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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,
    2002; 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)




---

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, 2002,
was approximately $312,181,137 (based on the closing price for
shares of the Registrants common stock as reported by The
Nasdaq National Market 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 24,312,454 shares of the
Registrants common stock issued and outstanding as of
September 30, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

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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TABLE OF CONTENTS



|              |                                                                                                         |  |  |  |  |  |  | 
|------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1. Business                                                                                       
|              | Item 2. Properties                                                                                     
|              | Item 3. Legal Proceedings                                                                              
|              | Item 4. Submission of Matters to a Vote of Security Holders                                            
|PART II      
|              | Item 5. Market for Our Common Equity and Related Stockholder Matters                                   
|              | Item 6. Selected Consolidated Financial Data                                                           
|              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|              | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|              | Item 8. Financial Statements and Supplementary Data                                                    
|              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           
|PART III     
|              | Item 10. Directors and Executive Officers of the Registrant                                            
|              | Item 11. Executive Compensation                                                                        
|              | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|              | Item 13. Certain Relationships and Related Transactions                                                
|              | Item 14. Controls and Procedures                                                                       
|PART IV      
|              | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|SIGNATURES   
|EXHIBIT INDEX
|EXHIBIT 10.25
|EXHIBIT 10.29
|EXHIBIT 10.31
|EXHIBIT 10.32
|EXHIBIT 10.33
|EXHIBIT 10.34
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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##### Table of Contents



Endocare, Inc.

Form 10-K

For the Fiscal Year Ended December 31,
2002

TABLE OF CONTENTS

|         |  |                                                                                                    |  |      |     | 
|-------- |  | -------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|         |  |                                                                                                    |  | Page
|         |  |                                                                                                    |  |     
|Part I  
|Item 1.  |  | Business                                                                                           |  |      | 1   | 
|Item 2.  |  | Properties                                                                                         |  |      | 31  | 
|Item 3.  |  | Legal Proceedings                                                                                  |  |      | 31  | 
|Item 4.  |  | Submission of Matters to a Vote of Security
    Holders                                            |  |      | 33  | 
|Part II 
|Item 5.  |  | Market for Our Common Equity and Related
    Stockholder Matters                                   |  |      | 33  | 
|Item 6.  |  | Selected Consolidated Financial Data                                                               |  |      | 34  | 
|Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |  |      | 35  | 
|Item 7A. |  | Quantitative and Qualitative Disclosures About
    Market Risk                                     |  |      | 46  | 
|Item 8.  |  | Financial Statements and Supplementary Data                                                        |  |      | 47  | 
|Item 9.  |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure           |  |      | 47  | 
|Part III
|Item 10. |  | Directors and Executive Officers of the Registrant                                                 |  |      | 50  | 
|Item 11. |  | Executive Compensation                                                                             |  |      | 52  | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |  |      | 60  | 
|Item 13. |  | Certain Relationships and Related Transactions                                                     |  |      | 64  | 
|Item 14. |  | Controls and Procedures                                                                            |  |      | 66  | 
|Part IV 
|Item 15. |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                |  |      | 67  | 
|         |  | Signatures                                                                                         |  |      | 71  | 
|         |  | Financial Statements                                                                               |  |      | F-1 | 

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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 not filed
our quarterly reports for our quarters ended on
September 30, 2002, March 31, 2003, June 30,
2003, and September 30, 2003 with the Securities and
Exchange Commission, or SEC. Some of the information to be
contained in those quarterly reports is unavailable at this
time. Moreover, we can provide no assurances as to when such
information will become available. Additionally, 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, as explained in more detail in
note 3 to our consolidated financial statements. Because
these restatements have also impacted our 2002 results, as
reflected herein and explained in more detail in notes 3
and 16 to our consolidated financial statements, 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.

AutoFreezeTM, CGCTM,
Cryocare®, Cryocare CSTM, Cryocare Surgical
System®, CryoDisc®, CryoGridTM,
Cryoguide®, Direct AccessTM, Endocare®
TM, ErecAid®, Esteem®, FastTrac®,
Horizon Prostatic Stent®, Integrated
UltrasoundTM, RigiScan®, SmartTempTM,
SnapGauge, 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

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 certain changes to our
senior management team and Board of Directors. For a further
description of the nature and status of our internal review see
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of Operations
and note 3 to our consolidated financial statements.

Legal Proceedings.Beginning in November 2002, we, together with certain current
and former officers, one of whom is also a former board member,
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

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also under investigation by the 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
Item 3  Legal Proceedings.


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 so-called
Pink Sheets. We are working towards compliance with
all listing requirements of The Nasdaq Stock Market, and we will
be seeking 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.

Proxy Contest.Douglas O. Chinn, M.D., Solana Capital Partners, Inc., David
Eller, William A. Barry, Joseph L. DAngelo, Robert P. Fry,
M.D., J.D., Kurt Landgraf and John R. Queen, operating through a
self-supported organization called the Committee to Revitalize
Endocare, have filed proxy materials and commenced a proxy
contest in opposition to the director nominees recommended by
our Board of Directors.

New Independent Accountants and Restatements
of Financials.In March of 2003, we
dismissed KPMG LLP as our independent accounting firm. We then
engaged Ernst and 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. For a
further description of the nature and status of these
adjustments see Item 7  Managements
Discussion and Analysis of Financial Condition and Results of
Operations and note 3 to our consolidated financial
statements.

Management Changes.In March 2003, we appointed a new President and Chief Operating
Officer, William J. Nydam, and a new Chief Financial Officer,
Katherine Greenberg, as part of a management and corporate
governance restructuring. In order to complete an orderly
transition to our new management team, Paul W. Mikus has vacated
his position as a director and as our Chairman and Chief
Executive Officer and John V. Cracchiolo, our former Chief
Financial Officer and Chief Operating Officer, has vacated his
position as President of our Interventional Radiology business
group.

Strategic
Divestures.We are refocusing our
business on the development of minimally invasive technologies
for tissue and cancer tumor ablation. 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 prostheses product line to American
Medical Systems, Inc., or AMS. Under the terms of the agreement,
the transaction, valued at approximately $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
SurgiFrostTM 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 approximately
three and one-half years, included, among other things, 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.

Additionally, in connection with our divestiture
strategy, we have terminated or allowed to lapse our rights to
certain product offerings including the FastPack® System, a
proprietary prostate cancer test

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developed by Qualigen, Inc., the Thermoflex®
System, an office-based thermal therapy for benign prostate
hyperplasia, or 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 vacuum therapy
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.


Overview

We are a medical device company focused on
developing, manufacturing and selling cryoablation products with
the potential to dramatically improve the treatment of cancer.
We also contract with hospitals and healthcare payors to perform
cryoablation procedures using our proprietary technology and
products on a fee-for-service basis. We initially concentrated
on developing devices for the treatment of prostate cancer, and
our Food and Drug Administration, or FDA-cleared Cryocare
Surgical System occupies a leading position in the market for
the cryosurgical treatment of prostate cancer. Because of our
initial concentration on prostate cancer, the majority of our
sales and marketing resources are directed towards the promotion
of our technology to urologists for the treatment of prostate
and renal cancer. We are, however, expanding our focus across a
number of surgical markets, including the ablation of tumors in
the kidney, lung, and liver, as well as bone pain management.
Accordingly, we recently formed a new sales and marketing group
to focus on the radiology market where our products can be used
to treat these other cancer sites.

In addition to our cryoablation products, we also
offer the ErecAid line of vacuum therapy systems, which include
the SurErec system, Classic system, and Esteem
system  a leading non-pharmaceutical treatment of
erectile dysfunction and penile rehabilitation following
treatment for cancer. We acquired these product lines in the
first quarter of 2002 through our acquisition of the assets of
Timm Medical, a leading provider of vacuum pumps for the
treatment of erectile dysfunction. Also through our acquisition
of Timm Medical, we acquired or obtained marketing rights to a
number of other products, many of which we have or may be
divesting, including products used in the diagnosis and
management of BPH, products used in the diagnosis and treatment
of erectile dysfunction, and products used in the diagnosis and
management of urinary incontinence. More importantly, through
our acquisition of Timm Medical, we significantly expanded our
urology sales force. We believe this sales force will be a
valuable asset as we continue divestiture of our non-core
product lines and redeploy resources in the area of cancer
treatment.

Prostate Cancer:Our
Cryocare Surgical System is a minimally invasive cryosurgical
system for the targeted treatment of prostate cancer. In fiscal
year 2002, we derived a significant percentage of our revenues
from the sale of Cryocare Surgical System units and from
recurring sales of disposable supplies used with the Cryocare
Surgical System. The key elements of our Cryocare Surgical
System include our patented real-time temperature monitoring
system, our Cryoguide computer-controlled ultrasound guidance
and planning system, and our disposable cryoprobes and
temperature probes. Careful monitoring of the temperature around
the prostate and optimal positioning of the cryoprobes enable
physicians to destroy cancer with relatively minimal risk to
surrounding healthy tissue. 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 prostate cancer. Effective July 2001,
Medicare approved reimbursement of secondary cryosurgical
treatment for men who have been unsuccessfully treated with
radiation therapy.

