Greenberg, and each or any one of them,
his true and lawful attorney-in-fact and agent, with full power
of substitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith,
with the SEC, granting unto said attorneys-in-fact and agents,
and each of them, full power and authority to do and perform
each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as
he might or could do in person, hereby ratifying and confirming
all that said attorneys-in-fact and agent, or any of them, or
their or his substitutes or substitute, may lawfully do or cause
to be done by virtue hereof.

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

|                                               |  |                                                                                                        |  |                |  | 
|---------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ |  | -------------- |  | 
|                                               |  |                                                                                                        |  |               
|Signature                                      |  | Title                                                                                                  |  | Date          
|                                               |  |                                                                                                        |  |               
|                                              
|/s/ CRAIG T. DAVENPORTCraig T. Davenport       |  | Chairman and Chief Executive Officer
    (principal executive officer)                                 |  | March 15, 2004
|                                              
|/s/ KATHERINE GREENBERGKatherine Greenberg     |  | Senior Vice President and Chief Financial
    Officer
    (principal financial and accounting officer) |  | March 15, 2004
|                                              
|/s/ ROBERT F. BYRNESRobert F. Byrnes           |  | Director                                                                                               |  | March 15, 2004
|                                              
|/s/ JOHN R. DANIELS, M.D.John R. Daniels, M.D. |  | Director                                                                                               |  | March 15, 2004
|                                              
|/s/ RONALD A. MATRICARIARonald A. Matricaria   |  | Director (lead director)                                                                               |  | March 15, 2004
|                                              
|/s/ TERRENCE A. NOONANTerrence A. Noonan       |  | Director                                                                                               |  | March 15, 2004

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|                                                     |  |          |  |                |  | 
|---------------------------------------------------- |  | -------- |  | -------------- |  | 
|                                                     |  |          |  |               
|Signature                                            |  | Title    |  | Date          
|                                                     |  |          |  |               
|                                                    
|/s/ MICHAEL J. STRAUSS, M.D.Michael J. Strauss, M.D. |  | Director |  | March 15, 2004
|                                                    
|/s/ THOMAS R. TESTMANThomas R. Testman               |  | Director |  | March 15, 2004

59



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REPORT OF ERNST & YOUNG
LLP, INDEPENDENT AUDITORS

To the Board of Directors

Endocare, Inc.


We have audited the accompanying consolidated
balance sheets of Endocare, Inc. (the Company) and
subsidiaries as of December 31, 2002 and 2003, and the
related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2003. Our audits
also included the financial statement schedule listed in the
Index at Item 15(a). These financial statements and
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Endocare, Inc. and
subsidiaries at December 31, 2002 and 2003, and the
consolidated results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles
generally accepted in the United States. Also in our opinion,
the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

Los Angeles, California

March 10, 2004


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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |            |            | 
|---------------------------------------------------------- | ------------------------------------- | ------------------------ | ----------- | ---------- | ---------- | ---- | ----------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | 
|                                                           |                                       |                         
|                                                           |                                       | Years Ended December 31 
|                                                           |                                       |                         
|                                                           |                                       | 2001                     |             | 2002       |            | 2003
|                                                           |                                       |                          |             |            |            |     
|Total revenues                                             |                                       | $                        | 13,036,566  |            |            | $    | 30,916,425  |            |            | $ | 30,497,177  |           
|Costs and expenses:                                        |                                       |                          |             |            |            |      |             |            |            |   |             |           
|                                                           | Cost of revenues                      |                          |             | 6,208,258  |            |      |             | 16,484,396 |            |   |             | 16,057,526 |           
|                                                           | Research and development              |                          |             | 2,543,557  |            |      |             | 2,899,866  |            |   |             | 1,257,620  |           
|                                                           | Selling, general and administrative   |                          |             | 15,728,183 |            |      |             | 33,769,442 |            |   |             | 47,189,348 |           
|                                                           | Goodwill impairment and other charges |                          |             |           |            |      |             | 20,311,293 |            |   |             |           |           
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|                                                           |                                       | Total costs and expenses |             |            | 24,479,998 |      |             |            | 73,464,997 |   |             |            | 64,504,494 | 
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Loss from operations                                       |                                       |                          | (11,443,432 | )          |            |      | (42,548,572 | )          |            |   | (34,007,317 | )         
|Gain on divestitures, net                                  |                                       |                          |            |            |            |      |            |            |            |   | 8,630,890   |           
|Loss on minority investment                                |                                       |                          | (250,000    | )          |            |      |            |            |            |   |            |           
|Interest income                                            |                                       |                          | 771,982     |            |            |      | 1,013,343   |            |            |   | 587,556     |           
|Interest expense                                           |                                       |                          | (531,028    | )          |            |      | (6,839      | )          |            |   | (39,531     | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Loss before minority interests                             |                                       |                          | (11,452,478 | )          |            |      | (41,542,068 | )          |            |   | (24,828,402 | )         
|Minority interests                                         |                                       |                          |            |            |            |      | (443,678    | )          |            |   | (618,900    | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Net loss                                                   |                                       | $                        | (11,452,478 | )          |            | $    | (41,985,746 | )          |            | $ | (25,447,302 | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Net loss per share of common stock 
    basic and diluted |                                       | $                        | (0.68       | )          |            | $    | (1.76       | )          |            | $ | (1.05       | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Weighted-average shares of common stock
    outstanding    |                                       |                          | 16,741,000  |            |            |      | 23,822,000  |            |            |   | 24,162,090  |           
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           

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

F-2



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |              |            | 
|---------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ---------- | ----------- | ---------- |  | ---------- | ------------ | ---------- | 
|                                         |                                                                                                                                                                              |                                           
|                                         |                                                                                                                                                                              | December 31                               
|                                         |                                                                                                                                                                              |                                           
|                                         |                                                                                                                                                                              | 2002                                       |            | 2003       
|                                         |                                                                                                                                                                              |                                            |            |            
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         | Cash and cash equivalents                                                                                                                                                    |                                            | $          | 18,177,825  |            |  | $          | 23,976,539   |           
|                                         | Available-for-sale securities                                                                                                                                                |                                            |            | 22,183,160  |            |  |            |             |           
|                                         | Accounts receivable less allowances for doubtful
    accounts and sales returns of $2,226,432 and $2,431,835 at
    December 31, 2002 and 2003, respectively                 |                                            |            | 4,604,576   |            |  |            | 3,822,570    |           
|                                         | Inventories                                                                                                                                                                  |                                            |            | 4,491,642   |            |  |            | 2,609,046    |           
|                                         | Prepaid expenses and other current assets                                                                                                                                    |                                            |            | 640,758     |            |  |            | 4,432,578    |           
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         |                                                                                                                                                                              | Total current assets                       |            |             | 50,097,961 |  |            |              | 34,840,733 | 
|Property and equipment, net              |                                                                                                                                                                              |                                            | 8,244,693  |             |            |  | 5,638,579  |             
|Goodwill                                 |                                                                                                                                                                              |                                            | 17,538,224 |             |            |  | 17,538,224 |             
|Intangibles, net                         |                                                                                                                                                                              |                                            | 15,763,323 |             |            |  | 11,745,778 |             
|Investments and other assets             |                                                                                                                                                                              |                                            | 983,754    |             |            |  | 2,233,601  |             
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         |                                                                                                                                                                              | Total assets                               |            | $           | 92,627,955 |  |            | $            | 71,996,915 | 
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         | Accounts payable                                                                                                                                                             |                                            | $          | 2,932,439   |            |  | $          | 3,035,242    |           
|                                         | Accrued compensation                                                                                                                                                         |                                            |            | 2,816,320   |            |  |            | 3,858,527    |           
|                                         | Other accrued liabilities                                                                                                                                                    |                                            |            | 7,327,703   |            |  |            | 8,942,830    |           
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         |                                                                                                                                                                              | Total current liabilities                  |            |             | 13,076,462 |  |            |              | 15,836,599 | 
|Minority interests                       |                                                                                                                                                                              |                                            | 928,741    |             |            |  | 839,029    |             
|Stockholders equity:                    |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         | Preferred stock, $.001 par value;
    1,000,000 shares authorized; none issued and outstanding                                                                               |                                            |            |            |            |  |            |             |           
|                                         | Common stock, $.001 par value;
    50,000,000 shares authorized; 24,148,254 and
    24,183,254 shares issued and outstanding at
    December 31, 2002 and 2003, respectively |                                            |            | 24,350      |            |  |            | 24,390       |           
|                                         | Additional paid-in capital                                                                                                                                                   |                                            |            | 169,935,487 |            |  |            | 171,875,434  |           
|                                         | Accumulated deficit                                                                                                                                                          |                                            |            | (88,931,583 | )          |  |            | (114,378,885 | )         
|                                         | Receivable from stockholder                                                                                                                                                  |                                            |            | (214,292    | )          |  |            |             |           
|                                         | Accumulated other comprehensive income, net of tax                                                                                                                           |                                            |            | 12,466      |            |  |            |             |           
|                                         | Deferred compensation                                                                                                                                                        |                                            |            | (132,045    | )          |  |            | (107,271     | )         
|                                         | Treasury stock at cost, 201,200 and
    206,200 shares at December 31, 2002 and 2003,
    respectively                                                                       |                                            |            | (2,071,631  | )          |  |            | (2,092,381   | )         
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         |                                                                                                                                                                              | Total stockholders equity                 |            |             | 78,622,752 |  |            |              | 55,321,287 | 
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             
|                                         |                                                                                                                                                                              | Total liabilities and stockholders equity |            | $           | 92,627,955 |  |            | $            | 71,996,915 | 
|                                         |                                                                                                                                                                              |                                            |            |             |            |  |            |             

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

F-3



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY (DEFICIENCY)

|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |                |   |              |          |   |  |   |        |        |  |   |          |   |  |   |         |   |  |   |             |             |  
|---------------------------------------------------------------------------------------- | --------------------------------------------------------- | ------------ | ---------- | ---------- |  | --------------- | ------ | --------------- |  | ------------- | ----------- | ----------- |  | ------------ | ----------- | -------------- | - | ------------ | -------- | - |  | - | ------ | ------ |  | - | -------- | - |  | - | ------- | - |  | - | ----------- | ----------- | -
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             | Accumulated |  |              |             |                |   |             
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  | Other         |             |             |  |              |             | Total         
|                                                                                         |                                                           | Common Stock |            |            |  |                 |        |                 |  | Comprehensive |             |             |  |              |             | Stockholders 
|                                                                                         |                                                           |              |            | Additional |  | Accumulated     |        | Receivable From |  | Income, Net   |             | Deferred    |  |              |             | Equity        
|                                                                                         |                                                           | Shares       |            | Capital    |  | Paid-In Capital |        | Deficit         |  | Stockholder   |             | of Tax      |  | Compensation |             | Treasury Stock |   | (Deficiency)
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |                |   |             
|Balance at December 31, 2000                                                             |                                                           |              | 14,991,649 |            |  | $               | 15,019 |                 |  | $             | 52,139,306  |             |  | $            | (35,493,359 | )              |   | $            | (728,292 | ) |  | $ |       |        |  | $ |         |   |  | $ | (61,410 | ) |  | $ | 15,871,264  |            
|Net loss                                                                                 |                                                           |              |           |            |  |                 |       |                 |  |               |            |             |  |              | (11,452,478 | )              |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | (11,452,478 | )          
|Secondary offering of common stock, net                                                  |                                                           |              | 4,600,000  |            |  |                 | 4,600  |                 |  |               | 72,573,737  |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 72,578,337  |            
|Conversion of convertible debentures and accrued
    interest, net                       |                                                           |              | 1,128,733  |            |  |                 | 1,129  |                 |  |               | 7,240,512   |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 7,241,641   |            
|Common stock issued in exchange for investment                                           |                                                           |              | 213,010    |            |  |                 | 213    |                 |  |               | 2,837,080   |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 2,837,293   |            
|Common stock issued for patents                                                          |                                                           |              | 20,921     |            |  |                 | 21     |                 |  |               | 149,979     |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 150,000     |            
|Common stock issued, other                                                               |                                                           |              | 20,883     |            |  |                 | 21     |                 |  |               | 73,144      |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 73,165      |            
|Stock options and warrants exercised                                                     |                                                           |              | 1,076,630  |            |  |                 | 1,076  |                 |  |               | 2,550,241   |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 2,551,317   |            
|Compensation related to issuance of options and
    warrants to consultants for services |                                                           |              |           |            |  |                 |       |                 |  |               | 773,027     |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 773,027     |            
|Forgiveness of receivable from stockholder                                               |                                                           |              |           |            |  |                 |       |                 |  |               |            |             |  |              |            |                |   |              | 257,000  |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 257,000     |            
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |                |   |              |          |   |  |   |        |        |  |   |          |   |  |   |         |   |  |   |             |            
|Balance at December 31, 2001                                                             |                                                           |              | 22,051,826 |            |  |                 | 22,079 |                 |  |               | 138,337,026 |             |  |              | (46,945,837 | )              |   |              | (471,292 | ) |  |   |       |        |  |   |         |   |  |   | (61,410 | ) |  |   | 90,880,566  |            
|Comprehensive income (loss):                                                             |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |                |   |              |          |   |  |   |        |        |  |   |          |   |  |   |         |   |  |   |             |            
|                                                                                         | Net loss                                                  |              |            |           |  |                 |        |                |  |               |             |            |  |              |             | (41,985,746    | ) |              |          |  |  |   |        |       |  |   |          |  |  |   |         |  |  |   |             | (41,985,746 | )
|                                                                                         | Unrealized gain on available-for-sale securities,
    net |              |            |           |  |                 |        |                |  |               |             |            |  |              |             |               |   |              |          |  |  |   |        | 12,466 |  |   |          |  |  |   |         |  |  |   |             | 12,466      |  
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |                |   |              |          |   |  |   |        |        |  |   |          |   |  |   |         |   |  |   |             |            
|Comprehensive income (loss)                                                              |                                                           |              |           |            |  |                 |       |                 |  |               |            |             |  |              | (41,985,746 | )              |   |              |         |   |  |   | 12,466 |        |  |   |         |   |  |   |        |   |  |   | (41,973,280 | )          
|Common stock issued and options assumed in Timm
    Medical acquisition                  |                                                           |              | 1,620,530  |            |  |                 | 1,621  |                 |  |               | 25,739,507  |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   | (165,114 | ) |  |   |        |   |  |   | 25,576,014  |            
|Common stock issued for patents and covenant not
    to compete                          |                                                           |              | 220,022    |            |  |                 | 220    |                 |  |               | 3,256,919   |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 3,257,139   |            
|Stock options and warrants exercised                                                     |                                                           |              | 430,076    |            |  |                 | 430    |                 |  |               | 2,033,128   |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 2,033,558   |            
|Amortization of options issued to employees                                              |                                                           |              |           |            |  |                 |       |                 |  |               |            |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   | 33,069   |   |  |   |        |   |  |   | 33,069      |            
|Compensation related to issuance of options and
    warrants to consultants for services |                                                           |              |           |            |  |                 |       |                 |  |               | 568,907     |             |  |              |            |                |   |              |         |   |  |   |       |        |  |   |         |   |  |   |        |   |  |   | 568,907     |            

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY (DEFICIENCY)  (Continued)

|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |             |  
|---------------------------------------------------------------------------------------- | --------------------------------------------------------- | ------------ | ---------- | ---------- |  | --------------- | ------ | --------------- |  | ------------- | ----------- | ----------- |  | ------------ | ------------ | -------------- | - | ------------ | -------- | ------- |  | - | ------- | ------- | - | - | -------- | - |  | - | ---------- | - |  | - | ----------- | ----------- | -
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             | Accumulated |  |              |              |                |   |             
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  | Other         |             |             |  |              |              | Total         
|                                                                                         |                                                           | Common Stock |            |            |  |                 |        |                 |  | Comprehensive |             |             |  |              |              | Stockholders 
|                                                                                         |                                                           |              |            | Additional |  | Accumulated     |        | Receivable From |  | Income, Net   |             | Deferred    |  |              |              | Equity        
|                                                                                         |                                                           | Shares       |            | Capital    |  | Paid-In Capital |        | Deficit         |  | Stockholder   |             | of Tax      |  | Compensation |              | Treasury Stock |   | (Deficiency)
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |             
|Repurchase of treasury stock                                                             |                                                           |              | (174,200   | )          |  |                 |       |                 |  |               |            |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   |         |   |  |   | (2,010,221 | ) |  |   | (2,010,221  | )          
|                                                                                         | Forgiveness of receivable from stockholder                |              |            |           |  |                 |        |                |  |               |             |            |  |              |              |               |   |              |          | 257,000 |  |   |         |        |   |   |          |  |  |   |            |  |  |   |             | 257,000     |  
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |            
|Balance at December 31, 2002                                                             |                                                           |              | 24,148,254 |            |  |                 | 24,350 |                 |  |               | 169,935,487 |             |  |              | (88,931,583  | )              |   |              | (214,292 | )       |  |   | 12,466  |         |   |   | (132,045 | ) |  |   | (2,071,631 | ) |  |   | 78,622,752  |            
|Comprehensive income (loss)                                                              |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |            
|                                                                                         | Net loss                                                  |              |            |           |  |                 |        |                |  |               |             |            |  |              |              | (25,447,302    | ) |              |          |        |  |   |         |        |   |   |          |  |  |   |            |  |  |   |             | (25,447,302 | )
|                                                                                         | Unrealized gain on available for-sale securities,
    net |              |            |           |  |                 |        |                |  |               |             |            |  |              |              |               |   |              |          |        |  |   |         | (12,466 | ) |   |          |  |  |   |            |  |  |   |             | (12,466     | )
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |            
|Comprehensive loss:                                                                      |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              | (25,447,302  | )              |   |              |         |         |  |   | (12,466 | )       |   |   |         |   |  |   |           |   |  |   | (25,459,768 | )          
|Stock options exercised                                                                  |                                                           |              | 35,000     |            |  |                 | 35     |                 |  |               | 22,777      |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   |         |   |  |   |           |   |  |   | 22,812      |            
|Issuance of restricted stock                                                             |                                                           |              | 5,000      |            |  |                 | 5      |                 |  |               | 19,995      |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   |         |   |  |   |           |   |  |   | 20,000      |            
|Compensation related to issuance of options to
    employees                             |                                                           |              |           |            |  |                 |       |                 |  |               | 1,780,322   |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   | 24,774   |   |  |   |            |   |  |   | 1,805,096   |            
|Compensation related to issuance of options and
    warrants to consultants for services |                                                           |              |           |            |  |                 |       |                 |  |               | 116,853     |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   |         |   |  |   |           |   |  |   | 116,853     |            
|Treasury stock received as repayment of loan
    previously forgiven                     |                                                           |              | (5,000     | )          |  |                 |       |                 |  |               |            |             |  |              |             |                |   |              |         |         |  |   |        |         |   |   |         |   |  |   | (20,750    | ) |  |   | (20,750     | )          
|Forgiveness of receivable from stockholder                                               |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              | (214,292 | )       |  |   |         |         |   |   |          |   |  |   |            |   |  |   | 214,292     |            
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |            
|Balance at December 31, 2003                                                             |                                                           |              | 24,183,254 |            |  | $               | 24,390 |                 |  | $             | 171,875,434 |             |  | $            | (114,378,885 | )              |   | $            |         |         |  | $ |        |         |   | $ | (107,271 | ) |  | $ | (2,092,381 | ) |  | $ | 55,321,287  |            
|                                                                                         |                                                           |              |            |            |  |                 |        |                 |  |               |             |             |  |              |              |                |   |              |          |         |  |   |         |         |   |   |          |   |  |   |            |   |  |   |             |            

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

F-5



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                        |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |             |            |  
|------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ----------------------------------------- | ----------- | ----------- | ---------- | ---- | ----------- | ----------- | ---------- | - | ----------- | ----------- | ---------- | -
|                                                        |                                                                                                  |                                          
|                                                        |                                                                                                  | For the Years Ended December 31          
|                                                        |                                                                                                  |                                          
|                                                        |                                                                                                  | 2001                                      |             | 2002        |            | 2003
|                                                        |                                                                                                  |                                           |             |             |            |     
|Cash flows from operating activities:                   |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            
|                                                        | Net loss                                                                                         |                                           | $           | (11,452,478 | )          |      | $           | (41,985,746 | )          |   | $           | (25,447,302 | )         
|                                                        | Adjustments to reconcile net loss to net cash
    used in operating activities                   |                                           |             |             |            |      |             |             |            |   |             |             |           
|                                                        | Depreciation and amortization                                                                    |                                           |             | 716,336     |            |      |             | 3,095,472   |            |   |             | 4,668,701   |           
|                                                        | Gain on sale of marketable securities                                                            |                                           |             |            |            |      |             |            |            |   |             | (12,466     | )         
|                                                        | Gain on divestitures, net                                                                        |                                           |             |            |            |      |             |            |            |   |             | (8,630,890  | )         
|                                                        | Compensation expense related to issuance of
    options, warrants and restricted stock           |                                           |             | 773,027     |            |      |             | 601,976     |            |   |             | 1,941,949   |           
|                                                        | Treasury stock received as repayment of loan
    previously forgiven                             |                                           |             |            |            |      |             |            |            |   |             | (20,750     | )         
|                                                        | Goodwill impairment and other charges                                                            |                                           |             |            |            |      |             | 20,311,293  |            |   |             |            |           
|                                                        | Loss on minority investment                                                                      |                                           |             | 250,000     |            |      |             |            |            |   |             |            |           
|                                                        | Minority interests                                                                               |                                           |             |            |            |      |             | 443,678     |            |   |             | 618,900     |           
|                                                        | Forgiveness of receivable from stockholder                                                       |                                           |             | 257,000     |            |      |             | 257,000     |            |   |             | 214,292     |           
|                                                        | Amortization of deferred financing costs                                                         |                                           |             | 229,847     |            |      |             |            |            |   |             |            |           
|                                                        | Common stock issued for interest payable                                                         |                                           |             | 143,337     |            |      |             |            |            |   |             |            |           
|                                                        | Changes in operating assets and liabilities, net
    of effects from purchases and divestitures: |                                           |             |             |            |      |             |             |            |   |             |             |           
|                                                        |                                                                                                  | Accounts receivable                       |             |             | (2,770,285 | )    |             |             | 1,366,069  |   |             |             | 932,006    |  
|                                                        |                                                                                                  | Inventories                               |             |             | (808,885   | )    |             |             | (3,508,305 | ) |             |             | 643,752    |  
|                                                        |                                                                                                  | Prepaid expenses and other current assets |             |             | (163,842   | )    |             |             | (198,366   | ) |             |             | (1,291,873 | )
|                                                        |                                                                                                  | Accounts payable                          |             |             | (437,547   | )    |             |             | 76,123     |   |             |             | 102,803    |  
|                                                        |                                                                                                  | Accrued compensation                      |             |             | (88,961    | )    |             |             | 422,608    |   |             |             | 1,042,207  |  
|                                                        |                                                                                                  | Other accrued liabilities                 |             |             | 58,758     |      |             |             | 4,255,072  |   |             |             | 1,615,127  |  
|                                                        |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            
|Net cash used in operating activities                   |                                                                                                  |                                           | (13,293,693 | )           |            |      | (14,863,126 | )           |            |   | (23,623,544 | )          
|                                                        |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            
|Cash flows from investing activities:                   |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            
|                                                        | Acquisitions, net of cash acquired                                                               |                                           |             |            |            |      |             | (24,092,497 | )          |   |             |            |           
|                                                        | Purchases of property and equipment                                                              |                                           |             | (672,738    | )          |      |             | (2,075,575  | )          |   |             | (276,385    | )         
|                                                        | Intangibles                                                                                      |                                           |             | (50,339     | )          |      |             |            |            |   |             | (28,924     | )         
|                                                        | Loan made to investee                                                                            |                                           |             | (250,000    | )          |      |             |            |            |   |             |            |           
|                                                        | Repayment of loan made to investee                                                               |                                           |             | 250,000     |            |      |             |            |            |   |             |            |           
|                                                        | Partnership distributions to minority interests                                                  |                                           |             |            |            |      |             | (776,532    | )          |   |             | (708,558    | )         
|                                                        | Sale (purchase) of available-for-sale
    securities                                             |                                           |             |            |            |      |             | (22,170,694 | )          |   |             | 22,183,160  |           
|                                                        | Other assets                                                                                     |                                           |             | (241,428    | )          |      |             | 246,111     |            |   |             | (1,249,847  | )         
|                                                        |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            
|Net cash (used in) provided by investing
    activities |                                                                                                  |                                           | (964,505    | )           |            |      | (48,869,187 | )           |            |   | 19,919,446  |            
|                                                        |                                                                                                  |                                           |             |             |            |      |             |             |            |   |             |            

F-6



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH
FLOWS  (Continued)

|                                                         |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |           | 
|-------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------- | ---------- | ---------- | - | ---- | ----------- | ---------- | - | - | ---------- | --------- | 
|                                                         |                                                                                                                                                             |                                
|                                                         |                                                                                                                                                             | For the Years Ended December 31
|                                                         |                                                                                                                                                             |                                
|                                                         |                                                                                                                                                             | 2001                            |            | 2002       |   | 2003
|                                                         |                                                                                                                                                             |                                 |            |            |   |     
|Cash flows from financing activities:                    |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|                                                         | Payments made on credit facility and other debt                                                                                                             |                                 |            | (1,074,268 | ) |      |             |           |   |   |            |          | 
|                                                         | Proceeds from secondary offering                                                                                                                            |                                 |            | 72,578,337 |   |      |             |           |   |   |            |          | 
|                                                         | Proceeds from other issuance of common stock                                                                                                                |                                 |            | 73,165     |   |      |             |           |   |   |            |          | 
|                                                         | Stock options and warrants exercised                                                                                                                        |                                 |            | 2,551,317  |   |      |             | 2,033,558  |   |   |            | 22,812    | 
|                                                         | Repurchase of treasury stock                                                                                                                                |                                 |            |           |   |      |             | (2,010,221 | ) |   |            |          | 
|                                                         | Proceeds from divestitures                                                                                                                                  |                                 |            |           |   |      |             |           |   |   |            | 9,480,000 | 
|                                                         |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|Net cash provided by financing activities                |                                                                                                                                                             |                                 | 74,128,551 |            |   |      | 23,337      |            |   |   | 9,502,812  |          
|                                                         |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|Net increase (decrease) in cash and cash
    equivalents |                                                                                                                                                             |                                 | 59,870,353 |            |   |      | (63,708,976 | )          |   |   | 5,798,714  |          
|Cash and cash equivalents, beginning of year             |                                                                                                                                                             |                                 | 22,016,448 |            |   |      | 81,886,801  |            |   |   | 18,177,825 |          
|                                                         |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|Cash and cash equivalents, end of year                   |                                                                                                                                                             | $                               | 81,886,801 |            |   | $    | 18,177,825  |            |   | $ | 23,976,539 |          
|                                                         |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|Noncash activities:                                      |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|                                                         | Convertible debentures and accrued interest
    converted to common stock, net of unamortized deferred financing
    costs of $458,694 at December 31, 2001 |                                 | $          | 7,241,641  |   |      | $           |           |   |   | $          |          | 
|                                                         | Transfer of inventory to property and equipment
    for placement at customer sites                                                                         |                                 |            | 10,251     |   |      |             | 2,902,184  |   |   |            | 505,454   | 
|                                                         | Common stock exchanged for investment in
    U.S. Medical Development, Inc.                                                                                 |                                 |            | 2,837,293  |   |      |             |           |   |   |            |          | 
|                                                         | Common stock issued and options assumed in the
    acquisition of Timm Medical                                                                              |                                 |            |           |   |      |             | 25,741,128 |   |   |            |          | 
|                                                         | Common stock issued for patents and covenant not
    to compete                                                                                             |                                 |            | 150,000    |   |      |             | 3,257,139  |   |   |            |          | 
|                                                         | Change in unrealized gain on available-for-sale
    securities                                                                                              |                                 |            |           |   |      |             | 12,466     |   |   |            |          | 
|Other supplemental information:                          |                                                                                                                                                             |                                 |            |            |   |      |             |            |   |   |            |          
|                                                         | Interest paid                                                                                                                                               |                                 |            | 776,055    |   |      |             |           |   |   |            | 39,530    | 
|                                                         | Income taxes paid                                                                                                                                           |                                 |            | 1,600      |   |      |             | 1,600      |   |   |            | 1,600     | 

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

F-7



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                               
|-- | ----------------------------------------------
|1. | Organization and Operations of the
    Company

Endocare, Inc. (Endocare or the
Company) is a medical device company focused on
developing, manufacturing and selling cryosurgical products with
the potential to improve the treatment of cancer and other
tumors, and on manufacturing and marketing vacuum technology as
a non-pharmacological option for treatment of erectile
dysfunction. The Company was formed in 1990 as a research and
development division of Medstone International, Inc., a
manufacturer of shockwave lythotripsy equipment for the
treatment of kidney stones. Following its incorporation under
the laws of the state of Delaware in 1994, the Company became an
independent, publicly owned corporation upon Medstones
distribution of the Companys stock to the existing
stockholders on January 1, 1996.

The Company initially concentrated on developing
devices for the treatment of prostate cancer. The Company
commenced sales of its Food and Drug Administration, or
FDA-approved Cryocare Surgical System (System) in the United
States in 1999. Because of the Companys initial
concentration on prostate cancer, a majority of its sales and
marketing resources are directed towards the promotion of its
cryoablation technology to urologists for the treatment of
prostate and renal cancer. The Company is also expanding its
focus across a number of surgical markets, including the
ablation of tumors in the kidney, lung and liver, as well as for
pain management in patients with metastatic bone cancer.
Accordingly, Endocare recently formed a new sales and marketing
group to focus on the radiology market where its products can be
used to treat these other cancer sites.

Endocare primarily markets and sells its
cryosurgical products and services directly to hospitals and
other providers of healthcare services. Internationally, the
Company markets its products through distributors and other
third parties. Endocare also contracts with third-party payors
in the United States for the use of its Cryocare Surgical
Systems in cryoablation treatments for prostate diseases on a
per-procedure fee basis.

In addition, the Company offers the ErecAid line
of vacuum therapy systems, which include the ErecAid Classic
system, and ErecAid Esteem system for non-pharmaceutical
treatment of erectile dysfunction. The Company acquired these
product lines in the first quarter of 2002 through the
acquisition of Timm Medical Technologies, Inc. (Timm
Medical), a provider of a variety of urological products.
Several of these product lines were divested during 2003,
including the urological prostheses product line and certain
products used in the diagnosis and treatment of erectile
dysfunction, urinary incontinence and benign prostatic
hyperplasia (BPH). This acquisition has allowed the
Company to expand its sales and marketing organization and to
increase market access to urologists for its cryoablation and
penile rehabilitation technologies (see Note 4).

Recent Operating Results and
Liquidity

The Companys 2003 operating results
included divestiture of non-core lines of business allowing it
to better concentrate on its core businesses. At the same time,
divestiture of these lines reduced or eliminated some sources of
revenue and gross profit for the Company. In addition, while the
Company lowered research and development costs in 2003, and
consolidated functions formerly performed by subsidiaries at the
Companys Irvine, California headquarters, the Company also
incurred significant one-time charges associated with the
ongoing investigations related to its historical accounting and
financial reporting. The net result of the Companys
activities in 2003 was a $25,447,000 loss. Significant factors
contributing to the 2003 operating results were as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Costs of $14,255,000 incurred in connection with
    on-going regulatory investigations of our historical accounting
    and financial reporting, including $5,057,000 in attorneys
    fees and settlement costs, $4,000,000 in accounting and audit
    fees for re-audits and restatements of the 2000, 2001 and audit
    of 2002 financial statements, $1,630,000 in financial consulting
    and staffing support and $3,568,000 in severance payments mainly
    due to the former CEO and CFO;

F-8



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |   |                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Incremental sales and marketing investments to
    gain market share in the urology market and to advance the use
    of our cryosurgical technology in the interventional radiology
    market;                                                                                         
|
| |  | Net gains on divestitures of $8,631,000 in
    connection with sales of the intellectual property and inventory
    related to the SurgiFrost cardiac arrhythmia products, the
    Dura II penile prosthesis and the urinary incontinence line
    which partially reduced the 2003 loss.

Since inception, the Company has incurred losses
from operations and has reported negative cash flows. As of
December 31, 2003, the Company had an accumulated deficit
of $114,379,000, and cash and cash equivalents of $23,977,000.
The Company has no long-term debt and no other material
financial commitments other than those under operating lease
agreements and purchase commitments for raw materials used in
manufacturing its products. Management anticipates further
growth in procedure revenues in 2004 (42.3% growth was
experienced in 2003 as compared to 2002). However, the Company
expects to record another loss in 2004. The Company will
continue to invest in sales and marketing activities to increase
market penetration, and research and development to improve its
existing products and develop new ones. The Company also faces
potentially large costs related to directors and
officers liability insurance, delinquent state and local
taxes, as well as expenditures needed to bring the Company into
compliance with SEC rules and regulations, including with
Section 404 of Sarbanes-Oxley Act of 2002, and efforts to
regain its listing on Nasdaq.

In addition to the cash needed to fund the
Companys ongoing operations, there have been and will
continue to be substantial demands on cash related to ongoing
investigations of the Companys historical accounting and
financial reporting. There may also be material cash payments
required in connection with resolving a class action and a
derivative lawsuit (see Note 12). The Company may be
required to pay judgments or settlements and to incur expenses
in defending against these claims that could exceed the
Companys directors and officers liability
insurance coverage. Regulators may fine the Company when the
investigations are complete.

The Company will continue to use cash reserves,
which it believes to be adequate, to finance its projected 2004
cash flow deficit. If the Company is unable to generate cash
flow from operations, it may need to raise additional capital to
fund its operations through the sale of equity securities to
private or public investors, debt, further divestiture of
product lines and licensure of its cryoablation technology for
applications other than the treatment of prostate, liver, lung
and kidney diseases and bone pain management. Additional
capital, if needed, might not be available on terms acceptable
to the Company, or at all. If additional capital were raised
through the issuance of equity securities, the percentage of the
Companys stock owned by its then-current stockholders
would be reduced.



|   |                                               
|-- | ----------------------------------------------
|2. | Summary of Significant Accounting
    Policies



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include the
accounts of the Company and all majority owned and controlled
subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.



| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements. Estimates
also affect the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these
estimates. Principal areas requiring the use of estimates
include: determination of allowances for uncollectible accounts
and sales returns, warranty obligations, reserves for excess and
obsolete inventory, valuation allowances for investments and
deferred tax assets, impairment of

F-9



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

long-lived and intangible assets, determination
of stock-based compensation to employees and consultants, and
reserves for litigation. The Company cannot predict what effect,
if any, that these or other events or circumstances may have on
its financial position, results of operations and cash flows.