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 internal visualization of
the prostate gland and 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 Cryocare CS also includes a new

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Urethral Warmer along with the highly successful
vacuum-insulated Direct Access CryoProbes and CryoGrid, a
brachytherapy-like grid fixed to the ultrasound stepper. We plan
to be in full commercialization of the new system by the end of
2003. 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.


Additional Cryosurgical Markets:We believe our proprietary
cryosurgical technologies have broad applications across a
number of surgical markets, including the treatment of tumors in
the kidney, lung, breast and liver, as well as bone pain
management and the treatment of cardiac arrhythmias. In October
1999, we formed a strategic alliance with Sanarus Medical, Inc.
to commercialize our proprietary cryosurgical technology for the
treatment of breast cancer, benign breast tumors and
gynecological diseases. As part of this strategic alliance, we
have made equity investments in Sanarus and also have entered
into a licensing, supply and manufacturing arrangement. We
received FDA clearance in October 2001 for the use of our
cryosurgical system for the treatment of benign breast tumors.
Sanarus markets this product as the VisicaTM
Treatment System. Effective December 2002, we are no longer
manufacturing or supplying products for Sanarus in connection
with our strategic alliance.

In September 2001, we formed a strategic alliance
with CryoCath to market, sell and distribute our proprietary
cryosurgical technology for the treatment of cardiac
arrhythmias. In February 2002, we received FDA clearance for use
of our cryosurgical technologies for the treatment of cardiac
arrhythmias. CryoCath markets this product as the
SurgiFrostTM system. In April 2003, we terminated our
original agreement with CryoCath and sold our cardiac-related
product manufacturing operations and licensed the related
intellectual property to CryoCath. Under the terms of the new
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
SurgiFrostTM system. Terms of the new 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 a strong position to
exploit the opportunities for our technology in this highly
competitive arena.

In addition to these two diversification
strategies, we intend to continue to enhance and leverage our
cryosurgical technology platform by partnering with third
parties who can effectively assist in the development,
distribution and commercialization of our technology in clinical
areas outside of tumor ablation.

Erectile Dysfunction:Through our acquisition of Timm
Medical, we acquired fully commercialized products used in the
diagnosis and treatment of erectile dysfunction. Our principal
diagnostic tool is the Rigiscan, an ambulatory device that
measures the frequency, rigidity and duration of both nocturnal
and provocative erections. We also offer the ErecAid line of
vacuum therapy systems, which include the Esteem, Classic and
SurErec systems. We previously offered a prosthetic device for
the treatment of erectile dysfunction, the Dura II Penile
Prosthesis, which was sold to AMS in April 2003.

We were incorporated under the laws of the State
of Delaware in May 1994. 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.

Prostate Cancer



| |                  
| | -----------------
| | 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.

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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 about
220,900 new cases of prostate cancer diagnosed and an estimated
28,900 deaths associated with the disease in the United States
during 2003. 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
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 the 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, either 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.

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.



| |                                   
| | ----------------------------------
| | 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 ancillary 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, particularly for patients having more
advanced stages of the disease. The procedure is dependent on
the skill of the surgeon and is often associated with relatively
high rates of impotence and incontinence and can 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.

Ancillary 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. Ancillary 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, 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
some physicians in some 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

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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.



| |                                                
| | -----------------------------------------------
| | 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.

The majority 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 through a
combination of early detection and improved surgical 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, sold as an accessory to the
Cryocare Surgical System, is a significant advancement in
targeted cryoablation of the prostate. 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 iceball 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.

6



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##### Table of Contents



We are regularly evaluating and implementing
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 internal visualization of
the prostate gland and 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 highly successful vacuum-insulated Direct
Access CryoProbes and CryoGrid, a brachytherapy-like grid fixed
to the ultrasound stepper. We plan to be in full
commercialization of the new system by the end of 2003.

The Cryocare Surgical System has been cleared for
marketing by the FDA. We commercially launched the Cryocare
Surgical System in July 1999 following the initiation of
national Medicare coverage for cryosurgical procedures as a
primary treatment alternative for localized prostate cancer. As
a result of direct sales and our placement program, there were
approximately 100 Cryocare Surgical Systems in use in the United
States as of the end of 2001 and approximately 190 in use as of
the end of 2002. There were approximately 110 United States
physicians trained and using the Cryocare Surgical System as of
the end of 2001 and approximately 275 as of the end of 2002. The
number of cryoablation procedures performed domestically was
1,093 in 2001 and increased to 2,474 in 2002. Our blended
average selling price for those periods was approximately $2,900
per procedure in 2001 and $4,500 per procedure in 2002. This was
primarily due to a shift in our business model from selling only
probes and other disposables used in a cryosurgical procedure,
without the service component, to invoicing for a bundled
procedure, which includes both the devices and a service fee.
The service fee covers use and transport of the Cryocare
Surgical System as well as clinical assistance provided to the
physician in the use and monitoring of the equipment during the
cryosurgical procedure. The service component is either provided
directly by Endocare or subcontracted to a third party service
provider.

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.



| |                                                   
| | --------------------------------------------------
| | 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 surgery.
    In medium to high risk cases, results of cryosurgery are at
    least equivalent and appear to be superior to radiation therapy
    and 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 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.                                                                                                                               

7



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Benign Prostate Hyperplasia



| |                             
| | ----------------------------
| | Our Stent Technology for BPH

We have developed 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 BPH. We also have explored the development
of a stent, the ThermaStent, that physicians could use to
deliver 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 does not fit well with 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.

Erectile Dysfunction



| |                  
| | -----------------
| | Market Background

Erectile dysfunction, or impotence, is the
inability to achieve or maintain an erection firm enough, or for
a sufficient amount of time, 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 Viagra by
Pfizer Inc. 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 Viagra has had a positive impact on the diagnosis and
treatment of patients suffering from erectile dysfunction, a
significant number of patients do not respond to Viagra,
experience side effects or are not proper candidates for Viagra
or other 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.



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

We also offer a leading line of vacuum therapy
systems for the treatment of erectile dysfunction. Even with the
success of 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.

8



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##### Table of Contents



We hold a leading market position in vacuum
therapy systems. We offer a full line of products, including the
ErecAid line of vacuum therapy systems, which include the
SurErec system, Classic system, and 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. We are reviewing various
revenue opportunities in this market, including the development
and distribution of new accessories for our existing vacuum
therapy systems.

As part of our strategy to focus on tumor
ablation, we have begun divesting our non-core product lines,
including our Dura-II positionable urological prostheses product
line, which we sold to AMS in April 2003.

Strategy

Since our inception we have focused considerable
resources on establishing our Cryocare Surgical System as a
primary treatment option for prostate cancer. We have recently
expanded that focus across broad surgical markets, including
liver, lung, kidney and bone cancer. Our strategy is to apply
our proprietary cryosurgical technology across horizontal
markets, while acquiring a dominant position in the market for
prostate cancer. Key objectives of our strategy include:



| |   |                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | maximizing the market opportunity for use of our
    Cryocare Surgical System in treating tumors of the prostate,
    liver, lung and kidney and for alleviation of bone pain in
    metastatic cancer patients;                       
|
| |  | educating physicians and patients regarding the
    use and advantages of our Cryocare Surgical System;                                                                                                                                
|
| |  | further demonstrating the safety and efficacy of
    cryosurgery as a primary treatment for prostate, liver, and
    kidney cancer;                                                                                                    
|
| |  | demonstrating the safety and efficacy of
    cryosurgery as a primary treatment for lung cancer, as well as a
    safe and effective tool for bone pain management;                                                                    
|
| |  | further demonstrating the safety and efficacy of
    cryosurgery as a secondary treatment in treating patients that
    have failed radiation therapy;                                                                                 
|
| |  | obtaining appropriate reimbursement for
    cryosurgery;                                                                                                                                                                               
|
| |  | marketing our products to physicians and
    hospitals through our direct sales force and our
    direct-to-consumer advertising programs;                                                                                             
|
| |  | continuing to enhance our Cryocare Surgical
    System to improve its ease of use across a broad range of tissue
    ablation applications; and                                                                                        
|
| |  | further demonstrating the utility of regular
    penile vacuum therapy as an effective sexual function
    rehabilitation therapy following definitive prostate cancer
    treatments, including radical prostatectomy and cryosurgery.

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.



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

U.S. Medical Development, Inc.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.,

9



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##### Table of Contents



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 businesses in
exchange for a total consideration of approximately
$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.
The balance of $ 7.7 million owed to us by USMD at the
purchase date will be forgiven, pro-rata, upon the achievement
of $12,000,000 in gross revenues by the businesses purchased
from USMD during the period between October 1, 2002 and
December 31, 2005. Management believes that the entire
$7.7 million will be forgiven.



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

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 public
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
SurgiFrostTM system.

10



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##### Table of Contents



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 SurgiFrostTM 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 a strong
position to exploit the opportunities for our technology in this
highly competitive arena.