Revenue
Recognition

Revenues from sales of Cryocare Surgical Systems,
disposable cryoprobes and other urological products are
recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed and determinable, and
collectibility is reasonably assured. The Company also contracts
with medical facilities and healthcare payors for the use of the
Cryocare Surgical Systems in cryoablation treatments for which
the Company charges a per-procedure fee. The fee typically
includes a procedure kit containing cryoprobes and
other disposables needed to perform a cryoablation procedure, in
addition to a service component. The service component of the
procedure generally consists of rental and transport of a
Cryocare Surgical System as well as the services of a technician
to assist the physician with the set-up, use and monitoring of
the equipment. The medical facilities and healthcare payors are
billed for procedures performed using Cryocare Surgical Systems
owned either by the Company or by third parties who perform the
service component of the procedure. The Company receives
procedure fee revenue from the payors and, where a third-party
service provider is involved, remits a portion of the fee to the
service provider. The fee is recorded as revenue in the period
when the procedure is performed and, where applicable, a service
fee paid for the Cryocare Surgical System owned by a third party
is included in cost of revenues. The cost of revenues for the
bundled services includes depreciation related to Company owned
Cryocare Surgical Systems over an estimated useful life of three
years.

The Company has deferred the recognition of
certain Cryocare Surgical System revenues where it has granted
future minimum procedure fee guarantees. Deferred revenues are
adjusted in future periods when the minimum procedure fee
guarantees have been met. Deferred revenue at December 31,
2001, 2002, and 2003, totaled $119,000, $1,082,000 and $459,000,
respectively (included in other accrued liabilities).

In 2001, sales to U.S.M.D., Ltd. accounted for
31.5% of total revenues. No other customers accounted for more
than 10% of total revenues in 2001 and no individual customer
accounted for more than 10% of total revenues in 2002 and 2003.
The Company derived approximately 88% from sales in the United
States during this three-year period. See Notes 4, 5 and 11.

The Company routinely assesses the financial
strength of its customers and, as a consequence, believes that
its accounts receivable credit risk exposure is limited.
Accounts receivable are carried at original invoice amount less
an estimate for doubtful accounts and sales returns based on a
periodic review of outstanding receivables. International
shipments are billed and collected by the Company in
U.S. dollars. Allowances are provided for known and
anticipated credit losses as determined by management in the
course of regularly evaluating individual customer receivables.
This evaluation takes into consideration a customers
financial condition and credit history as well as current
economic conditions. Accounts receivable are written off when
deemed uncollectible. Recoveries of accounts receivable
previously written off are recorded when received.



| |            
| | -----------
| | Inventories

Inventories, consisting of raw materials,
work-in-process and finished goods, are stated at the lower of
cost or market, with cost determined by the first-in, first-out
method. Reserves for slow-moving and obsolete inventories are
provided based on historical experience and product demand. The
Company evaluates the adequacy of these reserves periodically.

F-10



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                                           
| | --------------------------------------------------------------------------
| | Long-Lived Assets, including Intangible Assets
    Subject to Amortization

The Company reviews long-lived assets and asset
groups for impairment whenever events or changes in
circumstances indicate that the carrying value of such assets
may not be recoverable. The Company considers assets to be
impaired and writes them down to fair value if estimated cash
flows associated with those assets are less than their carrying
amounts. Fair value is based upon the present value of the
associated cash flows. The Company has determined that no
long-lived assets were impaired at December 31, 2003.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost and are
depreciated on a straight-line basis over the estimated useful
lives of the respective assets, which range from three to seven
years. Leasehold improvements are amortized over the shorter of
the estimated useful lives of the assets or the related lease
term. Cryosurgical equipment placed at customer sites for use
with the Companys disposable cryoprobes is depreciated
into cost of revenues over estimated useful lives of three
years. Repair and maintenance costs are expensed as incurred.
Depreciation expense was $428,169, $1,893,939 and $3,372,221 in
2001, 2002 and 2003, respectively.



| |                               
| | ------------------------------
| | Goodwill and Intangible Assets

The excess of the purchase price over the fair
value of net assets acquired has been allocated to goodwill and
identifiable intangible assets. The Company had no reported
goodwill prior to January 1, 2002. The Company does not
amortize goodwill which is consistent with the provisions of
Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and other Intangible
Assets. Intangible assets that are deemed to have finite
useful lives are recorded at cost and amortized using the
straight-line method over the estimated useful lives of the
assets. Estimated useful lives of such intangible assets are as
follows:

|                        |  |              
|----------------------- |  | -------------
|Trade name              |  | 15 years     
|Domain name             |  | 5 years      
|Covenant not to compete |  | 3 to 5 years 
|Developed technology    |  | 15 years     
|Patents                 |  | 3 to 15 years

Changes in circumstances (for example, changes in
laws or regulations to which we are subject, technological
advances or changes in the Companys strategies) may result
in changes to the useful lives from initial estimates. Factors
such as changes in the planned use of intangibles may result
from changes in customer base, contractual agreements, or
regulatory requirements and may result in shorter useful lives.
In such circumstances, the Company will revise the useful life
of the long-lived asset and amortize the remaining net book
value over the adjusted remaining useful life. There were no
changes in estimated useful lives during 2001, 2002 and 2003. In
the fourth quarter of 2002, the Company recorded a $17,984,000
impairment charge relating to the goodwill arising from the Timm
Medical acquisition. There was no impairment change recorded for
the year ended December 31, 2003.

F-11



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Amortization expense for each of the years ending
December 31 will consist of the following amounts:

|           |  |   |            | 
|---------- |  | - | ---------- | 
|2004       |  | $ | 1,212,753  | 
|2005       |  |   | 1,111,615  | 
|2006       |  |   | 1,037,115  | 
|2007       |  |   | 972,490    | 
|2008       |  |   | 966,615    | 
|Thereafter |  |   | 6,445,190  | 
|           |  |   |            | 
|           |  | $ | 11,745,778 | 
|           |  |   |            | 

Amortization expense totaled $288,167, $1,201,533
and $1,296,480 in 2001, 2002 and 2003, respectively.



| |                              
| | -----------------------------
| | Available-for-Sale Securities

During 2002 and 2003, the Company invested its
funds in a diversified portfolio of marketable debt securities,
which consisted of corporate bonds, government agencies
securities and commercial paper. Available-for-sale securities
are classified as available-for-sale securities in accordance
with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities.Fair values of
marketable securities are based on quoted prices in active
markets. Unrealized gains or losses, net of applicable income
taxes, are recorded as a component of accumulated other
comprehensive income in stockholders equity. Investments
are periodically evaluated to determine if an
other-than-temporary decline in value has occurred. Such
evaluation is dependent on specific facts and circumstances and
includes factors, such as the market value of the security in
relation to its cost basis, the financial condition of the
subject investment and the intent and ability to hold the
investment for a sufficient period of time to allow for recovery
in market value. Realized gains and losses and unrealized losses
judged to be other-than-temporary are included in the
determination of net income. The cost of securities sold is
determined using the specific-identification method. Since these
securities are available for use in current operations, they are
classified as current assets without regard to the
securities contractual maturity dates. During 2003, the
Company sold its available-for-sale securities and reinvested
the proceeds in highly liquid instruments such as money market
funds. Realized gains on sale were not significant.

Following is a summary of available-for-sale
securities (gross unrealized gains and losses are not presented
as they are immaterial):

|                                              |  |           |            |            |  |   |            | 
|--------------------------------------------- |  | --------- | ---------- | ---------- |  | - | ---------- | 
|                                              |  | Amortized |            | Estimated 
|                                              |  | Cost      |            | Fair Value
|                                              |  |           |            |           
|December 31, 2002                             |  |           |            |            |  |   |            | 
|U.S. government and federal agency securities |  | $         | 3,000,000  |            |  | $ | 3,009,390  | 
|Municipal bonds                               |  |           | 15,100,000 |            |  |   | 15,100,000 | 
|Corporate bonds                               |  |           | 1,000,000  |            |  |   | 1,080,820  | 
|Commercial paper                              |  |           | 3,000,000  |            |  |   | 2,992,950  | 
|                                              |  |           |            |            |  |   |            | 
|Total                                         |  | $         | 22,100,000 |            |  | $ | 22,183,160 | 
|                                              |  |           |            |            |  |   |            | 



| |                  
| | -----------------
| | Other Investments

Other investments primarily consist of strategic
investments of less than 20% equity interest in certain
companies acquired in conjunction with various strategic
alliances. These represent minority interests in start-up
technology companies and mobile medical service providers. The
Company does not have the ability to exercise significant
influence over any of these companies; therefore, they are
recorded at cost and

F-12



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

accounted for under the cost method of
accounting. Realized gains and losses are recorded in interest
and other income when related investments are sold. Investments
in privately held companies are regularly assessed for
impairment through review of operations and indicators of
continued viability. Reviews of operations to assess the
carrying values include evaluation of operating performance,
financing status, liquidity prospects and cash flow forecasts.
Impairment losses are recorded when events and circumstances
indicate that such assets might be impaired and the decline in
value is other-than-temporary. These investments are included in
investments and other assets.



| |                   
| | ------------------
| | Product Warranties

Certain of the Companys products are
covered by warranties against defects in material and
workmanship for periods up to two years after the sale date,
except for the erectile dysfunction products, which are subject
to a limited lifetime warranty. The estimated warranty cost is
recorded at the time of sale and is adjusted periodically to
reflect actual experience. Factors that affect the
Companys warranty liability include the number of units
sold, historical and anticipated rates of warranty claims, and
cost per claim. The Companys warranty costs and liability
(included in other accrued liabilities) were not significant.



| |                         
| | ------------------------
| | Research and Development

Research and development expenditures primarily
include personnel, clinical studies, and material expenses
incurred to design, create, and test prototypes. These
expenditures are charged to operations as incurred until
technological feasibility has been established.



| |            
| | -----------
| | Advertising

Amounts incurred for advertising costs are
included in selling, general and administrative expenses as
incurred and totaled $424,402, $1,591,009 and $581,163 for the
years ended December 31, 2001, 2002 and 2003, respectively.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

All highly liquid investments purchased with an
original maturity of three months or less are considered to be
cash equivalents. Cash and cash equivalents include money market
funds and various deposit accounts.



| |                              
| | -----------------------------
| | Concentrations of Credit Risk

Financial instruments, which potentially subject
the Company to concentrations of credit risk, primarily consist
of cash and cash equivalents, available-for-sale securities, and
accounts receivable. The Company from time to time may be
exposed to credit risk with its bank deposits in excess of the
FDIC insurance limits. The Company has not experienced any
losses in such accounts and believes it is not exposed to any
significant credit risk on cash and cash equivalents.
Available-for-sale securities are invested under the direction
of the Board of Directors. The Companys receivables are
derived primarily from sales of Cryocare Surgical Systems,
disposable CryoProbes and other urological products to medical
facilities, medical groups, urologists and direct consumers, and
procedure fees generated from medical facilities that are not
considered high credit risk. The Company performs ongoing credit
evaluations of its customers and generally does not require
collateral. Reserves are maintained for potential credit losses.



| |                                    
| | -----------------------------------
| | Fair Value of Financial Instruments

The primary objective of the Companys
investment activities is to preserve principal while at the same
time maximizing the income the Company receives from its
invested cash without significantly increasing risk of loss. The
Companys consolidated balance sheets include the following
financial instruments: cash and cash

F-13



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

equivalents, available-for-sale securities,
accounts receivable, minority investments, accounts payable and
accrued liabilities. The carrying amounts of current assets and
liabilities approximate their fair values because of the
relatively short period of time between the origination of these
instruments and their expected realization.



| |                        
| | -----------------------
| | Risks and Uncertainties

The Companys profitability depends in large
part on increasing its revenue base and effectively managing
costs of sales, customer acquisition costs and administrative
overhead. The Company continually reviews its pricing and cost
structure in an effort to select the optimal revenue and
distribution models. Several factors could adversely affect
revenues and costs, such as changes in health care practices,
payor reimbursement, inflation, new technologies, competition
and product liability litigation, which are beyond any
companys control and could adversely affect the
Companys ability to accurately predict revenues and
effectively control costs. Many purchasers of the Companys
products and services rely upon reimbursement from third-party
payors, including Medicare, Medicaid and other government or
private organizations. These factors could have a material
adverse effect on the Companys financial condition,
results of operations or cash flows.



| |                    
| | -------------------
| | Segment Information

The Company presents segment information
externally the same way management uses financial data
internally to make operating decisions and assess performance.
Each of the Companys subsidiaries manufactures, markets
and sells urological products and services to insurers and
health care providers. They share similar characteristics in the
customers they serve, the nature of products and services
provided and the methods by which the products and services are
distributed. The subsidiaries are also subject to similar
regulatory environment and long-term economic prospects. As
such, the Company has one reportable segment.



| |                                                 
| | ------------------------------------------------
| | Off-Balance Sheet Financings and
    Liabilities

Other than lease commitments, legal contingencies
incurred in the normal course of business, and employment
contracts, the Company does not have any off-balance sheet
financing arrangements or liabilities. In addition, the
Companys policy is not to enter into derivative
instruments, futures or forward contracts. The Companys
business is transacted solely in U.S. dollars and, while
future fluctuations of the U.S. dollar may affect the price
competitiveness of the Companys products, there is no
known significant direct foreign currency exchange rate risk.
Finally, the Company does not have any majority-owned
subsidiaries or any interests in, or relationships with, any
material special-purpose entities that are not included in the
consolidated financial statements.



| |                         
| | ------------------------
| | Stock-Based Compensation

The Company has four stock-based employee
compensation plans, which are described more fully in
Note 9. The Company accounts for the plans under the
recognition and measurement principles (the intrinsic-value
method) prescribed in Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations. Compensation cost
for stock options granted to employees is reflected in net
income (loss) and is measured as the excess of the market price
of the Companys stock at the date of grant over the amount
an employee must pay to acquire the stock. Compensation cost for
fixed awards subject to vesting is recognized pro rata over the
vesting period.

The Company has adopted the disclosure provisions
required by SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and
Disclosure. The following table illustrates the effect on
net loss and

F-14



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

loss per share if the Company had applied the
fair value recognition provisions to stock-based employee
compensation.

|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |            |  
|----------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ---------------------- | ----------- | ---------- | - | ---- | ----------- | ---------- | - | - | ----------- | ---------- | -
|                                                |                                                                                                                            |                       
|                                                |                                                                                                                            | Year Ended December 31
|                                                |                                                                                                                            |                       
|                                                |                                                                                                                            | 2001                   |             | 2002       |   | 2003
|                                                |                                                                                                                            |                        |             |            |   |     
|Net loss, as reported(a)                        |                                                                                                                            | $                      | (11,452,478 | )          |   | $    | (41,985,746 | )          |   | $ | (25,447,302 | )         
|Reconciling items (net of related tax effects): |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|                                                | Add: Stock-based employee compensation expense
    determined under the intrinsic-value-based method for all
    awards(b) |                        |             |           |   |      |             | 33,069     |   |   |             | 24,774     |  
|                                                | Less: Stock-based compensation expense determined
    under the fair-value-based method for all awards expense             |                        |             | (2,020,142 | ) |      |             | (4,075,475 | ) |   |             | (2,312,996 | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Net adjustment                                  |                                                                                                                            |                        | (2,020,142  | )          |   |      | (4,042,406  | )          |   |   | (2,288,222  | )         
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Net loss, as adjusted                           |                                                                                                                            | $                      | (13,472,620 | )          |   | $    | (46,028,152 | )          |   | $ | (27,735,524 | )         
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Basic and diluted loss per share:               |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|                                                | As reported                                                                                                                |                        | $           | (0.68      | ) |      | $           | (1.76      | ) |   | $           | (1.05      | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|                                                | As adjusted                                                                                                                |                        |             | (0.80      | ) |      |             | (1.93      | ) |   |             | (1.15      | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           



---



|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | The Company issues stock options and warrants to
    consultants for services performed. Compensation expense for the
    fair value of these options is determined by the Black-Scholes
    option-pricing model and is charged to operations over the
    service period or as the performance goals are achieved. Such
    expense is included in net loss as reported. In addition, the
    net loss for 2003 included compensation expense totaling
    $1,780,000 relating to option settlements with two former
    employees in conjunction with their separation arrangements in
    accordance with the fair value method of accounting under
    SFAS No. 123, Accounting for Stock Based
    Compensation (see Note 9).
|   
|(b) |  | Since the Company issues options with exercise
    prices equal to or exceeding the fair values of the underlying
    common stock, no compensation expense is recorded for options
    issued to employees, except for compensation expense equal to
    the intrinsic value of unvested options assumed in the Timm
    Medical acquisition and amortized over the remaining vesting
    period.                                                                                                                                                                                                                                                                                                                                 



| |                   
| | ------------------
| | Net Loss Per Share

Basic loss per share is calculated by dividing
the net loss by the weighted-average number of common shares
outstanding during the period. Diluted loss per share adjusts
basic loss per share for the effects of convertible securities,
stock options, warrants and other potentially dilutive
securities. Dilutive loss per share for each of the three years
in the period ended December 31, 2003 is calculated using
only the weighted-average number of common shares outstanding
during the periods, as the inclusion of stock options and
warrants would have been antidilutive. Accordingly, diluted loss
per share equals basic loss per share for each of the three
years in the period ended December 31, 2003.



| |      
| | -----
| | Taxes

The Company recognizes deferred tax assets and
liabilities for temporary differences between the financial
reporting basis and the tax basis of the Companys assets
and liabilities along with net operating loss and credit
carryforwards, if it is more likely than not that the tax
benefits will be realized. To the extent a deferred tax asset
cannot be recognized under the preceding criteria, allowances
must be established. The impact on deferred taxes of changes in
tax rates and laws, if any, are applied to the years during which

F-15



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

temporary differences are expected to be settled
and reflected in the financial statements in the period of
enactment.

The Company is also subject to other taxes,
including capital taxes, sales and use taxes, and various other
state and local taxes, which are assessed on a basis other than
taxable income. These taxes totaled $512,000, $1,074,000 and
$685,000 during 2001, 2002 and 2003, respectively, and are
included in selling, general and administrative expenses. Taxes
payable at December 31, 2002 and 2003 were $2,194,000 and
$2,579,000, respectively (included in other accrued liabilities).



|   |                    
|-- | -------------------
|3. | Goodwill Impairment

The Company adopted SFAS No. 142,
Goodwill and Other Intangible Assets, with respect to
amortization for acquisitions after June 2001 and, with respect
to impairment, as of January 1, 2002. Under
SFAS No. 142, goodwill and indefinite-lived intangible
assets are no longer amortized but instead are reviewed annually
for impairment and on an interim basis if events or changes in
circumstances between annual tests indicate that an asset might
be impaired. Indefinite-lived intangible assets are tested for
impairment by comparing their fair values to their carrying
values under a two-step process. The first step requires the
Company to compare the fair value of its reporting units to the
carrying value of the net assets of the respective reporting
units, including goodwill. If the fair value of the reporting
unit is less than the carrying value, goodwill of the reporting
unit is potentially impaired and the Company then completes
Step 2 to measure the impairment loss, if any. The second
step requires the calculation of the implied fair value of
goodwill by deducting the fair value of all tangible and
intangible net assets of the reporting unit from the fair value
of the reporting unit. If the implied fair value of goodwill is
less then the carrying amount of goodwill, an impairment loss is
recognized equal to the difference.

In accordance with SFAS No. 142, the
Company completed its annual goodwill impairment test on
October 1, 2002 and 2003 for all of its reporting units.
The Company utilized an independent third-party appraiser to
assess the fair values of each reporting unit. The Company then
compared the fair values of the reporting units to their
carrying values. Based on this assessment, a goodwill impairment
charge of $17,984,000 was recorded in the fourth quarter of 2002
to reduce the carrying value of the goodwill acquired in the
Timm Medical acquisition. The impairment resulted from the
termination or abandonment of three of the acquired distribution
agreements for urological products following the acquisition due
to performance and market acceptance issues and concern over the
financial viability of their manufacturers. At the time of the
acquisition, these arrangements were expected to account for 60%
of Timm Medicals annual revenue growth. The Company
completed its annual goodwill impairment test for all reporting
units as of October 1, 2003, and determined that the
remaining goodwill was not impaired.

In the fourth quarter of 2002, the Company also
recorded a $2,327,000 other-than-temporary loss in the value of
the Companys investment in U.S. Medical
Development, Inc. acquired in June 2001 (see Note 11).
The loss was based on managements assessment that the
investee is unable to sustain an earnings capacity, which would
justify the carrying amount of the investment.



|   |             
|-- | ------------
|4. | Acquisitions



| |                      
| | ---------------------
| | Business Acquisitions



| |                                
| | -------------------------------
| | Timm Medical Technologies, Inc.

On February 21, 2002, the Company entered
into an agreement and plan of reorganization to acquire Timm
Medical for total consideration of $36,512,000 and $838,000 in
legal, accounting and other acquisition related costs. In
connection with the merger, all outstanding shares of the
capital stock of Timm Medical were exchanged for $10,770,000 in
cash and 1,620,530 shares of the Companys common
stock valued at $23,806,000 (of which 63,412 shares were
held in escrow, of which all but 2,841 were released after six

F-16



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

months). In addition, the Company assumed certain
outstanding options of Timm Medical, which were exercisable into
168,162 shares of Endocare common stock at $7.25 per
share. These options were valued at $1,935,000 using the
Black-Scholes option pricing model, of which $1,770,000 related
to vested options and $165,000 related to unvested options.
Except for the adjustment in the number of exercisable shares
and the corresponding exercise price per share based on the
conversion ratio as defined in the purchase agreement, all other
option terms and vesting periods remain unchanged. The value of
the unvested options was recorded as deferred compensation on
the acquisition date to be amortized over the remaining vesting
period.

This transaction was accounted for under the
purchase method of accounting and the consolidated financial
statements of the Company include the financial results of Timm
Medical from February 21, 2002. The total purchase price of
$37,350,000 (including transaction costs and the amount recorded
as deferred compensation) was allocated to the tangible and
intangible assets acquired based on their respective fair value
as follows:

|                                               |                      |   |            |             |  
|---------------------------------------------- | -------------------- | - | ---------- | ----------- | -
|Total purchase consideration and related costs |                      | $ | 37,350,000 |            
|Fair value of tangible net assets acquired     |                      |   | (1,041,000 | )          
|Fair value of amortizable intangibles:         |                      |   |            |            
|                                               | Developed technology |   |            | (10,000,000 | )
|                                               | Trademark            |   |            | (500,000    | )
|Unearned compensation                          |                      |   | (165,000   | )          
|                                               |                      |   |            |            
|Goodwill (non-tax deductible)                  |                      | $ | 25,644,000 |            
|                                               |                      |   |            |            

Factors contributing to the origination of
goodwill include the enhancement of the product line and
projected growth in urology sales through collaborative
distribution agreements with other medical device companies and
the sales force which the Company believed are valuable assets
as the Company divests non-core product lines and redeploys
existing resources in the area of tumor ablation. Subsequent to
the acquisition, the Company recorded a goodwill impairment
charge of $17,984,000 in the fourth quarter of 2002 (see
Note 3).

Net cash paid in the acquisition is as follows:

|                                               |  |   |             |  
|---------------------------------------------- |  | - | ----------- | -
|Total purchase consideration and related costs |  | $ | 37,350,000  |  
|Fair value of common stock issued              |  |   | (23,806,000 | )
|Fair value of options assumed                  |  |   | (1,935,000  | )
|                                               |  |   |             |  
|Cash paid                                      |  |   | 11,609,000  |  
|Cash acquired                                  |  |   | (1,127,000  | )
|                                               |  |   |             |  
|Net cash paid                                  |  | $ | 10,482,000  |  
|                                               |  |   |             |  

Subsequent to the acquisition date, the Company
decided to divest certain non-core product lines, including the
Dura II penile implants line sold in April 2003, and the
urinary incontinence and urodynamics lines sold in October 2003
(see Note 5).



| |                                     
| | ------------------------------------
| | Mobile Prostate Treatment Businesses

On September 30, 2002, the Company completed
the acquisition of certain general and limited equity interests
in the mobile prostate and BPH treatment businesses
(Mobile Businesses) of U.S. Medical
Development, Inc. (formerly U.S. Therapies, LLC), a
privately held urology services company based in Dallas, Texas,
and its affiliates, U.S.M.D., Ltd. and U.S.M.D. I, L.L.C.
(collectively, USMD). USMD is a customer and was the
exclusive distributor of the Companys Cryocare Surgical
Systems and cryoprobes in

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

certain states (see Note 11). The purchase
included equity interests held by USMD ranging from 1% to 100%
in 13 partnerships and limited liability companies for
total consideration of $11,185,000 as follows: $3,300,000 in
cash, $185,000 in assumption of debt, forgiveness of a
$6,800,000 loan previously made by the Company to USMD, and
application of a $900,000 earnest money deposit made by the
Company in April 2002 upon the execution of a letter of intent.

The $6,800,000 note was a non-recourse loan made
to USMD in July 2002 to fund the acquisition of certain business
interests by USMD. Interest was at prime rate plus one percent
with a scheduled maturity on September 30, 2002. The note
was secured by the business interests acquired by USMD. Upon the
acquisition in September 2002, the loan was converted to a full
recourse unsecured note and was amended to reduce the interest
rate to the lowest federal applicable rate in effect with
maturity extended to March 30, 2006.

Pursuant to the original terms of the purchase
agreement, the Company agreed to forgive the $7,700,000
principal balance of the note and the earnest deposit (the
Indebtedness) upon the achievement of $12,000,000 in
gross revenues by the Mobile Businesses during the period
October 1, 2002 to December 31, 2005 (the
Forgiveness Period). The purchase agreement was
amended February 2004 to extend the Forgiveness Period to
December 31, 2008. In addition, effective January 1,
2004, the Company reduced the service fee it pays to one of the
partnerships for the use of their Cryocare Surgical Systems from
$2,500 to $2,000 per procedure, representing an adjustment to a
market rate. As a result, the reduction in service fee does not
require a reallocation of goodwill.

Management believes that the $7,700,000 will be
forgiven and has treated the note as additional purchase price
allocation as follows:

|                                                                                  |  |   |            |  
|--------------------------------------------------------------------------------- |  | - | ---------- | -
|Total purchase consideration (includes $549,000
    in acquisition-related costs) |  | $ | 11,734,000 |  
|Fair value of tangible net assets acquired
    (primarily property and equipment) |  |   | (1,616,000 | )
|Covenant not to compete                                                           |  |   | (240,000   | )
|                                                                                  |  |   |            |  
|Goodwill (non-tax deductible)                                                     |  | $ | 9,878,000  |  
|                                                                                  |  |   |            |  

The goodwill is primarily related to the
distribution network provided by the Mobile Businesses, which
allows the Company to further penetrate desired markets. Since
investors in the Mobile Businesses are comprised of urologists,
the acquisition facilitates the continued promotion of
cryosurgery as the preferred treatment for prostate cancer. In
addition, USMD exited the cryosurgical and BPH operations upon
the sale and terminated its exclusive distribution agreement
with Endocare. This allows the Company to market directly to
urologists previously served by USMD and to competitors of USMD
who were precluded from purchasing from the Company under the
previous distribution relationship. No sales have been made to
USMD since the September 30, 2002 acquisition was completed.

The tangible assets acquired include
11 Cryocare Surgical Systems previously purchased from the
Company by USMD and resold to the partnerships. These systems
are recorded at fair value of $2,109,000 on the acquisition
date, which approximated the carrying value recorded by USMD,
and are depreciated over their remaining useful lives not to
exceed three years. The covenant not to compete is amortized
over three years.

|                                                |  |   |            |  
|----------------------------------------------- |  | - | ---------- | -
|Net cash paid in the acquisition is as follows: |  |   |            |  
|Total purchase consideration and related costs  |  | $ | 11,734,000 |  
|Cash acquired                                   |  |   | (396,000   | )
|                                                |  |   |            |  
|Net cash paid                                   |  | $ | 11,338,000 |  
|                                                |  |   |            |  

Endocare is the general partner or member in each
of the Mobile Businesses and generally holds over 20% in
combined general and limited equity interests. The Company has
sole responsibility for the

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

management of the Mobile Businesses and exercises
exclusive control over their operations. Other equity holders
have limited participation rights, which are protective in
nature. As such, the Mobile Businesses have been consolidated
with the Companys operations since September 30, 2002.



| |                                
| | -------------------------------
| | Pro Forma Results of Operations

The following table presents unaudited pro forma
results of operations for the year ended December 31, 2002
assuming the Timm Medical and Mobile Business acquisitions
occurred as of January 1, 2002:

|                                     |  |   |             |  
|------------------------------------ |  | - | ----------- | -
|Revenues                             |  | $ | 34,876,000  |  
|                                     |  |   |             |  
|Net loss                             |  | $ | (43,773,000 | )
|                                     |  |   |             |  
|Net loss per share basic and diluted |  | $ | (1.82       | )
|                                     |  |   |             |  
|Weighted average shares outstanding  |  |   | 24,053,000  |  
|                                     |  |   |             |  

The pro forma results of operations reflect
adjustments for additional amortization expense for intangible
assets acquired, reduction in interest income due to net cash
paid in acquisitions and stock compensation expense related to
employee options assumed, and increased weighted average shares
outstanding to reflect the issuance of common stock in the Timm
Medical acquisition.



| |                
| | ---------------
| | Asset Purchases

The Company has acquired intangible assets from
time to time, including patents and intellectual property as
follows:

On May 28, 2002, pursuant to an asset
purchase agreement, the Company agreed to acquire the
cryosurgical assets of Cryomedical Sciences, Inc., now
known as BioLife Solutions, Inc. (BioLife),
consisting primarily of a portfolio of patents central to the
cryoablation technology, for $2,200,000 in cash and
120,022 shares of the Companys common stock valued at
$1,847,000. This transaction was accounted for under the
purchase method of accounting. The total purchase consideration
of $4,119,000 (including $72,000 in acquisition-related costs)
was allocated to the patents since other assets acquired had
de minimus value. Pursuant to a Registration Rights
Agreement, the Company was required to file a registration
statement with the SEC to register the shares issued to BioLife.
In November 2002, BioLife filed suit against the Company for
failing to register the shares in a timely manner, seeking
damages for breach of contract. See Note 12.

In February 2002, the Company entered into an
asset purchase agreement with a cryosurgeon inventor of certain
technologies related to the Companys business, to acquire
certain patents and a covenant not to compete for
100,000 shares of the Companys common stock valued at
$1,410,000. Of this amount, $1,058,000 (75,000 shares) was
allocated to the patent and is amortized over 15 years and
the remaining $352,000 (25,000 shares) was allocated to the
covenant not to compete and is amortized over five years. The
agreement also requires the seller to provide certain consulting
services over 15 years for the consideration received. No

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

consideration was allocated to the consulting
agreement since the value of such services could not be
accurately determined. In January 2003, the Company extended a
$344,000 loan to the seller to finance tax payments related to
the gain on the sale (see Note 13).

In April 2001, the Company entered into an
assignment agreement to acquire the rights to a patent related
to the cryoguide system in exchange for $50,000 in cash and
20,921 shares of Companys common shares with a fair
value of $150,000 as of the purchase date. In addition, the
Company is obligated to make royalty payments equal to 3.5% of
net revenues (as defined) related to the cryoguide system
through the patent expiration date. The total purchase price of
$200,000 was allocated to patents and is amortized over the
remaining useful life of 12 years.



|   |                                              
|-- | ---------------------------------------------
|5. | Dispositions and Restructuring
    Activities

In 2003, the Company embarked on a strategy to
refocus its core technological competence and primary market
emphasis on the development of minimally invasive technologies
for tissue and cancer ablation. Part of this strategy entails
divestiture of certain product lines that are unrelated to the
Companys focus. The Company also undertook a review of its
strategic plans and operational infrastructure in order to
maximize efficiency and promote optimal use of resources. In
addition to the divestiture of a Florida billing and contracting
subsidiary in December 2002, which reduced headcount by
12 employees, the Company downsized its Eden Praire,
Minnesota, operations in June 2003, consolidating many
administrative functions at its Irvine, California, headquarters
and reducing headcount by 26 employees. The Companys Board
of Directors also approved the divestiture of certain non-core
product lines and assets in the first quarter of 2003, including
the sale of the Dura II penile implants, the
cardiac-related product manufacturing operations and license of
related technology, and the urinary incontinence and urodynamics
product lines. These related assets were classified as
held and used at December 31, 2002.



| |                                             
| | --------------------------------------------
| | Advanced Medical Procedures, LLC
    (AMP)

Effective December 31, 2002, the Company
divested certain assets held by AMP, a Florida limited liability
company originally acquired in June 1999 through a
pooling-of-interests transaction. AMP operated a mobile
cryosurgery business, which provided cryosurgical equipment for
the treatment of prostate and liver cancer on a procedural
basis. AMP also performed payor and reimbursement contracting,
billing and collection services for the Company and certain
third parties. To consolidate its operations, the Company
centralized AMPs former operations in its Irvine,
California, headquarters. AMPs office facility, leases and
third-party billing contracts were transferred to the former
employees under a newly incorporated entity for no
consideration. The asset divestiture resulted in a loss of
$115,000 in the fourth quarter of 2002 (included in selling,
general and administrative expenses), which was primarily
related to property and equipment transferred to the former
employees.



| |                        
| | -----------------------
| | Dura II Penile Implants

On April 7, 2003, Timm Medical sold certain
assets related to the Dura II positionable urological
prostheses product line to American Medical Systems, Inc.
for approximately $2,150,000 in cash. Assets sold include
developed technology, intellectual property, customer lists,
production equipment and Dura II inventory. The sale
resulted in a loss of $35,000 in the second quarter of 2003
(included in gain on divestitures, net).



| |                                                   
| | --------------------------------------------------
| | Cryosurgical Products for Cardiac
    Applications

On April 14, 2003, the Company sold its
cardiac-related product manufacturing operations and licensed
the related intellectual property to CryoCath for $10,000,000.
CryoCath was the exclusive distributor for cryoprobes and
consoles in connection with the SurgiFrostTM system,
a cryoablation system designed to treat

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

cardiac arrhythmias. The Company transferred all
of its manufacturing assets and inventory related to the cardiac
product line to CryoCath, including technical know-how, vendor
lists, production equipment and inventory. In addition, CryoCath
received an exclusive worldwide perpetual license for cardiac
uses to the Companys proprietary argon gas based
technology associated with the product and will make payments to
the Company under a nine-year descending royalty stream based on
net sales of products incorporating the licensed technology. The
Company also agreed to a 12-year worldwide covenant not to
compete in the cardiac field. Upon the consummation of the sale,
the Company terminated its pre-existing distribution agreement
with CryoCath. The Company is also required to attend quarterly
and annual technical update meetings through 2014. Since the
technology was internally developed and the tangible assets sold
had de minimus value, the sale resulted in a 2003 second
quarter gain of $9,980,000. The royalty stream decreases from
10% to 3% of net sales from the SurgiFrostTM system
during the period 2004 to 2012. The royalty payments will be
recorded in the periods earned. At December 31, 2003, the
Company had collected $7,480,000 of the total sale proceeds. The
remaining $2,500,000, included in prepaid expenses and other
current assets at December 31, 2003, was collected in
January 2004.