Products

We are marketing, developing or have commercial
rights to distribute the following products:

|                                              |  |                                                                                      |  |                                             
|--------------------------------------------- |  | ------------------------------------------------------------------------------------ |  | --------------------------------------------
|Product Name                                  |  | Function                                                                             |  | Status                                      
|                                              |  |                                                                                      |  |                                             
|Prostate Cancer                               |  |                                                                                      |  |                                             
|Cryocare Surgical System  8 Probe
    System |  | Cryosurgical system with eight cryoprobe
    capability                              |  | Marketing                                   
|CryoCare CS System                            |  | Cryosurgical system with on board ultrasound                                         |  | Anticipate Market Release by the End of 2003
|CryoGuide                                     |  | Computerized cryoprobe placement, simulation and
    guidance system for cryosurgery |  | Marketing                                   
|Cryoprobes                                    |  | Disposable probes used with the Cryocare Surgical
    System                         |  | Marketing                                   
|FastTrac                                      |  | Percutaneous access device that allows one-step
    insertion of cryoprobes          |  | Marketing                                   
|Additional Cryosurgical Markets               |  |                                                                                      |  |                                             
|Cryocare  4 Probe System                     |  | Cryosurgical system with 4 probe capability for
    general surgery                  |  | Marketing                                   
|Erectile Dysfunction                          |  |                                                                                      |  |                                             
|RigiScan Monitor                              |  | Diagnostic tool for erectile dysfunction                                             |  | Marketing                                   
|ErecAid Esteem System                         |  | Vacuum therapy system                                                                |  | Marketing                                   
|ErecAid Classic System                        |  | Vacuum therapy system                                                                |  | Marketing                                   
|SurErec System                                |  | Vacuum therapy system                                                                |  | Marketing                                   

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, there
can be no assurance that we will not 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.

11



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##### Table of Contents



Patents and Intellectual Property

We have rights to 32 issued U.S. patents
relating to cryosurgical ablative technology. Included within
these 32 issued U.S. patents are 5 patents in which we
have licensed-in rights. The remainder of the patents are
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
approximately 13 pending U.S. patent applications relative
to cryosurgical ablative technology. Additionally, we have
approximately 24 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.

We have rights to 16 issued U.S. patents
relating to our stent product line. Included within these
16 patents are 3 licensed-in patents. The remainder
are assigned to us. We also have approximately 3 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 approximately 15 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

12



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##### Table of Contents



bone cancer. To that end, we plan to develop
innovations which improve the speed and efficacy of our Cryocare
Surgical System.


We spent approximately $2.4 million,
$2.5 million and $2.9 million for the years ended
2000, 2001 and 2002, respectively, on research and development
activities.

Sales and Marketing

We sell our products primarily to physicians and
hospitals and have both domestic and international customers.
Net sales to CryoCath pursuant to our market access and supply
agreement with them constituted approximately 6.8% of our net
revenues for the year ended December 31, 2002. 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 in 2002. The following products and services account
for 15% or more of total revenues for each of the years ended
December 31:

|                                      |                                        |      |  |      |   |      |  |    |   |  |  |    |  
|------------------------------------- | -------------------------------------- | ---- |  | ---- | - | ---- |  | -- | - |  |  | -- | -
|                                      |                                        | 2000 |  | 2001 |   | 2002
|                                      |                                        |      |  |      |   |     
|Cyroablation and urological products: |                                        |      |  |      |   |      |  |    |   |  |  |   
|                                      | Cryocare Surgical Systems              |      |  | 44   | % |      |  | 56 | % |  |  | *  |  
|                                      | Cryoprobes, disposables and procedures |      |  | 56   | % |      |  | 44 | % |  |  | 41 | %
|                                      | Cardiac products (CryoCath)            |      |  | *    |   |      |  | *  |   |  |  | *  |  
|                                      | Urological products (Timm Medical)     |      |  | *    |   |      |  | *  |   |  |  | 41 | %



---



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

We currently sell our products domestically
through our direct sales force which, as of December 31,
2002, consisted of 57 people, including two directors of
partnership development, five regional sales managers, six
clinical application specialists and 44 field sales
representatives. 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. We
also have plans to expand our marketing initiatives to 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 further
expand this marketing strategy.

Internationally, our products are sold primarily
through independent distributors. Our international sales
represented approximately 12%, 8% and 15% of our consolidated
revenue in 2000, 2001 and 2002, respectively.

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

|                    |        |      |       |      |  |      |        |     |  |   |        |       | 
|------------------- | ------ | ---- | ----- | ---- |  | ---- | ------ | --- |  | - | ------ | ----- | 
|                    |        | 2000 |       | 2001 |  | 2002
|                    |        |      |       |      |  |     
|United States       |        | $    | 5,802 |      |  | $    | 11,988 |     |  | $ | 26,369 |      
|International:      |        |      |       |      |  |      |        |     |  |   |        |      
|                    | China  |      |       | 420  |  |      |        | 593 |  |   |        | 402   | 
|                    | Canada |      |       |     |  |      |        |    |  |   |        | 2,104 | 
|                    | Other  |      |       | 346  |  |      |        | 456 |  |   |        | 2,041 | 
|                    |        |      |       |      |  |      |        |     |  |   |        |      
|Total international |        |      | 766   |      |  |      | 1,049  |     |  |   | 4,547  |      
|                    |        |      |       |      |  |      |        |     |  |   |        |      
|Total revenues      |        | $    | 6,568 |      |  | $    | 13,037 |     |  | $ | 30,916 |      

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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 healthcare programs, as well as
private insurers to pay for their procedures. Accordingly, our
revenue is dependent upon third-party reimbursement,
particularly Medicare, since an estimated 70% of patients
receiving cryosurgical treatments using are proprietary
technology are Medicare beneficiaries.

Medicare reimbursement for cryosurgical
procedures using our products as a primary treatment alternative
for localized prostate cancer began 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 are
currently paid on a pass-through basis but these payments will
end 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 will
be 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 cannot provide assurance that the new
HOPPS payment levels will not have a negative impact on 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 payors.

Approval of 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

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whether to cover a device or procedure and sets
its own reimbursement rate. It is unlikely that a private
insurer would provide coverage if Medicare refused to do so.


Backlog

As of December 31, 2002, we maintained
minimal backlog. Our policy is to carry enough inventory to be
able to ship most orders within a few days of 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 2002, Timm Medical received approximately
$1.2 million 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 packaged and shipped
in our Irvine facility and are manufactured for us by The
MedTech Group of South Plainfield, New Jersey.

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 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

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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 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, ErecAid
and SurErec products have been cleared for marketing through the
510(k) process.

There can be no assurance that we will be able to
obtain necessary clearances or approvals for clinical testing or
for manufacturing or marketing of our products. 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.

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Healthcare Regulatory Issues

The healthcare industry is highly regulated and
there can be no assurance that the regulatory environment in
which we operate will not change significantly in the future. In
general, regulation of healthcare related companies is
increasing. We anticipate that Congress and state legislatures
will continue to review and assess alternative healthcare
delivery and payment systems. We cannot predict what impact the
adoption of any federal or state healthcare reform measures may
have on our business.

We regularly monitor developments in laws 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 there can be no
assurance that our arrangements will not be challenged
successfully or that required changes may not have a material
adverse effect on operations or profitability.

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 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
healthcare program. Because our products are reimbursable under
Medicare, Medicaid and other federal healthcare 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 program beneficiaries.
Noncompliance with, or violation of, the federal anti-kickback
law can result in exclusion from federal healthcare 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

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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, 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. We are
continuing to monitor and assess the impact seasonality may have
on demand for our products.

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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 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, 2002, we had a total of
194 employees. Of these employees, 13 are engaged directly in
research and development activities, 11 in regulatory affairs/
quality assurance, 50 in manufacturing, 94 in sales, marketing
and customer service and 26 in general and administrative
positions. We expect to increase employment in order to expand
the sales and marketing of our Cryocare Surgical System as well
as to 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 we have not yet filed our
quarterly reports on Form 10-Q since the second quarter of
2002 and we do not currently intend to amend prior filings based
on the restatements. 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.

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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 William J. Nydam, our President
and 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. We are also currently in the process of
searching for a Chief Executive Officer. While we have
identified potential candidates and are in final negotiations
with one such candidate, we can provide no assurance as to when
and under what terms we might be able to retain a Chief
Executive Office. Competition for such personnel is intense,
particularly in southern California where we are located. If we
do not attract and retain qualified personnel we will not be
able to achieve our growth objectives.

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

In addition to the challenges of the SEC
investigation, the DOJ investigation, various shareholder
class-action and derivative lawsuits 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 13 months we have incurred
significant costs related to, among other things, business
acquisitions, 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. Additionally, we have become subject to
a $1.6 million judgment in favor of BioLife as described in
Item 3 of this Annual Report on Form 10-K. If we are
not able to significantly reduce our operating expenses, or we
are unsuccessful in our appeal of the judgment obtained by
BioLife and we become subject to other significant judgments or
settlements in connection with the legal proceedings described
in Item 3 of this Annual Report on Form 10-K, we may
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, or relinquish rights to technologies or products that
we might otherwise seek to develop or commercialize.