| |                   
| | ------------------
| | Minnesota Facility

Subsequent to the acquisition of Timm Medical,
the Company undertook a review of the Companys operational
and financial infrastructure. To maximize operational efficiency
and resource utilization, the Board of Directors approved a plan
in the first quarter of 2003 to close Timm Medicals former
manufacturing facility in Minnesota after the sale of the
Dura II and urinary incontinence product lines. With the
exception of certain marketing and financial functions, all
operations were transferred to the Companys Irvine,
California, headquarters in June 2003 or were outsourced. The
cost of the restructuring totaled $386,000, which included
$266,000 in severance payments and $120,000 in lease losses for
vacating the unused leased space. These losses are recorded in
the second quarter of 2003 upon the communication of the
separation terms to the affected employees. In addition, Timm
Medical had $465,000 in property and equipment, a portion of
which may be abandoned or sold for salvage value at a future
date. These assets are classified as held and used until they
are disposed or abandoned. In the first quarter of 2003,
management has adjusted the useful life of the assets to be
abandoned to amortize their carrying value, less estimated
salvage, through the scheduled abandonment date of April 2004.



| |                                     
| | ------------------------------------
| | Urinary Incontinence and Urodynamics

On October 15, 2003, Timm Medical agreed to
sell the manufacturing assets related to its urodynamics and
urinary incontinence product lines to SRS Medical Corp.
(SRS) for a $2,742,000 note. These assets include
certain patents and trademarks related to the urodynamics and
urinary incontinence products, inventory, customer lists and
technical know-how. The note bears interest at 7.5% and is
secured by the assets sold. Quarterly payments will begin on
March 31, 2004, equal to the higher of (a) minimum
quarterly payments as defined or (b) 15% of the net
revenues related to the urinary incontinence assets acquired and
15% of the net revenues related to SRS existing
urodynamics business, including the urodynamics assets acquired.
The minimum quarterly payments will commence at $112,500 for the
quarter ended March 31, 2004, and increase to $298,406 for
the quarter ended March 31, 2007. Amounts which remain
outstanding at March 31, 2007 will be payable at
$250,000 per quarter thereafter until fully paid. The
carrying values of the urodynamics and urinary incontinence
related assets were $1,314,000 on the date of sale. Management
concluded that collection of the note from SRS was not
reasonably assured. As a result, a loss of $1,314,000 was
recorded in the fourth quarter of 2003 equal to the carrying
value of the assets sold. Collections on the note, if any, will
be reported as gain in the period received.

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                     
| | ------------------------------------
| | Mobile Prostate Treatment Businesses

In late 2003, the Company initiated the
dissolution of four of the 13 partnerships acquired from
USMD, one of which was engaged in BPH treatment and three of
which were engaged in cryosurgical procedures for prostate
cancer. The BPH partnership discontinued operations beginning in
the first quarter of 2003 due to significant reduction in payor
reimbursements and the Companys desire to exit the
non-core BPH business. The Company elected to terminate the
cryosurgical partnerships due to decisions by certain of the
limited partner physicians to withdraw from these partnerships.
After the dissolution, the Cryocare Surgical Systems held by
these partnerships will be redeployed to other markets as
placement units.

Since the Company will continue to receive
license fees from CryoCath and may receive installment purchase
price payments from SRS (to be recognized as revenue when
received) after the sales, the revenues and related costs of the
CryoCath and the urinary incontinence product lines have been
included in continuing operations for each of the three years in
the period ended December 31, 2003. The revenues and cost
of revenues for the Dura II product line are not
significant and are not presented as discontinued operations.

The combined revenues and costs of revenues
related to the divested product lines for each of the years
ended December 31 are as follows:

|                 |  |      |           |      |  |   |           | 
|---------------- |  | ---- | --------- | ---- |  | - | --------- | 
|                 |  | 2002 |           | 2003
|                 |  |      |           |     
|Revenues         |  | $    | 5,375,435 |      |  | $ | 1,972,017 | 
|Cost of Revenues |  |      | 2,337,258 |      |  |   | 948,776   | 
|                 |  |      |           |      |  |   |           | 
|Gross Margin     |  | $    | 3,038,177 |      |  | $ | 1,023,241 | 
|                 |  |      |           |      |  |   |           | 

Incremental selling, general and administrative
expenses attributable to these product lines were not
significant.

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|6. | Balance Sheet Supplemental
    Information

|                                           |                                               |                                           |   |            |            |  |   |            |            | 
|------------------------------------------ | --------------------------------------------- | ----------------------------------------- | - | ---------- | ---------- |  | - | ---------- | ---------- | 
|                                           |                                               |                                          
|                                           |                                               | December 31                              
|                                           |                                               |                                          
|                                           |                                               | 2002                                      |   | 2003      
|                                           |                                               |                                           |   |           
|Inventories:                               |                                               |                                           |   |            |            |  |   |           
|                                           | Raw materials                                 |                                           | $ | 1,391,161  |            |  | $ | 859,886    |           
|                                           | Work in process                               |                                           |   | 176,011    |            |  |   | 272,606    |           
|                                           | Finished goods                                |                                           |   | 2,924,470  |            |  |   | 1,476,554  |           
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Total inventories                         |   | $          | 4,491,642  |  |   | $          | 2,609,046  | 
|                                           |                                               |                                           |   |            |            |  |   |           
|Prepaid expenses and other current assets: |                                               |                                           |   |            |            |  |   |           
|                                           | Prepaid insurance                             |                                           | $ | 262,922    |            |  | $ | 212,593    |           
|                                           | Restricted cash held in escrow (see Note 12)  |                                           |   |           |            |  |   | 1,366,775  |           
|                                           | Receivable from CryoCath (see Note 5)         |                                           |   |           |            |  |   | 2,500,000  |           
|                                           | Other                                         |                                           |   | 377,836    |            |  |   | 353,210    |           
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Prepaid expenses and other current assets |   | $          | 640,758    |  |   | $          | 4,432,578  | 
|                                           |                                               |                                           |   |            |            |  |   |           
|Property and equipment:                    |                                               |                                           |   |            |            |  |   |           
|                                           | Equipment                                     |                                           | $ | 5,498,473  |            |  | $ | 4,940,757  |           
|                                           | Cryosurgical systems placed at customer sites |                                           |   | 4,260,653  |            |  |   | 3,825,115  |           
|                                           | Furniture and fixtures                        |                                           |   | 1,118,852  |            |  |   | 1,072,827  |           
|                                           | Leasehold improvements                        |                                           |   | 487,812    |            |  |   | 372,194    |           
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Total property and equipment, at cost     |   |            | 11,365,790 |  |   |            | 10,210,893 | 
|                                           | Accumulated depreciation and amortization     |                                           |   | (3,121,097 | )          |  |   | (4,572,314 | )         
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Property and equipment, net               |   | $          | 8,244,693  |  |   | $          | 5,638,579  | 
|                                           |                                               |                                           |   |            |            |  |   |           
|Intangibles:                               |                                               |                                           |   |            |            |  |   |           
|                                           | Trade name                                    |                                           | $ | 500,000    |            |  | $ | 500,000    |           
|                                           | Domain name                                   |                                           |   | 435,000    |            |  |   | 435,000    |           
|                                           | Covenant not to compete                       |                                           |   | 592,500    |            |  |   | 592,500    |           
|                                           | Patents                                       |                                           |   | 5,734,733  |            |  |   | 5,450,025  |           
|                                           | Developed technology                          |                                           |   | 10,000,000 |            |  |   | 7,000,000  |           
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Total intangibles                         |   |            | 17,262,233 |  |   |            | 13,977,525 | 
|                                           | Accumulated amortization                      |                                           |   | (1,498,910 | )          |  |   | (2,231,747 | )         
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           | Intangibles, net                              |                                           | $ | 15,763,323 |            |  | $ | 11,745,778 |           
|                                           |                                               |                                           |   |            |            |  |   |           
|Other accrued liabilities:                 |                                               |                                           |   |            |            |  |   |           
|                                           | Professional fees                             |                                           | $ | 277,617    |            |  | $ | 2,966,436  |           
|                                           | State and local taxes                         |                                           |   | 2,193,548  |            |  |   | 2,578,679  |           
|                                           | Litigation accrual (see Note 12)              |                                           |   | 1,500,000  |            |  |   | 1,500,000  |           
|                                           | Deferred revenue                              |                                           |   | 1,081,566  |            |  |   | 465,320    |           
|                                           | Warranty reserves                             |                                           |   | 431,947    |            |  |   | 274,847    |           
|                                           | Discounts payable to distributor              |                                           |   | 557,890    |            |  |   |           |           
|                                           | Other                                         |                                           |   | 1,285,135  |            |  |   | 1,157,548  |           
|                                           |                                               |                                           |   |            |            |  |   |           
|                                           |                                               | Total other accrued liabilities           |   | $          | 7,327,703  |  |   | $          | 8,942,830  | 
|                                           |                                               |                                           |   |            |            |  |   |           

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |     
|-- | ----
|7. | Debt



| |                       
| | ----------------------
| | Convertible Debentures

In June and July 1999, the Company received
$8,000,000 from the sale to institutional investors of
7% convertible debentures due in three years from the date
of issuance. Interest was payable annually in cash or, at the
Companys option, in common stock at a price per share
based on recent bid prices. The debentures were convertible into
common shares at $5.125 to $6 per share. During the second
quarter of 2000, these debentures were converted into
1,475,610 shares of the Companys common stock.

On May 5, 2000, the Company received a total
of $8,000,000 from the sale of additional 7% convertible
debentures, of which $500,000 of these debentures were converted
into 74,074 shares of the Companys common stock
during the fourth quarter of 2000, $1,000,000 of these
debentures were converted into 148,148 shares of the
Companys common stock during the first quarter of 2001,
$4,200,000 of these debentures were converted into
622,222 shares of the Companys common stock during
the second quarter of

2001, and the final $2,300,000 of these
debentures were converted into 340,741 shares of the
Companys common stock in July 2001. Of the debentures
converted in 2000 and 2001, an additional $549,098 or
38,861 shares and $200,335 or 17,622 shares,
respectively, were issued as interest at a rate of 7%.

Under the financing agreements, the purchasers
had a call option exercisable at any time through July 29,
2002, to require the Company to sell to the purchasers an
additional $8,000,000 in convertible debentures, which mature in
three years, bear interest at 7% per annum and are
convertible at $6.75 per share. The Company also had a put
option to require the investors to acquire an additional
$8,000,000 in convertible debentures if the closing bid price
for the common stock as listed was more than $9 to $10 per
share for (i) 20 trading days in a consecutive 30 trading
day period, and (ii) on the date the Company elected to
exercise the put option, and (iii) if certain other
conditions were met. The fair value of the investors two
call options described above totaling $1,600,000 was estimated
using the Black-Scholes pricing model and was recorded in
deferred financing costs. This amount was amortized into
interest expense over the original lives of the call options.
The net unamortized balance of $1,156,863 was reclassified to
additional paid in capital upon conversion of the original
$8,000,000 of convertible debentures into common stock in 2000.

Credit
Facility

On July 29, 1999, the Company entered into a
Loan and Security Agreement with a lender, which originally
provided for a revolving credit line plus up to an additional
amount based on eligible accounts receivable of the Company (the
Loan). The balance available under the revolving
portion of the credit facility was $4,000,000 with an additional
$1,000,000 available based on eligible accounts receivable of
the Company. The Loan accrued interest at the highest prime or
equivalent rate announced by certain designated banks, plus 2%
for the portion of the loan based on eligible accounts
receivable or 3.5%. The Loan was secured by a first priority
lien on all of the assets of the Company, except for
intellectual property, was fully guaranteed by AMP, a wholly
owned subsidiary of the Company, and contained certain
restrictive covenants. The loan was repaid upon maturity on
July 31, 2001, and the Loan and Security Agreement was
canceled on the same date.



|   |                     
|-- | --------------------
|8. | Stockholders Equity



| |                   
| | ------------------
| | Secondary Offering

On November 21, 2001, the Company completed
a public offering of 4,000,000 shares of its common stock
at a price of $17.00 per share. On December 4, 2001,
the Company sold an additional 600,000 shares of its common
stock at the public offering price of $17.00 per share upon
exercise of the over-allotment granted

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

to the underwriters in the public offering. The
Company raised $78,200,000 in proceeds through the public
offering before deducting commissions and offering expenses of
$5,600,000.



|   |                       
|-- | ----------------------
|9. | Equity Incentive Plans



| |              
| | -------------
| | Stock Options

At December 31, 2003, Endocare had four
stock-based compensation plans. The 1995 Stock Plan authorizes
the Board or one or more committees designated by the Board (the
Committee) to grant options and rights to purchase
common stock to employees and certain consultants and
distributors. Options granted under the 1995 Stock Plan may be
either incentive stock options as defined in
Section 422 of the Internal Revenue Code of 1986, as
amended, nonstatutory stock options or other equity instruments,
as determined by the Board or the Committee. The exercise price
of options granted under the 1995 Stock Plan is equal to the
fair market value of Endocare common stock on the date of grant.
Options generally vest 25% on the one-year anniversary date,
with the remaining 75% vesting monthly over the following three
years. Options are exercisable for 10 years. Through
December 31, 2003, 5,330,083 shares of common stock
have been reserved for issuance under the 1995 Stock Plan. On
the first trading day of each calendar year, the number of
shares available for issuance automatically increases by 3% of
the total number of outstanding common shares at the end of the
preceding calendar year, up to a maximum of
1,000,000 shares. As of December 31, 2003, options to
purchase 2,738,752 shares of the Companys common
stock are outstanding and 472,354 options are available for
grant.

The 1995 Director Option Plan (the Director
Plan) was adopted by the Board of Directors in October
1995 and approved by the shareholders in November 1995. It
provides automatic, non-discretionary grants of options to
Endocares non-employee directors (Outside
Directors). The Director Plan provides that each Outside
Director is granted an option to purchase 20,000 shares of
Endocare common stock vested over a two-year period upon his or
her initial election or appointment as an Outside Director.
Subsequently, each Outside Director who has served for at least
six months will be granted an additional option
(Subsequent Option) to purchase 5,000 shares of
Endocare common stock, on January 1 of each year, or the
first trading day thereafter, so long as he or she remains an
Outside Director. The exercise price of options granted to
Outside Directors must be the fair market value of Endocare
common stock on the date of grant. Options granted to Outside
Directors have 10-year terms, subject to an Outside
Directors continued service as a director. The Subsequent
Options granted to the Outside Directors become fully
exercisable on the first anniversary of the date of grant.
275,000 shares of common stock have been reserved for
issuance under the Director Plan. As of December 31, 2003,
options to purchase 265,000 common shares have been granted;
75,000 have been exercised; 10,000 were forfeited and are
available for reissuance; and 180,000 are outstanding.

The Company adopted the 2002 Supplemental Stock
Plan (2002 Plan) effective June 25, 2002. Under
the 2002 Plan, non-statutory options may be granted to
employees, consultants and outside directors with an exercise
price equal to at least 85% of the fair market value per share
of the Companys common stock on the date of grant. The
2002 Plan expires June 24, 2012, unless earlier terminated
in accordance with plan provisions. The 2002 Plan also
terminates automatically upon certain extraordinary events, such
as the sale of substantially all of the Companys assets, a
merger in which the Company is not the surviving entity or
acquisition of 50% or more of the beneficial ownership in the
Companys common stock by other parties. Upon such an
event, all options become fully exercisable. Through
December 31, 2003, 435,000 shares of common stock have
been reserved for issuance, all of which have been granted;
235,000 options have been forfeited and are available for
reissuance; and 200,000 are outstanding.

In addition to the option plans described above,
on June 25, 2001, the Company granted to its then Chief
Financial Officer and Chief Operating Officer (the former
CFO) options to purchase 300,000 shares of the
Companys common stock at $13.75 per share. 62,500 of
the shares vested on June 25, 2002, and

F-25



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

187,500 shares were to vest on a monthly
basis over 36 months thereafter. The remaining
50,000 shares were to vest upon the earlier of (i) the
former CFOs continuation in service through June 25,
2006, or (ii) his attainment of a performance-based
objective. This option was canceled on March 3, 2003 as
discussed in Note 12  Employment and Severance
Agreements.

On March 3, 2003, the Company granted
750,000 and 250,000 options to purchase common stock to the
current President and Chief Operating Officer and the Chief
Financial Officer, respectively. The options were granted at
$2.25 per share; 250,000 of the Presidents options
are available for accelerated vesting based on the attainment of
certain milestones and objectives or five years, whichever
comes first. 25% of the remaining 750,000 options vest on the
first anniversary with the balance ratably over three years.

On December 15, 2003, the Company granted
1,000,000 options to purchase common stock to the Chief
Executive Officer. The options were granted at 4.27 per
share; 100,000 of these options are available for accelerated
vesting based on the attainment of certain milestones and
objectives or five years, whichever comes first. 25% of the
remaining options vest immediately with the balance vesting
ratably over three years.

All options granted pursuant to the
Companys stock-based compensation plans are subject to
immediate vesting upon a change in control as defined.