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.

Since our inception, we have engaged primarily in
research and development activities, and 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 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

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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, 2000, 2001 and 2002, we had net operating
losses of approximately $13.8 million, $11.5 million
and $42.0 million, respectively. As of December 31,
2002, our accumulated deficit was approximately
$88.9 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 our
equity securities, incurring additional 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, there
can be no assurance that we will not discover additional
instances of historical breakdowns in our internal controls,
policies and procedures of the types that led to the recent
restatements of our historical financial statements.

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

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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 current and former
officers, one of whom is also a former board member, have been
named defendants in a number of class-action and derivative
lawsuits. The findings and outcome of the investigations
described above may affect the class-action and derivative
lawsuits 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.

For a further description of the nature and
status of these legal proceedings see,
Item 3  Legal Proceedings.

We have postponed the filing of our most
recent quarterly reports, and material information concerning
our current operating results and financial condition is
therefore unavailable.

We have postponed the filing of our periodic
reports for the quarters ended September 30, 2002,
March 31, 2003, June 30, 2003, and September 30,
2003 and the information to be contained therein is unavailable
at this time. We cannot predict how soon complete financial and
operational information relating to our third quarter for 2002
and first three quarters for 2003 will become available. When it
is, it may reflect changes or trends that are material to our
business.

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. 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 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.
Additionally, although we will seek to have our common

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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.


We expect to derive a significant portion of
our future revenues from our Cryocare Surgical System, 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. We expect that sales
of Cryocare Surgical Systems, the related disposables and
per-procedure fees will constitute a significant portion of our
sales 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.
Accordingly, our success is reliant on the acceptance by doctors
and patients of the Cryocare Surgical System as a preferred
treatment for cancer. 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 fistula 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 large 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 cancer
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.
There can be no assurance that our strategy of focusing on our
core technologies for cancer applications and our divestitures
of non-core technologies and product lines will be successful.

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

Hospitals and other healthcare 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, there can be 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 healthcare
programs or private insurers are not sufficient, physicians may
choose not to recommend, and patients may not choose, procedures
utilizing our products.

Currently, reimbursement under Medicare for our
cryosurgical disposable products used in outpatient procedures
is provided on a so-called pass-through basis. This
enables the hospital or other healthcare provider to obtain
separate reimbursement for our disposable devices in addition to
reimbursement for the procedure fee. After pass-through status
terminates, which will occur on December 31, 2003 the cost
of our disposable products will be incorporated into HOPPS and
there will be no separate reimbursement for the disposables.

Once pass-through status for our disposable
cryoprobes and temperature probes ends total Medicare
reimbursement for our products used in outpatient settings is
expected to decrease by approximately 15%. This may influence
reimbursement rates for our products by private insurers as
well. There can be 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 healthcare payment systems. Reimbursement and
healthcare payment systems in international markets vary
significantly by country, and include both government sponsored
healthcare 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 healthcare system in
the United States and other countries. Any changes in Medicare,
Medicaid or third-party medical expense reimbursement, which may
arise from healthcare 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 healthcare 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 healthcare 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
healthcare spending, which may result in a material adverse
effect on our business.

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 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

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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 have terminated an exclusive distribution
agreement with U.S.M.D., Ltd. which may make it more difficult
for us to effectively commercialize our products and our
revenues could be adversely affected.

For 2002, 2001, and 2000, 7.3%, 31.5% and 8.0%,
respectively, of our revenues were derived from sales made to
U.S.M.D., Ltd. under an exclusive distribution agreement. In
September 2002, in connection with the acquisition of the mobile
prostate treatment businesses of USMD, we terminated our
exclusive distribution agreement with U.S.M.D, Ltd. As a result,
we will need to commit additional resources to operate the
businesses we acquired from USMD and to effectively market our
products in the geographic areas previously covered by USMD. If
we are unable to dedicate the necessary resources to handle our
increased obligations or if we are unsuccessful in marketing and
selling our products in the territories previously held by
U.S.M.D., Ltd., our revenues could be materially and adversely
affected.

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 in auditing our consolidated
financial statements for the year ended December 31, 2002.
The effects of restatements to these periods are more fully
described in note 3 to our consolidated financial
statements. Additionally, 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. 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.

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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 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.

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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.

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. 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.

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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 interests in an
entity and compensation arrangements with an entity. Many states
have similar and often broader laws prohibiting referrals by any
licensed healthcare 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, Item 1  Healthcare
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 above 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. In
addition, any product liability claim likely would harm our
reputation in the industry and our business.

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 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.

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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; and                                                                                                                                                                 
|
| |  | competition from other treatment modalities.                                                                                                                                                                                   

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.

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

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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; and                                                            
|
| |  | general economic and market conditions.                                                                                    

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 for all of our reporting units. We
utilized an independent 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 this
assessment, we recognized an impairment charge of approximately
$18 million in the fourth quarter of 2002 to reduce the
carrying value of the goodwill acquired in the Timm Medical
acquisition.

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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. No assurance can
be given that we will not have further impairment charges
related to Timm Medical or other acquisitions.

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

During 2001, 2002 and 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.






|        |           
|------- | ----------
|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, we
obtained offices, manufacturing and research facilities for our
erectile dysfunction products in a 28,066 square foot building
in Eden Prairie, Minnesota. The lease for this facility expires
in April 2004. In June 2003, we transferred certain operations
previously performed at this location to our Irvine, California
manufacturing facility and outsourced certain other operations.
In addition, we are in the process of divesting the non-core
product lines acquired in this transaction. As a result, we do
not intend to renew this lease. Rather, we are in the process of
locating 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, such as the judgment obtained by BioLife described
below, or settlements in connection with the legal proceedings
described below will not have a material adverse effect on our
consolidated financial condition, results of operations or 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 current and 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, but cannot assure you that
it will be resolved in our favor.

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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 have 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. We disagree with the decision, and have
noticed an appeal.

On December 6, 2002, Frederick Venables
filed a purported derivative action against us and certain of
our officers and directors 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. 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. We terminated Mr. Hafermann on
December 18, 2002 for cause under his employment agreement
based on misconduct that was demonstrably and materially
injurious to us, including disclosure of confidential
information relevant to a proposed business transaction. Our
complaint includes claims of breach of the duty of loyalty,
breach of fiduciary obligations to us, interference with our
prospective economic advantage and breach of contractual duties
owed to us. Mr. Hafermann counterclaimed alleging that we
defamed him, failed to provide his employment file, breached his
employment contract by failing to pay him severance, and
violated the Minnesota whistleblower and federal Sarbanes-Oxley
whistleblower laws. Mr. Hafermann claims that he therefore
suffered damages, including loss of wages and benefits, and harm
to his professional reputation. Discovery is ongoing. The
arbitration is scheduled for February 23, 2004. We are
vigorously defending against this action, while also
aggressively pursuing our claim for monetary damages, but cannot
assure you that this matter will be resolved in our favor.

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 Joseph Hafermann, the
former General Manager of our Minnesota subsidiary. 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. We, Mr. Mikus and Mr. Cracchiolo have
responded to the Department of Labor notification of
Mr. Hafermanns complaint in letters of May 7,
2003 and September 30, 2003, in which we, Mr. Mikus
and Mr. Cracchiolo denied all of Mr. Hafermanns
allegations, and in which we, Mr. Mikus and
Mr. Cracchiolo asserted that there is insufficient basis to
warrant a formal investigation and clear and convincing evidence
exists that we discharged Mr. Hafermann for cause based on
our determination that Mr. Hafermann had engaged in
misconduct that had materially harmed us. We cannot assure you
that the Department of Labor will not pursue this matter further.

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

32



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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 did not submit any matters to a vote of
security holders during the quarter ended December 31, 2002.




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. Such quotations
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, 2002: |                                            |      |   |       |  |  |   |      
|                              | First Quarter                              |      | $ | 20.00 |  |  | $ | 13.42 | 
|                              | Second Quarter                             |      |   | 21.05 |  |  |   | 11.30 | 
|                              | Third Quarter                              |      |   | 14.31 |  |  |   | 9.78  | 
|                              | Fourth Quarter (through December 11, 2002) |      |   | 14.29 |  |  |   | 2.58  | 
|Year Ended December 31, 2001: |                                            |      |   |       |  |  |   |      
|                              | First Quarter                              |      | $ | 14.06 |  |  | $ | 7.12  | 
|                              | Second Quarter                             |      |   | 15.99 |  |  |   | 5.12  | 
|                              | Third Quarter                              |      |   | 18.30 |  |  |   | 13.75 | 
|                              | Fourth Quarter                             |      |   | 22.95 |  |  |   | 15.53 | 

Holders

As of September 30, 2003, there were 297
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

33



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##### Table of Contents



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.


Recent Sales of Unregistered
Securities

Pursuant to an asset purchase agreement dated
February 6, 2002, we issued 100,000 shares of common stock
as consideration for the acquisition of intellectual property
assets and a covenant not to compete related to our cryosurgical
business from Gary M. Onik, M.D., a stockholder and
consultant to us. This transaction was a private offering exempt
from registration with the SEC under Section 4(2) of the
Securities Act of 1933, as amended.

Pursuant to an asset purchase agreement dated
May 28, 2002, as consideration for the cryosurgical
business line and assets of BioLife, we paid to BioLife
$2.2 million in cash and issued to BioLife 120,022 shares
of our common stock. This transaction was a private offering
exempt from registration with the SEC under Section 4(2) of
the Securities Act of 1933, as amended.






|        |                                         
|------- | ----------------------------------------
|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, 1998, 1999, 2000 and 2001 has been
restated. For additional information regarding the restatements,
please refer to note 3 to our consolidated financial
statements. Our historical results are not necessarily
indicative of operating results to be expected in the future.

|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |        |        | 
|---------------------------------------------------------- | ------------------------------------- | ----------------------------------------------- | ---------- | ----- | ----- | ---- | ---------- | ----- | ------ | ---- | ---------- | ------ | ------ | - | ---------- | ------ | ------ | - | ---------- | ------ | ------ | 
|                                                           |                                       |                                                
|                                                           |                                       | Years Ended December 31,                       
|                                                           |                                       |                                                
|                                                           |                                       | 1998                                            |            | 1999  |       | 2000 |            | 2001  |        | 2002
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |     
|                                                           |                                       |                                                
|                                                           |                                       | (In thousands, except share and per share data)
|Revenues:                                                  |                                       | $                                               | 2,495      |       |       | $    | 3,514      |       |        | $    | 6,568      |        |        | $ | 13,037     |        |        | $ | 30,916     |       
|Costs and expenses:                                        |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|                                                           | Cost of revenues                      |                                                 |            | 1,183 |       |      |            | 1,790 |        |      |            | 3,757  |        |   |            | 6,208  |        |   |            | 16,484 |       
|                                                           | Research and development              |                                                 |            | 1,953 |       |      |            | 2,618 |        |      |            | 2,371  |        |   |            | 2,544  |        |   |            | 2,900  |       
|                                                           | Selling, general and administrative   |                                                 |            | 4,785 |       |      |            | 9,231 |        |      |            | 13,436 |        |   |            | 15,728 |        |   |            | 33,770 |       
|                                                           | Goodwill impairment and other charges |                                                 |            |      |       |      |            |      |        |      |            |       |        |   |            |       |        |   |            | 20,311 |       
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|                                                           |                                       | Total costs and expenses                        |            |       | 7,921 |      |            |       | 13,639 |      |            |        | 19,564 |   |            |        | 24,480 |   |            |        | 73,465 | 
|Loss from operations                                       |                                       |                                                 | (5,426     | )     |       |      | (10,125    | )     |        |      | (12,996    | )      |        |   | (11,443    | )      |        |   | (42,549    | )     
|Loss on minority investment                                |                                       |                                                 |           |       |       |      |           |       |        |      |           |        |        |   | (250       | )      |        |   |           |       
|Interest income (expense), net                             |                                       |                                                 | 337        |       |       |      | (541       | )     |        |      | (832       | )      |        |   | 241        |        |        |   | 1,007      |       
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|Loss before minority interests                             |                                       |                                                 | (5,089     | )     |       |      | (10,666    | )     |        |      | (13,828    | )      |        |   | (11,452    | )      |        |   | (41,542    | )     
|Minority interests                                         |                                       |                                                 |           |       |       |      |           |       |        |      |           |        |        |   |           |        |        |   | (444       | )     
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|Net loss                                                   |                                       | $                                               | (5,089     | )     |       | $    | (10,666    | )     |        | $    | (13,828    | )      |        | $ | (11,452    | )      |        | $ | (41,986    | )     
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|Net loss per share of common stock 
    basic and diluted |                                       | $                                               | (0.51      | )     |       | $    | (0.98      | )     |        | $    | (1.08      | )      |        | $ | (0.68      | )      |        | $ | (1.76      | )     
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       
|Weighted-average shares of common stock
    outstanding    |                                       |                                                 | 10,062,000 |       |       |      | 10,838,000 |       |        |      | 12,757,000 |        |        |   | 16,741,000 |        |        |   | 23,822,000 |       
|                                                           |                                       |                                                 |            |       |       |      |            |       |        |      |            |        |        |   |            |        |        |   |            |       

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|                                                             |  |                    |       |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|------------------------------------------------------------ |  | ------------------ | ----- | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                                             |  |                   
|                                                             |  | As of December 31,
|                                                             |  |                   
|                                                             |  | 1998               |       | 1999 |  | 2000 |        | 2001 |  | 2002
|                                                             |  |                    |       |      |  |      |        |      |  |     
|                                                             |  |                   
|                                                             |  | (In thousands)    
|Balance Sheet Data:                                          |  |                    |       |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Cash, cash equivalents and available-for-sale
    securities |  | $                  | 6,286 |      |  | $    | 7,365  |      |  | $    | 22,016 |  |  | $ | 81,887 |  |  | $ | 40,361 | 
|Working capital                                              |  |                    | 5,544 |      |  |      | 6,532  |      |  |      | 20,885 |  |  |   | 84,999 |  |  |   | 37,021 | 
|Total assets                                                 |  |                    | 8,025 |      |  |      | 13,394 |      |  |      | 29,183 |  |  |   | 95,094 |  |  |   | 92,628 | 
|Long-term Obligations(1)                                     |  |                    | 201   |      |  |      | 10,153 |      |  |      | 8,574  |  |  |   |       |  |  |   |       | 
|Total stockholders equity (deficiency)                      |  |                    | 6,044 |      |  |      | (48    | )    |  |      | 15,871 |  |  |   | 90,881 |  |  |   | 78,623 | 



---



|    |                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------
|(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 our consolidated financial statements and
related notes contained elsewhere in this Annual Report on
Form 10-K. This discussion may contain forward-looking
statements based upon current expectations that involve risks
and uncertainties. Our actual results and the timing of selected
events could differ materially from those anticipated in these
forward-looking statements as a result of selected factors,
including those set forth under Risk Related to Our
Business set forth in Item 1 of this Annual Report on
Form 10-K. 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.

Restatement of 2001 and 2000 Consolidated
Financial Statements

This Annual Report on Form 10-K contains our
restated consolidated financial statements as of
December 31, 2001, and for the years ended
December 31, 2000 and 2001. We performed an analysis of our
previously issued consolidated financial statements for 2001 and
2000 and identified a number of errors. The nature of the errors
and the restatement adjustments that we have made to our
financial statements as of December 31, 2001, and for the
years ended December 31, 2000 and 2001 are set forth in
note 3 to our consolidated financial statements.

The restatements also affected certain quarterly
results of operations. See note 16 to our consolidated
financial statements for a summary of our quarterly results of
operations for the years ended December 31, 2002 and 2001,
and see note 3 for a discussion regarding restatement
adjustments.

Overview

We are a medical device company focused on
developing, manufacturing and selling cryoablation products with
the potential to dramatically improve the treatment of cancer.
We were formed in 1990 as a research and development division of
Medstone International, Inc. (Nasdaq: MEDS), a manufacturer of
shockwave lythotripsy equipment for the treatment of kidney
stones. On January 1, 1996, we became an independent,
publicly owned corporation upon Medstones distribution of
our stock to its existing stockholders.

We initially concentrated on developing devices
for the treatment of prostate cancer, and our FDA-approved
Cryocare Surgical System occupies a leading position in the
market for the cryosurgical treatment of prostate cancer.
Because of our initial concentration on prostate cancer, the
majority of our sales and marketing resources are directed
towards the promotion of our cryoablation technology to
urologists for the treatment of prostate and renal cancer. We
are also, however, expanding our focus across a number of
surgical markets, including the ablation of tumors in the
kidney, lung and liver, as well as for managing pain related to
metastatic bone cancer. Accordingly, we recently formed a new
sales and marketing group to focus on the radiology market where
our products can be used to treat these other cancer sites.

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In addition to our cryoablation products, we also
offer, or previously offered, a number of products acquired
through purchase of the assets of Timm Medical in the first
quarter of 2002. These products include devices used in the
diagnosis and treatment of erectile dysfunction and urinary
incontinence, common side effects of patients who are being
treated or have been treated for prostate cancer. Among the
products acquired in the Timm Medical purchase is a line of
vacuum therapy systems, including the ErecAid Esteem and ErecAid
Classic systems for the non-pharmaceutical treatment of erectile
dysfunction and for penile rehabilitation following treatment
for prostate cancer and also the Dura IITM
Penile Prosthesis for treatment of erectile dysfunction. We also
acquired the RigiScan Monitor and the SnapGuage, products used
in the diagnosis of erectile dysfunction, the
ProDynamicTM Monitor, UroBreezeTM
Urodynamics Monitor and the EasyFloTM Urometry System
for diagnosis and treatment of urinary incontinence in both men
and women.