The following tables summarize Endocares
option activity under the three plans:

|                               |  |                        |           |                |  |           |       |                |  |           |           |                |  |   |       |  |  |  |           |   |  |   |       | 
|------------------------------ |  | ---------------------- | --------- | -------------- |  | --------- | ----- | -------------- |  | --------- | --------- | -------------- |  | - | ----- |  |  |  | --------- | - |  | - | ----- | 
|                               |  |                       
|                               |  | Year Ended December 31
|                               |  |                       
|                               |  |                        |           |                |  |          
|                               |  | 2001                   |           | 2002           |  | 2003     
|                               |  |                        |           |                |  |          
|                               |  |                        |           | Weighted-Avg.  |  |           |       | Weighted-Avg.  |  |           |           | Weighted-Avg. 
|                               |  | Number of              |           | Exercise Price |  | Number of |       | Exercise Price |  | Number of |           | Exercise Price
|                               |  | Options                |           | Per Option     |  | Options   |       | Per Option     |  | Options   |           | Per Option    
|                               |  |                        |           |                |  |           |       |                |  |           |           |               
|Outstanding, beginning of year |  |                        | 2,743,293 |                |  | $         | 3.37  |                |  |           | 2,700,057 |                |  | $ | 6.70  |  |  |  | 3,153,427 |   |  | $ | 8.50  | 
|Granted                        |  |                        | 1,041,000 |                |  |           | 11.45 |                |  |           | 1,145,507 |                |  |   | 11.90 |  |  |  | 2,893,000 |   |  |   | 3.42  | 
|Cancelled                      |  |                        | (136,282  | )              |  |           | 6.43  |                |  |           | (272,649  | )              |  |   | 10.99 |  |  |  | (892,675  | ) |  |   | 11.96 | 
|Exercised                      |  |                        | (947,954  | )              |  |           | 2.28  |                |  |           | (419,488  | )              |  |   | 4.52  |  |  |  | (35,000   | ) |  |   | 3.73  | 
|Outstanding, end of year       |  |                        | 2,700,057 |                |  | $         | 6.70  |                |  |           | 3,153,427 |                |  | $ | 8.50  |  |  |  | 5,118,752 |   |  | $ | 5.06  | 

|               |               |                     |         |                     |           |                |      |                   |      |                |     |       |      |  |         |         |           |   |     |       |      | 
|-------------- | ------------- | ------------------- | ------- | ------------------- | --------- | -------------- | ---- | ----------------- | ---- | -------------- | --- | ----- | ---- |  | ------- | ------- | --------- | - | --- | ----- | ---- | 
|               |               |                     |         |                     |           |               
|               |               | Options Outstanding |         |                    
|               |               |                     |         | Options Exercisable
|               |               |                     |         | Weighted-Avg.       |           |                |      |                  
|               |               | Number              |         | Remaining           |           |                |      | Number            |      |               
|Range Of       |               | Outstanding at      |         | Contractual Life    |           | Weighted-Avg.  |      | Exercisable at    |      | Weighted-Avg. 
|Exercise Price |               | December 31, 2003   |         | (Number of Years)   |           | Exercise Price |      | December 31, 2003 |      | Exercise Price
|               |               |                     |         |                     |           |                |      |                   |      |               
|$ 0.18 -  2.00 |               |                     | 468,834 |                     |           |                | 2.34 |                   |      | $              | .45 |       |      |  | 469,834 |         |           | $ | .45 |      
|               |               | 2.03 -  4.00        |         |                     | 1,726,810 |                |      |                   | 7.98 |                |     |       | 2.40 |  |         |         | 447,810   |   |     |       | 2.66 | 
|               |               | 4.50 -  6.19        |         |                     | 1,940,949 |                |      |                   | 9.40 |                |     |       | 4.44 |  |         |         | 876,552   |   |     |       | 4.61 | 
|               |               | 6.93 -  9.00        |         |                     | 122,161   |                |      |                   | 6.31 |                |     |       | 8.60 |  |         |         | 106,599   |   |     |       | 8.71 | 
|               | 11.75 - 13.88 |                     |         | 526,145             |           |                |      | 8.06              |      |                |     | 12.17 |      |  |         | 261,145 |           |   |     | 12.32 |     
|               | 14.00 - 21.30 |                     |         | 332,853             |           |                |      | 7.85              |      |                |     | 16.50 |      |  |         | 202,460 |           |   |     | 16.50 |     
|               |               |                     |         |                     |           |                |      |                   |      |                |     |       |      |  |         |         |           |   |     |      
|               |               | 0.18 - 21.30        |         |                     | 5,118,752 |                |      |                   | 7.96 |                |     | $     | 5.06 |  |         |         | 2,364,400 |   |     | $     | 5.47 | 
|               |               |                     |         |                     |           |                |      |                   |      |                |     |       |      |  |         |         |           |   |     |      

The weighted average fair value of the
Companys options at the grant date was approximately $7.58
in 2001, $9.54 in 2002 and $3.02 in 2003.

F-26



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option pricing
model, with the following assumptions:

|                        |  |      |          |      |  |      |          |   |  |  |          |  
|----------------------- |  | ---- | -------- | ---- |  | ---- | -------- | - |  |  | -------- | -
|                        |  | 2001 |          | 2002 |  | 2003
|                        |  |      |          |      |  |     
|Stock volatility        |  |      | .8       |      |  |      | 1.14     |   |  |  | 1.57     |  
|Risk-free interest rate |  |      | 4.8      | %    |  |      | 4.3      | % |  |  | 3.4      | %
|Expected life in years  |  |      | 5  years |      |  |      | 5  years |   |  |  | 5  years |  
|Stock dividend yield    |  |      |         |      |  |      |         |   |  |  |         |  

During 2001, 2002 and 2003, the Company incurred
employment taxes associated with the exercise of employee stock
options and loan forgiveness totaling $182,000, $870,000 and
$121,000, respectively. Employment related taxes payable at
December 31, 2002 and 2003 were $1,169,000 and $1,290,000,
respectively (included in accrued compensation).

Warrants

The Company has issued warrants in conjunction
with debt financing transactions, underwriting agreements,
patent licenses and service contracts between 1996 and 2000
Warrants have a contractual term of five years and vest over a
one- to five-year period. Warrant exercise prices range from
$2.31 to $15.40 per share. As of December 31, 2003,
the Company had warrants outstanding to purchase
75,000 shares of the Companys common stock, of which
65,000 are exercisable. During 2001 and 2002, warrants to
purchase 106,896 and 30,000 shares of common stock,
respectively, were exercised. No warrants to purchase shares
were exercised in 2003.

The Company also issued detachable warrants to
investors to purchase 188,680 shares of the Companys
common stock in conjunction with the November 2000 private
placement (see Note 8). These warrants have a five-year
term and are immediately exercisable at $13.91 per share.
12,500 shares were exercised in 2001 with 176,180
outstanding at December 31, 2003.

The Company estimates the fair value of each
warrant on the date of grant using the Black-Scholes option
pricing model, with the assumptions similar to option grants
above. Warrants granted in connection with the issuance of
equity and debt and asset purchase transactions are recorded to
additional paid-in capital. Warrants issued for services are
amortized to expense over the related service periods.

Stockholder
Rights Plan

In April 1999, the Company adopted a stockholder
rights plan (the Plan) in which preferred stock purchase rights
were distributed as a dividend at the rate of one right for each
share of common stock held as of the close of business on
April 15, 1999. The rights are designed to guard against
partial tender offers and other abusive and coercive tactics
that might be used in an attempt to gain control of the Company
or to deprive the Companys stockholders of their interest
in the long-term value of the Company. The rights will be
exercisable only if a person or group acquires 15% or more of
the Companys common stock (subject to certain exceptions
stated in the Plan) or announces a tender offer the consummation
of which would result in ownership by a person or group of 15%
or more of the Companys common stock. At any time on or
prior to the close of business on the first date of a public
announcement that a person or group has acquired beneficial
ownership of 15% or more of the Companys common stock
(subject to certain exceptions stated in the Plan), the rights
are redeemable for one cent per right at the option of the Board
of Directors.

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|10. | Income Taxes

The Company reported no income tax expense for
each of the three years in the period ended
December 31, 2003 due to its operating losses. The
following table summarizes the tax effects of temporary
differences, which give rise to significant portions of the
deferred tax assets at December 31:

|                                   |                                                          |                         |            |             |   |  |            |             |   | 
|---------------------------------- | -------------------------------------------------------- | ----------------------- | ---------- | ----------- | - |  | ---------- | ----------- | - | 
|                                   |                                                          | 2002                    |            | 2003       
|                                   |                                                          |                         |            |            
|Deferred tax assets (liabilities): |                                                          |                         |            |             |   |  |            |            
|                                   | Investment valuation reserves                            |                         | $          | 1,074,000   |   |  | $          | 1,074,000   |  
|                                   | Basis difference in intangible assets                    |                         |            | (1,314,000  | ) |  |            | (146,000    | )
|                                   | Property and equipment allowances and depreciation       |                         |            | 570,000     |   |  |            | (320,000    | )
|                                   | Inventory obsolescence and related allowances            |                         |            | 1,087,000   |   |  |            | 1,135,000   |  
|                                   | Accounts receivable allowances and revenue
    deferrals |                         |            | 2,951,000   |   |  |            | 1,049,000   |  
|                                   | Note receivable allowances                               |                         |            |            |   |  |            | 1,040,000   |  
|                                   | Installment sales                                        |                         |            |            |   |  |            | (849,000    | )
|                                   | Other accrued liabilities                                |                         |            | 2,462,000   |   |  |            | 2,105,000   |  
|                                   | Accrued compensation                                     |                         |            | 654,000     |   |  |            | 1,397,000   |  
|                                   | Net operating loss and credit carryforwards              |                         |            | 23,274,000  |   |  |            | 33,808,000  |  
|                                   |                                                          |                         |            |             |   |  |            |            
|                                   |                                                          |                         | 30,758,000 |             |   |  | 40,293,000 |            
|                                   | Valuation allowance                                      |                         |            | (30,758,000 | ) |  |            | (40,293,000 | )
|                                   |                                                          |                         |            |             |   |  |            |            
|                                   |                                                          | Net deferred tax assets |            | $           |  |  |            | $           |  | 
|                                   |                                                          |                         |            |             |   |  |            |            

Due to continuing operating losses, the valuation
allowance increased by $8,877,000 and $9,535,000 during the
years ended December 31, 2002 and 2003, respectively. In
addition, the valuation allowance increased by an additional
$4,118,000 during 2002 due to the transfer of fully reserved
deferred tax assets obtained in connection with the Timm Medical
acquisition. Due to the Companys history of operating
losses, management has not determined that it is more likely
than not that the Companys deferred tax assets will be
realized through future earnings. Accordingly, valuation
allowances have been recorded to fully reserve the
Companys deferred tax assets as of December 31, 2002
and 2003.

In February 2002, the Company entered into a
definitive agreement to acquire Timm Medical in a nontaxable
stock transaction. As of the acquisition date, Timm Medical had
$4,118,000 of deferred tax assets (net of deferred tax
liabilities) consisting principally of $12,156,000 of federal
net operating loss carryforwards and $156,000 of federal
research and experimentation credit carryforwards. Due to the
uncertainty over the realization of these assets, a valuation
reserve has been recorded against the deferred tax assets
acquired. Subsequent tax benefits resulting from realization of
these deferred tax assets will be applied to reduce the
valuation allowance and goodwill related to the Timm Medical
acquisition. Additionally, as the acquisition resulted in an
ownership change for Timm Medical, the annual utilization of the
net operating loss and research and experimentation credit
carryforwards of Timm Medical will be limited for tax purposes
under Internal Revenue Code (IRC) Sections 382
and 383.

F-28



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Actual income tax expense differs from amounts
computed by applying the U.S. federal income tax rate of
34% to pretax loss as a result of the following:

|                                |                    |                          |            |      |  |      |             |   |  |   |            |   | 
|------------------------------- | ------------------ | ------------------------ | ---------- | ---- |  | ---- | ----------- | - |  | - | ---------- | - | 
|                                |                    |                         
|                                |                    | Years Ended December 31,
|                                |                    |                         
|                                |                    | 2001                     |            | 2002 |  | 2003
|                                |                    |                          |            |      |  |     
|Computed expected tax benefit   |                    | $                        | (3,894,000 | )    |  | $    | (14,275,000 | ) |  | $ | (8,442,000 | )
|Nondeductible expenses          |                    |                          | 177,000    |      |  |      | 244,000     |   |  |   | 302,000    |  
|Goodwill impairment             |                    |                          |           |      |  |      | 6,115,000   |   |  |   |           |  
|Increase in valuation allowance |                    |                          | 3,655,000  |      |  |      | 7,916,000   |   |  |   | 8,140,000  |  
|Other                           |                    |                          | 62,000     |      |  |      |            |   |  |   |           |  
|                                |                    |                          |            |      |  |      |             |   |  |   |            |  
|                                | Actual tax expense |                          | $          |     |  |      | $           |  |  |   | $          |  | 
|                                |                    |                          |            |      |  |      |             |   |  |   |            |  

As of December 31, 2003, the Company has
federal and state net operating loss carryforwards of
$85,411,000 and $53,740,000, respectively. The federal net
operating loss carryforwards begin to expire in 2011 and the
state net operating loss carryforwards begin to expire in 2006.
In addition, the Company has federal and state research and
experimentation credit carryforwards of $436,000 and $253,000,
respectively. The federal research and experimentation credit
carryforwards begin to expire in 2011 and the state research and
experimentation credit carryforwards do not expire.

IRC Sections 382 and 383 limit the annual
utilization of net operating loss and tax credit carryforwards
existing prior to a change in control. Based upon prior equity
transaction activity, some or all of the Companys existing
net operating loss and tax credit carryforwards may be subject
to annual limitations under IRC Sections 382 and 383. The
Company has not performed an analysis to determine whether such
change in control has occurred for tax reporting purposes and if
so, the specific limitations that may result.



|    |                                   
|--- | ----------------------------------
|11. | Collaborative and Other Agreements



| |                     
| | --------------------
| | Sanarus Medical Inc.

In October 1999, the Company entered into a
strategic alliance with Sanarus Medical, Inc. (Sanarus), a
privately held medical device company. The Company received
200,041 Series A voting convertible Preferred Shares or
6.8% of the total outstanding voting securities at the
investment date in exchange for $300,000. The Company also
received a warrant to acquire 3,166,000 common shares
(approximately 52.0% of Sanarus voting stock on an
as-converted, fully-diluted basis at that time) for
$.01 per share in consideration for entering into a
manufacturing, supply and license agreement (the 1999
Agreement). The 1999 Agreement provided Sanarus an
exclusive, royalty-free, worldwide non-sublicensable right to
develop, manufacture and sell products using cryoablation
technology developed by Endocare for use in the field of
gynecology and breast diseases. The 1999 Agreement expires at
the earlier of the 30th anniversary, expiration of the
patents underlying the licensed technology or a change in
control event (as defined) at Sanarus. The warrant is
exercisable at any time through October 12, 2009. In June
2001, the Company and Sanarus entered into a license agreement
(the 2001 Agreement) amending the terms and
conditions of the 1999 Agreement to provide for, among other
things: (i) the termination of Sanarus exclusive,
royalty-free, worldwide non-sublicensable right under the 1999
Agreement; (ii) Sanarus grant to Endocare of an
exclusive (even as to Sanarus), worldwide, irrevocable, fully
paid-up right to develop, manufacture and sell products using
certain Sanarus technology for use in the diagnosis, prevention
and treatment of prostrate, kidney and liver diseases, disorders
and conditions; and (iii) Endocares grant to Sanarus
of an exclusive (even as to Endocare), worldwide, irrevocable,
fully paid-up right to develop, manufacture and sell products
using certain Endocare technology for use in the diagnosis,
prevention and treatment of gynecological and breast diseases,
disorders and conditions.

F-29



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In June 2001, the Company provided a bridge loan
to Sanarus in the amount of $250,000 and received a warrant to
purchase 36,210 shares of Series B voting Preferred
Stock. The loan was repaid in July 2001 upon receipt of
additional equity funding by Sanarus. In April 2003, the Company
and other investors entered into a second bridge loan financing
in which Sanarus issued to the Company a convertible promissory
note in the aggregate amount of $600,000 and a warrant to
purchase equity shares in Sanarus with an aggregate exercise
price of up to $300,000. Upon completion of a $19,100,000 equity
financing by Sanarus in October 2003, the $600,000 bridge loan
and warrant were canceled in exchange for 908,025 shares of
Series C voting Preferred Stock and a warrant to purchase
308,823 Series C shares at $.68 per share. This and
other financings changed the Companys current voting
percentage from 1.8% on an as converted, basis (20% on an as
converted, fully diluted basis) at December 31, 2002 to
2.7% on an as converted basis (7.9% on an as converted, fully
diluted basis) at December 31, 2003.

Under the 1999 and 2001 Agreements, the Company
manufactured customized cryoprobes for the treatment of breast
diseases for Sanarus at cost plus a profit margin. Certain
proprietary components were purchased directly from Sanarus and
were included in cost of revenues. These revenues and cost of
revenues were not significant. Effective December 31, 2002,
the Company no longer supplied or manufactured products for
Sanarus.

The Companys former Chief Executive Officer
and Chairman of the Board was a member of Sanarus Board of
Directors through October 22, 2003. A former member of the
Companys Board of Directors is also a member of
Sanarus Board of Directors, and is an officer and partner
in a venture fund that in the aggregate beneficially owns more
than 10% of the outstanding Series A Preferred Stock of
Sanarus. Total investment in Sanarus of $300,000 and $917,000 at
December 31, 2002 and 2003, respectively, is included in
investments and other assets. The investment is recorded at cost
since the Company does not have significant influence over the
operations of Sanarus.



| |                                   
| | ----------------------------------
| | U.S. Medical
    Development, Inc.