In 2003, we embarked on a strategy focused on our
core technological competence and primary market emphasis in the
area of cancer ablation. Part of this strategy entails
divestiture of certain product lines that are unrelated to our
focus on cancer ablation. Toward that end, in April of 2003, we
sold the manufacturing rights to a product we had developed for
treatment of cardiac arrhythmia to CryoCath. Part of this
transaction included licensing of our technology and
intellectual property rights related to cryotherapy applications
in the cardiology market. Also in April of 2003, we sold the
intangibles and inventory associated with the
Dura IITM penile implant product acquired in the
Timm Medical purchase 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 also
acquired in the Timm Medical purchase to SRS Medical Corp. In
addition, we made the decision in 2003 to discontinue
development and clinical testing of our Horizon Prostatic Stent,
designed for treatment of BPH.

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 $13.8 million in 2000, $11.5 million in
2001 and $42.0 million in 2002. As of December 31, 2002, we
had an accumulated deficit of $88.9 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.

Results of Operations

The following table sets forth, for the periods
indicated, financial data as a percentage of revenues. The
results for 2001 and 2000 presented below are As
Restated. Please refer to note 3 of our consolidated
financial statements for an explanation of the restatement
adjustments.

|                               |                                       |                          |      |      |     |      |     |     |     |  |      |     |     | 
|------------------------------ | ------------------------------------- | ------------------------ | ---- | ---- | --- | ---- | --- | --- | --- |  | ---- | --- | --- | 
|                               |                                       |                         
|                               |                                       | Year Ended              
|                               |                                       | December 31,            
|                               |                                       |                         
|                               |                                       | 2000                     |      | 2001 |     | 2002
|                               |                                       |                          |      |      |     |     
|Revenues                       |                                       |                          | 100  | %    |     |      | 100 | %   |     |  | 100  | %  
|Costs and expenses:            |                                       |                          |      |      |     |      |     |     |     |  |      |    
|                               | Cost of revenues                      |                          |      | 57   |     |      |     | 48  |     |  |      | 53  |    
|                               | Research and development              |                          |      | 36   |     |      |     | 19  |     |  |      | 9   |    
|                               | Selling, general and administrative   |                          |      | 205  |     |      |     | 121 |     |  |      | 109 |    
|                               | Goodwill impairment and other charges |                          |      |     |     |      |     |    |     |  |      | 66  |    
|                               |                                       |                          |      |      |     |      |     |     |     |  |      |    
|                               |                                       | Total costs and expenses |      |      | 298 |      |     |     | 188 |  |      |     | 237 | 
|Loss from operations           |                                       |                          | (198 | )    |     |      | (88 | )   |     |  | (137 | )  
|Loss on minority investment    |                                       |                          |     |      |     |      | (2  | )   |     |  |     |    
|Interest income                |                                       |                          | 9    |      |     |      | 6   |     |     |  | 3    |    
|Interest expense               |                                       |                          | (22  | )    |     |      | (4  | )   |     |  |     |    
|                               |                                       |                          |      |      |     |      |     |     |     |  |      |    
|Loss before minority interests |                                       |                          | (211 | )    |     |      | (88 | )   |     |  | (134 | )  
|Minority interests             |                                       |                          |     |      |     |      |    |     |     |  | (2   | )  
|                               |                                       |                          |      |      |     |      |     |     |     |  |      |    
|Net loss                       |                                       |                          | (211 | )    |     |      | (88 | )   |     |  | (136 | )  
|                               |                                       |                          |      |      |     |      |     |     |     |  |      |    

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Revenues and cost of revenues related to the
following products and services for the three-year period ended
December 31, 2002 are as follows (in thousands):

|                  |                                                    |      |       |       |  |      |        |       |  |   |        |        | 
|----------------- | -------------------------------------------------- | ---- | ----- | ----- |  | ---- | ------ | ----- |  | - | ------ | ------ | 
|                  |                                                    | 2000 |       | 2001  |  | 2002
|                  |                                                    |      |       |       |  |     
|Revenues:         |                                                    |      |       |       |  |      |        |       |  |   |        |       
|                  | Cryocare Surgical Systems                          |      | $     | 2,921 |  |      | $      | 7,358 |  |   | $      | 3,422  | 
|                  | Cryoprobes, disposables and bundled procedure fees |      |       | 3,647 |  |      |        | 5,679 |  |   |        | 12,601 | 
|                  | Cardiac products (CryoCath)                        |      |       |      |  |      |        |      |  |   |        | 2,104  | 
|                  | Urological products (Timm Medical)                 |      |       |       |  |      |        |       |  |   |        | 12,789 | 
|                  |                                                    |      |       |       |  |      |        |       |  |   |        |       
|                  |                                                    | $    | 6,568 |       |  | $    | 13,037 |       |  | $ | 30,916 |       
|                  |                                                    |      |       |       |  |      |        |       |  |   |        |       
|Cost of Revenues: |                                                    |      |       |       |  |      |        |       |  |   |        |       
|                  | Cryocare Surgical Systems                          |      | $     | 1,160 |  |      | $      | 2,200 |  |   | $      | 1,480  | 
|                  | Cryoprobes, disposables and bundled procedure fees |      |       | 2,597 |  |      |        | 4,008 |  |   |        | 8,111  | 
|                  | Cardiac products (CryoCath)                        |      |       |      |  |      |        |       |  |   |        | 1,539  | 
|                  | Urological products (Timm Medical)                 |      |       |      |  |      |        |      |  |   |        | 5,354  | 
|                  |                                                    |      |       |       |  |      |        |       |  |   |        |       
|                  |                                                    | $    | 3,757 |       |  | $    | 6,208  |       |  | $ | 16,484 |       



| |                                                                          
| | -------------------------------------------------------------------------
| | 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 the
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 185 in
2001 to 292 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

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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.


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 3% to 10% 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. There were
175 Cryocare Surgical Systems owned by third parties in
operation at December 31, 2002 compared to 138 at
December 31, 2001. 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 47 at December 31,
2001 to 117 at

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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 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
SurgiFrostTM 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 SurgiFrostTM 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 $7.1 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.

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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
stock. The ruling was issued on October 1, 2003, following
our earnings release for the year ended December 31, 2002.
All adjustments required to correctly account for the impact of
this additional charge have been made to our consolidated
financial statements for the year ended December 31, 2002
as they appear in this Annual Report on Form 10-K.

In addition, following our earnings release for
the year ended December 31, 2002, we identified
$1.9 million in accrued liabilities recorded in the fourth
quarter of 2002 for legal, accounting and other professional
expenses that were actually incurred in 2003. These expenses and
the related liability have now been reversed and will be
recorded in the appropriate periods in our financial statements
for the year ended December 31, 2003. All adjustments
required to correctly record the reversal of this liability have
been made to our consolidated financial statements for the year
ended December 31, 2002 as they appear in this Annual
Report on Form 10-K.

The net result of the two adjustments made
subsequent to our earlier earnings release is to reduce selling,
general and administrative expenses for the year ended
December 31, 2002 by $0.4 million.

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 significant
impairment charges related to goodwill and investments. The
increases in operating expenses were partially offset by revenue
growth.



| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2001 Compared to
    Year Ended December 31, 2000

Revenues.Revenues
for the year ended December 31, 2001 increased
$6.4 million or 97.0% to $13.0 million from
$6.6 million in 2000. Sales of Cryocare Surgical Systems
increased $4.5 million or 155.2% from $2.9 million to
$7.4 million. We sold 28 Cryocare Surgical Systems in
2000 compared to 45 in 2001.

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Sales of cryoprobes, other disposables and
bundled procedure fees also increased $2.1 million or 58.3%
from $3.6 million in 2000 to $5.7 million in 2001. The
growth is due to the increase in the number of Cryocare Surgical
Systems in operation from 126 at December 31, 2000 to 185
at December 31, 2001, including both systems purchased by
third parties and systems in our placement program. The number
of cryoablation procedures performed increased from 805 in 2000
to 1,093 in 2001


Cost of Revenues.Cost of revenues for the year ended December 31, 2001
increased $2.4 million or 63.2% from $3.8 million in
2000 to $6.2 million in 2001. Cost of revenues for Cryocare
Surgical Systems as a percentage of related revenues decreased
from 39.7% in 2000 to 29.9% in 2001, reflecting greater
economies of scale in our manufacturing operations. Cost of
revenues for cryoprobes, other disposables and bundled procedure
fees as a percentage of related revenues decreased from 71.2% in
2000 to 70.6% in 2001. The decrease was due to manufacturing
efficiencies partially offset by a larger number of procedures
performed on Cryocare Surgical Systems owned by third parties
where we incur an additional outside service fee. Cryocare
Surgical Systems owned by third parties increased from 83 at
December 31, 2000 to 138 at December 31, 2001. As a
percentage of revenues, overall cost of revenues declined from
57.2% in 2000 to 47.6% in 2001 due to a reduction in the cost of
sourced components and manufacturing efficiencies resulting from
higher production levels.

Gross Margins.Gross
margins on revenues improved from 42.8% for the year ended
December 31, 2000 to 52.4% for the year ended
December 31, 2001. The improvement was related to the
reduction in manufacturing and materials costs discussed above.

Research and Development
Expenses.Research and development
expenditures in 2000 were $2.4 million compared to
$2.5 million in 2001, representing a 4.2% increase. The
increase was primarily related to staffing increases and costs
of development and testing of new technologies and applications
for our existing technology including products sold to Sanarus
Medical.

Selling, General and Administrative
Expenses.Selling, general and
administrative expenses for the year ended December 31,
2001 grew $2.3 million or 17.2% to $15.7 million from
$13.4 million for the year ended December 31, 2000.
The rise in selling, general and administrative costs was due to
an increase in the number of employees from 78 at the end of
2000 to 94 at the end of 2001 as well as to increased sales and
marketing investments made to support revenue growth and
expansion into new markets.

Interest Income (Expense),
Net.Net interest income was $241,000
for the year ended December 31, 2001 compared to net
interest expense for the year ended December 31, 2000 of
$832,000. The increase in net interest income is the result of
higher cash balances during 2001 following an equity offering in
late 2001 combined with a reduction in debt. The boost in
interest income for 2001 came partly from our secondary public
equity offering in November of 2001 in which we raised net cash
of approximately $72.6 million. Interest expense dropped in
the same year due to retirement of substantially all outstanding
debt through conversion into our common stock of $8 million
in debentures and related interest obligations and repayment of
funds drawn down under a credit facility.

Net Loss.Net loss
for the year ended December 31, 2001 was
$11.5 million, or $0.68 per share, compared to a net loss
of $13.8 million, or $1.08 per share for the year ended
December 31, 2000. The lower net loss in 2001 is
attributable to revenue growth and improvement in gross margins
partially offset by higher selling, general and administrative
expense.

Liquidity and Capital Resources

Since our inception, we have funded our
operations, including personnel, facilities, product
development, manufacturing, promotion of our technology and
acquisitions of business assets and intellectual property,
primarily through private placements of equity securities,
convertible debentures and loans that were subsequently
converted into shares of our common stock, the use of short-term
and long-term debt and a public offering of equity securities.
We have never generated cash from operations. Due to our ongoing
need to invest in the development and marketing of our products
as well as the significant investment needed to build our
infrastructure and to strengthen internal controls and financial
reporting systems, we are expected to

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operate at a cash flow deficit for the
foreseeable future. At December 31, 2002, we had cash, cash
equivalents and available-for-sale securities of
$40.4 million compared to $81.9 million at
December 31, 2001. Net cash used in operations was
$10.7 million in 2000, $13.5 million in 2001 and
$14.6 million in 2002. Net cash provided from financing
activities was $25.9 million in 2000, $74.1 million in
2001 and $23,000 in 2002. In 2002, we made cash payments
totaling $24.1 million in the acquisitions of Timm Medical,
the mobile prostate treatment businesses from USMD and the
business assets of BioLife. In addition, approximately
$2.1 million was invested in capital expenditures related
to the relocation and expansion of our facilities and
$2 million was spent to repurchase shares of our common
stock on the open market. There are no plans for additional
repurchases of common stock in the future. The drop in our cash,
cash equivalents and investments from 2001 to 2002 results from,
among other things, business acquisitions, legal and accounting
fees associated with our internal review of various accounting
and other matters, various shareholder class-action and
derivative lawsuits and other legal proceedings, and our ongoing
efforts to develop and implement internal controls and corporate
governance policies and procedures designed to enhance the
accuracy, quality and consistency of our financial information
and reporting.


Our future capital requirements will depend on a
number of factors, including our ability to successfully appeal
the $1.6 million judgment obtained by BioLife; other
judgments or settlements which may result from the ongoing
investigation of us by the SEC and the DOJ, various shareholder
class-action and derivative lawsuits and other legal proceedings
described above in Item 3  Legal
Proceedings; legal, accounting and other professional fees
associated with such investigations and legal proceedings, as
well as our ongoing efforts to develop and implement internal
controls and corporate governance policies and procedures
designed to enhance the accuracy, quality and consistency of our
financial information and reporting; costs associated with
satisfying the listing requirements of The Nasdaq National
Market should our common stock be relisted; costs associated
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; market
acceptance of our Cryocare Surgical System; our ability to
successfully integrate the operations of Timm Medical and our
other acquisitions into our business; market acceptance of the
products we acquired from Timm Medical; our ability to fulfill
our role as general partner of a number of partnerships in which
we acquired an interest from USMD; the resources we devote to
developing and supporting our products; continued progress of
our research and development of potential products; the need to
acquire licenses to technology; and potential future merger and
acquisition activity.

We believe that our current cash balances will be
sufficient to fund our operations for at least the next twelve
months. We may require additional financing sooner than expected
depending on the factors listed in the preceding paragraph.
Additionally, we may require additional financing sooner than
expected if we identify significant opportunities to invest in
our core technology or to accelerate growth in market share and
revenues. We expect that to meet our long-term needs we may need
to raise substantial additional funds through the sale of our
equity securities, the incurrence of indebtedness or through
funds derived through entering into collaborative agreements
with third parties.

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. Trading is now conducted in the over-the-counter
market in the so-called Pink Sheets. 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. In the event that we do 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.

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

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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
restatements described in note 3 to our consolidated
financial statements 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
more 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.

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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 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.

Long Lived Assets, Including Intangible Assets
Subject to Amortization and Goodwill.We have a significant amount of property, equipment and
intangible assets, including goodwill. 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 by the
amount by which the carrying value of the assets exceeds their
fair value. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell. In
accordance with SFAS No. 142, Goodwill and Other
Intangibles, we review goodwill annually for impairment and
on an interim basis if events or changes in circumstances
between annual tests indicate that an asset might be impaired.
Goodwill is tested for impairment at the reporting unit level
using a two-step process. The first step is to identify a
potential impairment, and the second step measures the amount of
impairment loss, in any. Goodwill is deemed to be impaired if
the carrying value of a reporting units goodwill exceeds
its estimated fair value. The value of our intangible assets,
including goodwill, is exposed to future adverse changes if we
experience declines in operating results or experience
significant negative industry or economic trends or if future
performance is below historical trends.

The determination as to whether events or changes
in circumstances indicate that the carrying amount of an asset
may not be recoverable involves managements judgment.
Should we conclude that recoverability of an asset is in
question, the estimate of undiscounted future operating cash
flows is used to determine whether an asset is recoverable and,
if not, the final determination of the fair value of the asset
is also based on the judgment of management. Fair value is
determined primarily using the estimated future cash flows
associated with the asset under review, discounted at a rate
commensurate with the risk involved. These judgments can be
impacted by a variety of underlying assumptions, such as the
general business climate, effectiveness of competition, supply
and cost of resources and the selection of appropriate discount
factors. Actual results can differ significantly from the
assumptions made by management in making its estimates. In
addition, the estimated fair values may produce significantly
different results if other reasonable assumptions and estimates
were to be used. Based on our analysis, we recorded an
impairment charge of approximately $18 million in the
fourth quarter of 2002 to reduce the carrying value of the
goodwill from the acquisition of Timm Medical. If we are unable
to support a fair value estimate in future impairment tests, we
may be required to record additional impairment losses against
future income.

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

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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 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. In
the fourth quarter of 2002, we 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 (see
note 4 to our consolidated financial statements).

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, 2002, we have
established a valuation allowance of $30.8 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.

Recently Issued Accounting Standards

In June 2001, SFAS No. 143,
Accounting for Asset Retirement Obligations, was issued.
This statement requires an enterprise to record the fair value
of an asset retirement obligation as a liability in the period
in which it incurs a legal obligation associated with the
retirement of tangible long-lived assets. Since the requirement
is to recognize the obligation when incurred, approaches that
have been used in the past to accrue the asset retirement
obligation over the life of the asset are no longer acceptable.
SFAS No. 143 also requires the enterprise to record
the contra to the initial obligation as an increase to the
carrying amount of the related long-lived asset, i.e., the
associated asset retirement costs, and to depreciate that cost
over the life of the asset. The liability is increased at the
end of each period to reflect the passage of time, i.e.,
accretion expense, and changes in the estimated future cash
flows underlying the initial fair value measurement.
SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002.

In May 2002, SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections as of April 2002was issued. As a result of the
rescission of SFAS No. 4, gains and losses related to
the extinguishment of debt should be classified as extraordinary
only if they meet the criteria outlined under APB Opinion
No. 30, Reporting the Results of Operations 
Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 64, Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements, was an
amendment to SFAS No. 4 and is no longer necessary.
SFAS No. 44, Accounting for Intangible Assets of
Motor Carriers, defined accounting requirements for the
effects of the transition to the Motor Carrier Act of 1980. The
transitions are complete and SFAS No. 44 is no longer
necessary. SFAS No. 145 amends SFAS No. 13,
Accounting for Leases, requiring that any capital lease
that is modified resulting in an operating lease should be
accounted for under the sale-leaseback provisions of SFAS
No. 98, Accounting for Leasesor
SFAS No. 28, Accounting for Sales with
Leasebacks, as applicable. SFAS No. 145 is
effective for fiscal years beginning after May 15, 2002.