On June 30, 2001, the Company issued
213,010 shares of its common stock with a fair value of
$2,837,293 as consideration for a membership interest in
U.S. Medical Development, Inc., formerly
U.S. Therapies, LLC, in the form of 1,134,922 Class A
units. The investment represents approximately 9% of the total
issued and outstanding Class A Units of U.S. Medical
Development, Inc. and approximately 5% of the Class A
Units on a fully diluted basis. U.S. Medical
Development, Inc. is a privately held national urology
services company based in Dallas, Texas, representing more than
150 urologists across the nation. In a related distributor
agreement, U.S.M.D., Ltd., formerly U.S. Medical Devices,
Ltd., a subsidiary of U.S. Medical Development, Inc,
was appointed a distributor and given exclusive sales rights to
the Companys Cryocare Surgical System and associated
disposable products in 16 states. U.S.M.D., Ltd. also had
the exclusive right to distribute the Cryocare Surgical System
to HealthTronics Surgical Services, Inc. and its
affiliates, a publicly held company that provides urologic and
orthopedic services to patients in 35 states through
physician partnerships. The investment in U.S. Medical
Development, Inc. is included in investments and other
assets and is carried using the cost method of accounting as the
Company does not have significant influence over the operations
of U.S. Medical Development, Inc. The Company has
recorded sales of Cryocare Surgical Systems and cryoprobes to
U.S.M.D., Ltd. totaling $4,105,000 and $2,257,000 in 2001 and
2002, respectively. As discussed in Note 4, the distributor
agreement was terminated upon the Companys acquisition of
certain Mobile Businesses from USMD on September 30, 2002.
No amounts were due from U.S.M.D., Ltd. at December 31,
2002 or 2003.

As discussed in Note 3, the Company recorded
an other-than-temporary loss of $2,327,000 in its investment in
U.S. Medical Development, Inc. during the fourth
quarter of 2002. The carrying value of the investment at
December 31, 2002 and 2003 was $510,000.

F-30



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |         
| | --------
| | CryoCath

In September 2001, the Company entered into a
strategic alliance with CryoCath pursuant to an exclusive global
market access and supply agreement, whereby CryoCath and the
Company would co-develop a new, advanced line of surgical probe
systems to treat cardiac arrhythmias. CryoCath would purchase
the newly developed systems from Endocare and market them on a
global basis under the CryoCath trademark,
SurgiFrostTM. CryoCath paid the Company $125,000 in
license fees upon execution of the agreement. Additional fees
were due upon the availability of a malleable cryoprobe and for
the sale of a fixed number of cryo-consoles. However, these
amounts were never received since the performance targets had
not been met. The agreement also provided volume purchase
discounts to CryoCath to be determined annually on a
retrospective basis. The agreement had an initial term of five
years and with renewals for two additional three-year periods if
certain conditions were met. As discussed in Note 5, the
distribution agreement was terminated in April 2003
(Note 5) upon the sale of the cardiac product line and
related assets to CryoCath. Purchase discounts due to CryoCath
of $558,000 at December 31, 2002 (included in other accrued
liabilities) were settled as part of the sale of the cardiac
product line to CryoCath in April 2003.



| |               
| | --------------
| | Qualigen, Inc.

In June 2001, the Company entered into an
exclusive original equipment manufacturer agreement with
Qualigen, Inc. (Qualigen), to distribute
Qualigens 15-minute PSA test known as the
FastPackTM System as part of the Companys
diagnostic workstation for urology. The agreement had a term of
five years and included one year of exclusivity with the option
for four one-year extensions of exclusivity based upon minimum
purchase commitments. In September 2001, the Company entered
into a new expanded distribution agreement with Qualigen to sell
Qualigens FDA-cleared 15-minute total prostate-specific
antigen test directly to urology practices as a stand-alone
product on a non-exclusive basis. These agreements were
terminated as of December 31, 2002. The Company purchased
$150,000 in products from Qualigen during 2001.



| |                                                           
| | ----------------------------------------------------------
| | Patent, Licensing, Royalty and Distribution
    Agreements

The Company has entered into other patent,
licensing and royalty agreements with third parties, some of
whom also have proctoring and other consulting agreements with
the Company and are owners of or affiliated with entities which
have purchased Cryocare Surgical Systems and cryoprobes from the
Company. These agreements generally provide for purchase
consideration in the form of cash, common shares, warrants or
options and royalties based on a percentage of sales related to
the licensed technology, subject to a minimum amount per year.
The patents and licensing rights acquired are recorded based on
the fair value of the consideration paid. Options and warrants
issued are valued using the Black-Scholes option pricing model.
These assets are amortized over their respective estimated
useful lives. Royalty payments are expensed as incurred.

In addition to the U.S.M.D., Ltd. and CryoCath
agreements, the Company has entered into distribution agreements
with third parties. These agreements govern all terms of sale,
including shipping terms, pricing, discounts and minimum
purchase quotas, if applicable. Pricing is fixed and
determinable and the distributors contractual obligation
to pay is not contingent on other events, such as final sale to
the end-user. The Company generally does not grant a right of
return except for defective products in accordance with its
warranty policy, and in some cases for unsold inventory within a
limited time period upon the termination of the distribution
agreement.

F-31



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                              
|--- | -----------------------------
|12. | Commitments and Contingencies



| |       
| | ------
| | Leases

The Company leases office space and equipment
under operating leases, which expire at various dates through
2007. Some of these leases contain renewal options and rent
escalation clauses. Future minimum lease payments by year and in
the aggregate under all noncancelable operating leases consist
of the following:

|                        |  |   |           | 
|----------------------- |  | - | --------- | 
|Year ending December 31 |  |   |           | 
|2004                    |  | $ | 663,231   | 
|2005                    |  |   | 497,676   | 
|2006                    |  |   | 472,214   | 
|2007                    |  |   | 76,910    | 
|                        |  |   |           | 
|                        |  | $ | 1,710,031 | 
|                        |  |   |           | 



| |                                    
| | -----------------------------------
| | Employment and Severance Agreements

The Company has entered into employment
agreements with certain executives which provide for annual base
salaries and cash bonuses of up to 45% of base salary subject to
attainment of corporate goals and objectives, and in addition to
stock options. The agreements provide for severance payments if
the executive is terminated other than for cause or terminates
for good reason as each is defined. The agreements generally
also provide that should a change in control occur, the
executives will receive benefits under the Companys 2002
Separation Benefits Plan and the severance payments provided in
their respective employment agreements will be reduced
dollar-for-dollar. The options vest over specified time periods
with accelerated vesting upon attainment of performance targets
in certain instances.



| |                
| | ---------------
| | Former Officers



| |                                                             
| | ------------------------------------------------------------
| | Former Chief Executive Officer and Chairman of
    the Board

The Company has entered into a Separation
Agreement and a one-year Consulting Agreement with the
Companys former Chief Executive Officer and Chairman of
the Board (the former CEO), each effective as of
July 31, 2003. Under the Separation Agreement, the former
CEO is entitled to receive a $375,000 severance payment, in
addition to accrued and unpaid wages and unused vacation time.
The former CEO waived all rights to which he is or may be
entitled under the Companys 2002 Separation Benefits Plan.
In exchange for an additional $375,000 upfront payment, under
the provisions of the Consulting Agreement, as amended, the
former CEO has agreed to a one-year covenant not to compete and
during its term, he is required to provide consulting services
at the direction of management for a minimum of eight hours per
quarter. Consulting services in excess of eight hours per
quarter will be compensated at $2,000 per day. The former
CEO will continue to participate in the Companys benefit
plans for 24 months. Of the former CEOs outstanding
vested stock options, 565,000 will continue to remain
outstanding as permitted under the 1995 Stock Plan, and 200,000
of his outstanding stock options were terminated. The Company
recorded a charge of $775,500 in the third quarter of 2003 for
the severance and related benefits. The Separation Agreement and
Consulting Agreement further provide that the former CEO is
required to repay the severance payment and consulting fees
received upon either (i) his conviction in a court of law,
or entering into a plea of guilt or no contest to, any crime
directly relating to his activities on behalf of the Company
during his employment, or (ii) successful prosecution of an
enforcement action by the Securities and Exchange Commission
(SEC) against him. The total severance payment due
of $750,000 was deposited into an escrow account held by the
Company. The restricted cash was included in prepaid expenses
and other current assets and the severance liability was
included in accrued compensation at December 31, 2003. In
March 2004, all amounts due under the Separation Agreement to
the former CEO were released from the escrow account.

F-32



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Former
Chief Financial Officer

The Company entered into an employment agreement,
dated March 3, 2003 (the Employment Agreement),
with the former CFO. Under the agreement, the Company is
required to pay the former CFO a base salary of $220,000 and
cash bonus of up to $88,000 per year. The Employment
Agreement also provides that all of the former CFOs
options to purchase outstanding common stock
(385,000 shares) would be cancelled and replaced by
immediately exercisable options to be granted between
September 4, 2003 and November 3, 2003. The
replacement options were issued on October 30, 2003 at an
exercise price of $4.50 per share, which is equal to the
fair market value of the common stock on the date of grant.

The Employment Agreement also provides that upon
any Qualified Termination (as defined), the former CFO will be
entitled to a cash payment of $616,000, continued participation
in the Companys benefit plans for 24 months, a
$50,000 relocation allowance and an additional payment to cover
the tax liabilities relating to the allowance. In addition, the
exercise period of the replacement options will be extended
until the second anniversary of the termination date. Effective
July 31, 2003, the Company terminated the former CFOs
employment other than for cause. The Company recorded a third
quarter charge for $731,000 for severance, medical, and
relocation benefits due under the Qualified Termination
provisions. In addition, the Company recorded a third quarter
charge for $1,715,000 for the fair value of the 385,000
replacement options determined using the Black-Scholes option
pricing model.

Under the Employment Agreement, the former CFO is
required to repay all amounts received in a Qualified
Termination upon (i) the former CFOs conviction in a
court of law, or entering into a plea of guilt or no contest to,
any crime directly relating to his activities on behalf of the
Company during his employment, or (ii) successful
prosecution of an enforcement action by the SEC against the
former CFO. The total severance payments due of $616,000 were
deposited into an escrow account held by the Company. The
restricted cash was included in prepaid expenses and other
current assets and the severance liability was included in
accrued compensation at December 31, 2003. In March 2004,
all amounts due under the Separation Agreement to the former CFO
were released from the escrow account.

2002
Executive Separation Benefits Plan

Effective July 17, 2002, the Company adopted
the 2002 Executive Separation Benefits Plan (Separation
Plan) to provide separation benefits to certain designated
employees. The Separation Plan provides that, in the case of any
Covered Termination, the participants will receive
from six months to two years of their base salary plus the
maximum bonus, as defined. Covered Terminations include
termination by the employee for good reason after a change in
control, by the employee for any or no reason during the 30-day
period immediately following the six-month anniversary of a
change in control, or voluntarily by the Company or its
successor after a change in control for a reason other than
cause, death or disability. Participants are also entitled to
continued eligibility for the Companys benefit program for
a period equal to the number of months of base pay to be
received.

Employee
Benefit Plans

The Company has a 401(k) savings plan covering
substantially all employees. The Plan currently provides for a
discretionary match of amounts contributed by each participant
as approved by the Compensation Committee of the Board of
Directors. Prior to the acquisition, Timm Medical also sponsored
a 401(k) savings plan for its employees (the Timm Medical
Plan). Management combined the two plans effective
September 30, 2003. Employer matching contributions to the
Endocares Plan totaled approximately $153,846 for the year
ended December 31, 2001. No matching contributions were
made in 2002 or 2003.

F-33



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Legal
Matters

In November 2002, the Company was sued in an
action filed by BioLife in the Delaware Court of Chancery.
BioLife sought damages for alleged breaches of contract stemming
from the Companys acquisition of the tangible and
intangible assets related to BioLifes cryosurgical
business (see Note 4). BioLife alleged that the Company
failed to timely register 120,022 shares of the
Companys common stock provided to BioLife as partial
consideration for the asset acquisition, in violation of a
registration rights agreement relating to the shares issued to
BioLife. On October 1, 2003, BioLife was awarded $1,648,000
plus prejudgment interest and costs (including legal fees) and
BioLife was required to surrender the 120,022 shares to the
Company. As a result of this decision, the Company recorded a
2002 fourth quarter charge of $1,500,000 (included in other
accrued liabilities), representing the difference between the
courts award to BioLife and the estimated fair value of
the shares to be surrendered. That ruling became an appealable
final order and judgment on October 10, 2003 and the
Company filed a notice of appeal. On February 20, 2004, the
Company agreed to abandon the appeal in exchange for a cash
payment of $1,887,474 to Biolife, which represented a discount
of $150,000 from the total judgment amount (including accrued
interest and costs) and return of the 120,022 common shares. The
shares were recorded as treasury stock in March 2004 based on
the fair value of $492,000 at that date and the balance of
$1,395,000 was applied against a litigation accrual previously
recorded in 2002 and included in other accrued liabilities at
December 31, 2003.

In November 2002, the Company was named as a
defendant, together with certain former officers, one of whom is
also a former board member, in a class-action lawsuit filed in
the United States District Court for the Central District of
California. On February 2, 2003, the court issued an order
consolidating this action with various other similar complaints
and ordered plaintiffs to file a consolidated complaint, which
they filed on October 31, 2003. The consolidated complaint
alleges that the defendants violated sections of the Securities
Exchange Act of 1934 by purportedly issuing false and misleading
statements regarding the Companys revenues and expenses in
press releases and SEC filings. The plaintiffs seek class
certification and unspecified damages as well as forfeiture and
reimbursement of bonus compensation received by two of the
individual defendants.

On December 6, 2002, Frederick Venables
filed a purported derivative action against the Company and
certain former officers and certain current and former board
members in the California Superior Court for the County of
Orange alleging breach of fiduciary duty, abuse of control,
gross mismanagement, waste of corporate assets and unjust
enrichment. On April 17, 2003, the court issued an order
staying the action until resolution of the anticipated motion to
dismiss the consolidated complaint in the federal securities
action pending in the Central District of California. Pursuant
to this order, no deadline is currently set for our response to
the complaint. The complaint seeks unspecified monetary damages,
equitable relief and injunctive relief based upon allegations
that the defendants issued false and misleading statements
regarding our revenues and expenses in press releases and SEC
filings.

Plaintiffs in the two lawsuits discussed in the
preceding paragraphs are seeking compensatory damages, including
interest, costs and expenses, attorneys fees, and other
relief. The Company intends to defend these cases vigorously.

The SEC is currently conducting an investigation
to determine whether any federal securities laws were violated
in connection with the filing of the Companys financial
statements for 2001 and the first two quarters of 2002,
including investigation into allegations that the Company and
certain of its current and former officers and directors issued
or caused to be issued false and misleading statements regarding
the Companys revenues and expenses in those SEC filings.
The Company is cooperating fully with this investigation.

The Department of Justice is currently conducting
an investigation into allegations that the Company and certain
of its current and former officers and directors intentionally
issued or caused to be issued false and

F-34



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

misleading statements regarding the
Companys revenues and expenses in SEC filings. The Company
is cooperating fully with this investigation.

In December 2002, the Company filed a demand for
arbitration before the American Arbitration Association in
Minnesota against a former employee. The complaint included
various claims in response to which the employee made several
counterclaims. In March 2003, the Company was notified by the
United States Department of Labor that counsel for the employee
had presented a letter of complaint alleging that the Company,
its former Chairman and Chief Executive Officer and former Chief
Financial Officer violated 18 U.S.C. § 1514A by
improperly retaliating against the employee. In December 2003,
the Company and the employee agreed to settle all claims on
mutually acceptable terms without the admission of liability by
any party for an amount that is not significant. Pursuant to the
settlement, the employee withdrew his letter of complaint, and
the Department of Labor has indicated that it considers this
matter closed.

In June 2003, the Company was awarded a favorable
judgment for $351,000 in a litigation matter previously
initiated by Timm Medical against a third party. Since
collection is not assured, this amount of this settlement will
be recorded in the period when it is actually paid to the
Company.

In addition, the Company, in the normal course of
business, is subject to various other legal matters, which
management believes will not individually or collectively have a
material adverse effect on the Companys results of
operations or cash flows of a future period. The results of
litigation and claims cannot be predicted with certainty, and
the Company cannot provide assurance that the outcome of various
legal matters, including a class action and a derivative
lawsuit, will not have a material adverse effect on its
consolidated financial condition, results of operations or cash
flows. At December 31, 2003, except as indicated above, the
Company has not established a liability for these contingencies
in the consolidated balance sheets since the likelihood of loss
and the potential liability cannot be reasonably estimated at
this time. Managements evaluation of the likelihood of an
unfavorable outcome with respect to these actions could change
in the future. The Company has purchased directors and officers
liability and other insurance which may fund certain losses,
including defense costs, related to the above litigation
matters. These recoveries will be recorded when the amounts are
determined to be recoverable from the insurance carriers.

From time to time, the Company has received other
correspondence alleging infringement of proprietary rights of
third parties. No assurance can be given that any relevant
claims of third parties would not be upheld as valid and
enforceable, and therefore that the Company could be prevented
from practicing the subject matter claimed or would be required
to obtain licenses from the owners of any such proprietary
rights to avoid infringement. Management does not expect any
material adverse effect on the consolidated financial condition,
the results of operations, or cash flows because of such actions.



|    |                           
|--- | --------------------------
|13. | Related Party Transactions



| |                  
| | -----------------
| | Loans to Officers

The Company has extended loans to certain
employees and related parties. Loans made that are other than
for the purchase of common stock are included in Investments and
Other Assets in the accompanying consolidated balance sheets.

In November 1999, the Company received a full
recourse promissory note for $1,028,125 in connection with the
sale of 175,000 common shares at fair value to the
Companys then-Senior Vice President, Sales and Marketing.
The four-year note bore interest at 5.99% per annum,
payable annually, and was recorded as a reduction in
stockholders equity. The Company agreed to forgive the
principal on the note ratably over four years subject to that
individual remaining an employee. At December 31, 2003, the
full value of the note has been forgiven. Principal forgiven
totaled $257,000 in 2001 and 2002, and $214,292 in 2003. The
Company recorded the annual forgiveness as compensation expense
(included in selling, general and administrative expense). No
interest income has been recorded on the note. In August 2003,
the Company terminated the

F-35



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

individuals employment and is currently
negotiating with this individual regarding repayment of the
loan. Recoveries, if any, will be recorded when received.

In March 2001, the Company received full recourse
promissory notes from three officers totaling $128,000 due at
the earlier of the second anniversary or the employment
termination date. These notes bear interest at 4.8% per
annum and were extended to facilitate the employees
acquisition of Companys common shares in the open market.
At December 31, 2002, the Company wrote off $140,000
representing the outstanding principal and unpaid interest on
these notes (included in selling, general and administrative
expense).

In January 2003, the Company extended a $344,000
non-recourse loan to an individual who is a shareholder and
consultant. The Company previously entered into an asset
purchase agreement with the shareholder in February 2002. The
Company extended the loan to the shareholder to assist with the
payment of related federal income taxes arising from the 2002
purchase transaction. The loan is secured by the shares issued,
bears interest at 1.8% and is due at the earlier of January 2005
or 30 days after the borrower ceases to be a consultant to
the Company.



|    |                  
|--- | -----------------
|14. | Other Investments

Material equity investments in companies acquired
through collaboration agreements not previously disclosed
earlier in the footnotes include the following:

a. 833,333 common shares (approximately 14%
interest) in Medical Resource Management, Inc.
(MRM), a publicly traded company that provides
mobile surgical equipment rental, certified technician, training
and support services to hospitals and medical facilities on a
fee per procedure basis (acquired September 2000 for cash of
$250,000). MRM specializes in laser surgery, cryosurgery,
brachytherapy and other capital-intensive medical equipment. In
June 2001, Emergent Group, Inc. acquired the outstanding
stock of MRM in a share exchange. The Company wrote off the
$250,000 carrying value of this investment as a loss on minority
investment in the second quarter of 2001 since the shares
received in exchange have de-minimus value.

b. 33,945 common shares in
Matritech, Inc., a publicly traded company that develops
proteomics-based diagnostic products for early detection of
cancer (acquired February 2001 for cash of $150,000). Timm
Medical was the exclusive United States distributor of bladder
cancer diagnostic test kits manufactured by Matritech, Inc.
The distribution agreement was terminated in June 2002.
Purchases from Matritech, Inc. were immaterial. The
carrying value of the investment at December 31, 2002 and
2003 was $72,000 and $64,000, respectively.

F-36



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                                
|--- | -----------------------------------------------
|16. | Quarterly Results of Operations
    (Unaudited)

The following is a summary of the quarterly
results of operations for the years ended December 31, 2003
and 2002.

|                                                         |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |            |  
|-------------------------------------------------------- | ------- | ------------- | ---------- | ------------- | - | ------------- | --------- | ------------- |  | - | ----------- | ---------- | - | - | ---------- | ---------- | -
|                                                         |         | Quarter Ended |            | Quarter Ended |   | Quarter Ended |           | Quarter Ended
|                                                         |         | March 31,     |            | June 30,      |   | September 30, |           | December 31, 
|                                                         |         | 2003          |            | 2003          |   | 2003          |           | 2003         
|                                                         |         |               |            |               |   |               |           |              
|Revenues                                                 |         | $             | 7,661,784  |               |   | $             | 7,490,367 |               |  | $ | 8,041,119   |            |   | $ | 7,303,907  |           
|                                                         |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|Cost of revenues                                         |         | $             | 3,996,046  |               |   | $             | 3,469,503 |               |  | $ | 4,093,747   |            |   | $ | 4,498,230  |           
|                                                         |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|Gain on divestitures, net                                |         | $             |           |               |   | $             | 9,944,424 |               |  | $ |            |            |   | $ | (1,313,534 | )         
|                                                         |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|Net income (loss)                                        |         | $             | (6,087,898 | )             |   | $             | 1,661,452 |               |  | $ | (11,112,845 | )          |   | $ | (9,908,011 | )         
|                                                         |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|Net income (loss) per share of common stock:             |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|                                                         | Basic   |               | $          | (.25          | ) |               | $         | .07           |  |   | $           | (.46       | ) |   | $          | (.41       | )
|                                                         | Diluted |               | $          | (.25          | ) |               | $         | .07           |  |   | $           | (.46       | ) |   | $          | (.41       | )
|Weighted average shares of common stock
    outstanding: |         |               |            |               |   |               |           |               |  |   |             |            |   |   |            |           
|                                                         | Basic   |               |            | 24,151,962    |   |               |           | 24,155,740    |  |   |             | 24,182,004 |   |   |            | 24,183,254 |  
|                                                         | Diluted |               |            | 24,151,962    |   |               |           | 25,287,911    |  |   |             | 24,182,004 |   |   |            | 24,183,254 |  

|                                                         |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |            |  
|-------------------------------------------------------- | ------- | ------------- | ---------- | ------------- | - | ------------- | ---------- | ------------- | - | - | ---------- | ---------- | - | - | ----------- | ---------- | -
|                                                         |         | Quarter Ended |            | Quarter Ended |   | Quarter Ended |            | Quarter Ended
|                                                         |         | March 31,     |            | June 30,      |   | September 30, |            | December 31, 
|                                                         |         | 2002          |            | 2002          |   | 2002          |            | 2002         
|                                                         |         |               |            |               |   |               |            |              
|Revenues                                                 |         | $             | 6,640,026  |               |   | $             | 8,785,887  |               |   | $ | 8,381,793  |            |   | $ | 7,108,719   |           
|                                                         |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|Cost of revenues                                         |         | $             | 3,304,736  |               |   | $             | 4,188,170  |               |   | $ | 4,525,786  |            |   | $ | 4,465,704   |           
|                                                         |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|Goodwill impairment and other charges                    |         |               |           |               |   |               |           |               |   |   |           |            |   |   | 20,311,293  |           
|                                                         |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|Net loss                                                 |         | $             | (3,473,281 | )             |   | $             | (5,205,052 | )             |   | $ | (4,724,897 | )          |   | $ | (28,582,516 | )         
|                                                         |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|Net loss per share of common stock:                      |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|                                                         | Basic   |               | $          | (0.15         | ) |               | $          | (0.22         | ) |   | $          | (0.19      | ) |   | $           | (1.18      | )
|                                                         | Diluted |               | $          | (0.15         | ) |               | $          | (0.22         | ) |   | $          | (0.19      | ) |   | $           | (1.18      | )
|Weighted average shares of common stock
    outstanding: |         |               |            |               |   |               |            |               |   |   |            |            |   |   |             |           
|                                                         | Basic   |               |            | 22,808,000    |   |               |            | 24,000,000    |   |   |            | 24,279,000 |   |   |             | 24,297,000 |  
|                                                         | Diluted |               |            | 22,808,000    |   |               |            | 24,000,000    |   |   |            | 24,279,000 |   |   |             | 24,297,000 |  

F-37



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

|                                                         |  |                |           |            |  |           |           |            |  |            |         |  |  |   |          |   |  |   |           | 
|-------------------------------------------------------- |  | -------------- | --------- | ---------- |  | --------- | --------- | ---------- |  | ---------- | ------- |  |  | - | -------- | - |  | - | --------- | 
|                                                         |  |                |           |            |  |           |           |           
|                                                         |  |                |           | Additions  |  |           |           |           
|                                                         |  | Balance at the |           |            |  |           |           | Balance at
|                                                         |  | Beginning of   |           | Charges to |  |           |           |            |  | the End of
|                                                         |  | the Period     |           | Operations |  | (a) Other |           | Deductions |  | the Period
|                                                         |  |                |           |            |  |           |           |            |  |           
|2001                                                     |  |                |           |            |  |           |           |            |  |            |         |  |  |   |          |   |  |   |           | 
|Allowance for Doubtful Receivables and Sales
    Returns |  | $              | 406,639   |            |  | $         | 897,450   |            |  | $          |         |  |  | $ | (636,537 | ) |  | $ | 667,552   | 
|2002                                                     |  |                |           |            |  |           |           |            |  |            |         |  |  |   |          |   |  |   |           | 
|Allowance for Doubtful Receivables and Sales
    Returns |  | $              | 667,552   |            |  | $         | 1,233,039 |            |  | $          | 538,000 |  |  | $ | (212,159 | ) |  | $ | 2,226,432 | 
|2003                                                     |  |                |           |            |  |           |           |            |  |            |         |  |  |   |          |   |  |   |           | 
|Allowance for Doubtful Receivables and Sales
    Returns |  | $              | 2,226,432 |            |  | $         | 650,961   |            |  | $          |         |  |  | $ | (445,558 | ) |  | $ | 2,431,835 | 



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|    |  |                                                                                                                                                                    
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Other additions of $538,000 in 2002 represents
    the allowance for doubtful receivables and sales returns related
    to Timm Medical as of the acquisition date.

F-38



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##### Table of Contents



EXHIBIT INDEX

|            |            |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | ---------- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 2.1(1)     |             |  | Agreement and Plan of Reorganization, dated
    February 21, 2002, by and among the Company, Timm Medical
    Technologies, Inc., TMT Acquisition Corporation and certain
    stockholders of Timm Medical Technologies, Inc. Certain
    schedules and other attachments to this exhibit were omitted. We
    agree to furnish supplementally a copy of any omitted schedules
    or attachments to the Commission upon request.    
|            | 2.2(2)     |             |  | Agreement and Plan of Merger, dated June 30,
    1999, by and among the Company, Advanced Medical
    Procedures, Inc., Advanced Medical Procedures, LLC, Gary M.
    Onik, M.D., Robert F. Byrnes and Jerry Anderson. Schedules
    and other attachments to this exhibit were omitted. We agree to
    furnish supplementally a copy of any omitted schedules or
    attachments to the Commission upon request.                   
|            | 2.3(3)     |             |  | Asset Purchase Agreement, dated February 6,
    2002, by and between the Company and Gary M. Onik, M.D.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                                          
|            | 2.4(3)     |             |  | Asset Purchase Agreement, dated May 28,
    2002, by and among the Company and Cryomedical
    Sciences, Inc. Certain schedules and other attachments to
    this exhibit were omitted. We agree to furnish supplementally a
    copy of any omitted schedules or attachments to the Commission
    upon request.                                                                                                                    
|            | 2.5(4)     |             |  | Partnership and Limited Liability Company
    Membership Interest Purchase Agreement, dated as of
    August 12, 2002, by and among the Company and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C. Certain schedules and other attachments
    to this exhibit were omitted. We agree to furnish supplementally
    a copy of any omitted schedules or attachments to the Commission
    upon request.
|            | 2.6(5)     |             |  | Amendment No. 1 to Partnership and Limited
    Liability Company Membership Interest Purchase Agreement, dated
    as of September 30, 2002, by and among the
    Company, Inc. and U.S. Medical Development, Inc.,
    U.S.M.D., Ltd. and U.S.M.D. I, L.L.C.                                                                                                                                                                        
|            | 2.7(6)     |             |  | Agreement of Purchase and Sale, dated as of
    April 7, 2003, by and among American Medical
    Systems, Inc., the Company and Timm Medical
    Technologies, Inc.                                                                                                                                                                                                                                                                  
|            | 2.8(7)     |             |  | Asset Purchase and Technology License Agreement,
    dated as of April 29, 2003, by and between the Company and
    CryoCath Technologies Inc.                                                                                                                                                                                                                                                                                       
|            | 2.9(8)     |             |  | Agreement of Purchase and Sale, dated as of
    October 15, 2003, by and between SRS Medical Corp. and Timm
    Medical Technologies, Inc.                                                                                                                                                                                                                                                                                           
|            | 3.1(2)     |             |  | Certificate of Amendment of Restated Certificate
    of Incorporation of the Company.                                                                                                                                                                                                                                                                                                                                                
|            | 3.2(2)     |             |  | Certificate of Designation of Series A
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                                                                                                                                                      
|            | 3.3(2)     |             |  | Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                               
|            | 3.4        |             |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                          
|            | 10.3(2)   |             |  | Promissory Note, dated November 2, 1999, by
    Jerry Anderson in favor of the Company.                                                                                                                                                                                                                                                                                                                                              
|            | 10.10(9)   |             |  | Lease Agreement, dated November 26, 2001 by
    and between the Company and the Irvine Company.                                                                                                                                                                                                                                                                                                                                      
|            | 10.11(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its directors.                                                                                                                                                                                                                                                                                                                                                  
|            | 10.12(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its executive officers.                                                                                                                                                                                                                                                                                                                                         
|            | 10.13(10) |             |  | 1995 Director Option Plan (as amended and
    restated through March 2, 1999).                                                                                                                                                                                                                                                                                                                                                       
|            | 10.14(12) |             |  | 1995 Stock Plan (as amended and restated through
    April 16, 2002).                                                                                                                                                                                                                                                                                                                                                                
|            | 10.15(13) |             |  | 2002 Supplemental Stock Plan.                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 10.16(4)   |             |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                   
|            | 10.17(5)   |             |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical
    Development, Inc. to the Company.                                                                                                                                                                                                                                                                                               
|            | 10.18(11)  |             |  | Registration Rights Agreement, dated as of
    February 21, 2002, by and among the Company and the parties
    listed on Schedule A thereto.                                                                                                                                                                                                                                                                                         



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##### Table of Contents



|            |            |             |  |                                                                                                                                                             
|----------- | ---------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 10.19(13)  |             |  | Registration Rights Agreement, dated as of
    May 28, 2002, by and between the Company and Cryomedical
    Sciences, Inc.                                  
|            | 10.20(13) |             |  | Letter Agreement, dated June 11, 1999, by
    and between the Company and Jerry Anderson                                                                    
|            | 10.21(13)  |             |  | Blanket Purchase Agreement, effective
    April 1, 2002, by and between Timm Medical
    Technologies, Inc. and the U.S. Department of Veterans
    Affairs.
|            | 10.22(13) |             |  | 2002 Executive Separation Benefits Plan.                                                                                                                    
|            | 10.23(14) |             |  | Employment Agreement, dated as of March 3,
    2003, by and between the Company and William J. Nydam.                                                       
|            | 10.24(14) |             |  | Employment Agreement, dated as of March 25,
    2003, by and between the Company and Katherine Greenberg.                                                   
|            | 10.25     |             |  | Employment Agreement, dated as of March 25,
    2003, by and between the Company and Kevin Quilty.                                                          
|            | 10.26     |             |  | First Amendment to Employment Agreement, dated as
    of September 14, 2003, by and between the Company and
    Katherine Greenberg.                        
|            | 10.27      |             |  | Consulting Agreement, dated as of August 27,
    2003, by and between the Company and Craig T. Davenport.                                                   
|            | 10.28(15) |             |  | Employment Agreement, dated as of
    December 15, 2003, by and between the Company and Craig T.
    Davenport.                                             
|            | 21.1       |             |  | Subsidiaries of Registrant.                                                                                                                                 
|            | 23.1       |             |  | Consent of Ernst & Young
    LLP, Independent Auditors.                                                                                                     
|            | 24.1       |             |  | Power of Attorney, included on signature pages.                                                                                                             
|            | 31.1       |             |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                               
|            | 31.2       |             |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                              
|            | 32.1       |             |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                               
|            | 32.2       |             |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                              



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| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| | * | We have requested confidential treatment with
    respect to certain portions of these documents.



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | Management contract or compensatory plan or
    arrangement



|    |                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------
|(1) | Previously filed on Form 8-K on
    March 5, 2002.                                                                    
|   
|(2) | Previously filed with our Registration Statement
    on Form S-3 filed on September 20, 2001 and
    October 31, 2001.
|   
|(3) | Previously filed on Form 10-Q for the
    quarter ended June 30, 2002.                                                
|   
|(4) | Previously filed on Form 8-K on
    August 16, 2002.                                                                  
|   
|(5) | Previously filed on Form 8-K on
    October 15, 2002.                                                                 
|   
|(6) | Previously filed on Form 8-K on
    April 22, 2003.                                                                   
|   
|(7) | Previously filed on Form 8-K on
    April 29, 2003.                                                                   
|   
|(8) | Previously filed on Form 8-K on
    October 20, 2003.                                                                 
|   
|(9) | Previously filed on Form 10-K for the year
    ended December 31, 2001.                                               



|     |                                                                                                                  
|---- | -----------------------------------------------------------------------------------------------------------------
|(10) | Previously filed with our Registration Statement
    on Form S-8 filed on June 2, 1999.                          
|    
|(11) | Previously filed with our Registration Statement
    on Form S-3 filed on May 15, 2002.                          
|    
|(12) | Previously filed with our definitive proxy
    statement for the 2002 annual meeting filed on April 30,
    2002.
|    
|(13) | Previously filed on Form 10-K for the year
    ended December 31, 2002.                                          
|    
|(14) | Previously filed on Form 8-K on
    March 27, 2003.                                                              
|    
|(15) | Previously filed on Form 8-K on
    December 16, 2003.