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In June 2002, SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities, which requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred, was issued. This statement nullifies
Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring), which required that a liability for an exit
cost be recognized upon the entitys commitment to an exit
plan. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002.

In November 2002, SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued.
SFAS No. 150 requires that certain financial
instruments previously reported as equity be reported as
liabilities (such as mandatorily redeemable equity instruments
and buy-sell arrangements). Depending on the type of financial
instrument, it will be accounted for at either fair value or
present value of future cash flows determined at each balance
sheet date with the change in that value reported as interest
expense in the income statement. In the past, either those
financial instruments were not required to be recognized, or if
recognized were reported in the balance sheet as equity and
changes in the value of those instruments were normally not
recognized in net income. The statement is effective for
instruments entered into or altered after May 31, 2003, and
is otherwise effective for interim periods ending after
June 15, 2003.

In November 2002, Financial Interpretation Number
(FIN) 45, Guarantors Accounting and Disclosure
Requirement for Guarantees, including Indirect Guarantees of
Indebtedness of Others, was issued. FIN No. 45
requires that a guarantor recognize, at the inception of the
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The initial recognition and
measurement provision of FIN No. 45 does not apply to
certain guarantee contracts, such as warranties, derivatives or
guarantees between either parent and subsidiaries or
corporations under common control, although disclosures of such
guarantees is required. For contracts that are within the
initial recognition and measurement provisions of
FIN No. 45, the provisions are to be applied to
guarantees issued or modified after December 31, 2002.

In January 2003, FIN No. 46,
Consolidation of Variable Interest Entities, was issued.
FIN 46 clarifies existing accounting principles that
determine when a company should include in its financial
statements the assets, liabilities and activities of another
entity when the equity investors do not have the characteristics
of a controlling financial interest or when the equity at risk
is not sufficient for the entity to finance its activities
without additional subordinated financial support from other
parties. The consolidation requirements of FIN No. 46
apply to variable interest entities (commonly evidenced by a
guarantee arrangement or other commitment to provide financial
support) created after January 31, 2003. We are required to
perform this assessment by September 30, 2003, and
consolidate any variable interest entities for which it will
absorb a majority of the entities expected losses or
receive a majority of the expected residual gains.

The adoption of the provisions of these
pronouncements is not expected to have a material impact on our
results of operations, financial position, cash flows and
related disclosures. We have not yet performed the assessment
required under FIN No. 46; however, we are not aware
of any material variable interest entity that we may be required
to consolidate.

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, 2002, the carrying values of these financial
instruments approximated their fair values.

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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,
or KPMG, as our independent auditor. The following disclosure
with respect to this Item is set forth in our preliminary proxy
statement filed on November 26, 2003:

Dismissal of KPMG

| | 
| | 
| | 



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | KPMG previously served as the Companys
    independent auditor. The Companys Board of Directors, upon
    recommendation of the Audit Committee, approved the dismissal of
    KPMG as the Companys independent auditor, effective
    March 7, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | 
|
| | KPMGs report on the Companys
    consolidated financial statements as of and for the fiscal years
    ended December 31, 2000 and 2001 did not contain an adverse
    opinion or a disclaimer of opinion, and was not qualified or
    modified as to uncertainty, audit scope or accounting principles.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 
|
| | As previously reported by the Company in a press
    release dated December 12, 2002, KPMG notified the
    Companys Audit Committee, by letter dated
    December 11, 2002 (the KPMG Letter), that
    KPMGs report dated February 19, 2002, except as to
    notes 1 and 15, which are dated as of March 25, 2002, on
    the Companys consolidated financial statements as of
    December 31, 2001, and for the year then ended, had been
    withdrawn and could no longer be relied upon. KPMG also advised
    the Audit Committee that it believed that sufficient evidence
    existed to conclude that the Companys consolidated
    financial statements for the quarters ended March 31, 2002 and
    June 30, 2002 should not be relied upon. KPMG stated that
    it was unable to rely on the representations of the
    Companys senior management and would continue to act as
    the Companys independent auditor only if those concerns
    were satisfactorily resolved. KPMG subsequently notified the
    Company by letter dated September 16, 2003 that KPMGs
    report dated February 19, 2002, except as to notes 1 and
    15, which are dated as of March 25, 2002, on the
    Companys consolidated financial statements as of
    December 31, 2000 and for the years ended December 31,
    2000 and 1999, could no longer be relied upon. | 
|
| | On March 14, 2003, the Company filed with
    the Securities and Exchange Commission a report on
    Form 8-K, which was amended on May 1, 2003 and
    May 16, 2003 (the Form 8-K). The
    Form 8-K stated that KPMG had concluded that it was unable
    to rely on the representations of the Companys management,
    based upon the totality of the circumstances described below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | 

Revenue
Recognition

| | 
| | 
| | 



| |   |                                                                                                                                                                                                                                           | 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | KPMG expressed concern in the KPMG Letter that
    the Company had recorded sales to customers of products that
    remained in Company-controlled facilities at the time of
    KPMGs performance of its most recent review procedures. | 

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                               | 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | KPMG expressed concern in the KPMG Letter that
    the Company had recorded sales to customers of products that
    were shipped to Company-controlled facilities, and then not
    delivered to the customers until a subsequent accounting period,
    remaining in Company-controlled facilities as of the close of
    the accounting period in which the sales were recorded.                                                                            | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    the Company engaged in two transactions to acquire assets from
    customers concurrent with the sale by the Company of products to
    such customers, but that only the sales to the customers were
    recorded in the Companys accounting records at the time of
    the sales, while the concurrent acquisitions of products from
    the customer were recognized in a different accounting period. | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    all of the revenue related to certain multiple-element sales was
    fully recorded in a single accounting period, though certain of
    the components were not delivered until a subsequent accounting
    period.                                                                                                                                                                                       | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    sales to one customer ultimately were delivered to a warehouse
    secured and paid for by a Company sales representative, for
    which the sales representative was reimbursed through his
    expense report, and that the accounting records noted that the
    sale was delivered to the customer location.                                                                                           | 

Expense
Recognition

| | 
| | 
| | 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                   | 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | KMPG expressed concern in the KPMG Letter that
    notations on supporting documentation for at least two expense
    transactions could be interpreted to indicate that the
    Companys senior management had instructed subordinates to
    record the related transactions outside of the Companys
    normal policies and procedures, and potentially not in
    accordance with generally accepted accounting principles. | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    expenses associated with certain products or services purchased
    by the Company knowingly were not accrued in the proper
    accounting period.                                                                                                                                                                                                                             | 

Accounts
Receivable

| | 
| | 
| | 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | 
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | KPMG expressed concern in the KPMG Letter that in
    two instances the Company has recorded cash receipts from
    customers as a reduction of accounts receivable near quarter
    end, where, at least in one instance, management knew the
    underlying check had been rejected by the bank for insufficient
    funds prior to the issuance of the Companys financial
    statements and the filing of the Companys corresponding
    report on Form 10-Q.          | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    there were cash receipts from customers recorded as a reduction
    of accounts receivable if the customer check was dated prior to
    the end of the accounting period, even though physical receipt
    of the check occurred after the end of the accounting period.                                                                                                                                                  | 
|
| |  | KPMG expressed concern in the KPMG Letter that
    one customer concession had been granted by senior management
    some period of time after the date of the original sale to
    facilitate payment of an outstanding account receivable by the
    customer, and that the concession was recorded in a period
    subsequent to when the cash receipt was recorded, despite the
    apparent linkage between the concession and the payment of cash
    by the customer. | 



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | The Form 8-K indicated that the
    Companys Audit Committee had investigated the matters
    described above and expressed certain views with respect to such
    matters, including that the Audit Committee disagreed with
    KPMGs conclusion that it could not rely on the
    representations made by the Companys then-senior
    management. The Form 8-K also stated that the Audit
    Committee had discussed with KPMG the subject matter of the
    disagreement, and that the Company had asked its | 

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | new independent auditor, Ernst & Young LLP,
    to consider the issues raised in the KPMG letter in connection
    with its reaudit of the Companys financial statements for
    the fiscal years ended December 31, 2000 and 2001 and the
    audit for the fiscal year ended December 31, 2002. In
    addition, the Form 8-K stated that the Company had
    authorized KPMG to respond fully to the inquiries of Ernst &
    Young LLP concerning the matters described above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|
| | The Companys Audit Committee has since
    overseen an additional investigation regarding the matters
    described above, and discussed extensively with Ernst &
    Young LLP the results of its reaudit of the Companys
    financial statements for the fiscal years ended
    December 31, 2000 and 2001 and audit for the fiscal year
    ended December 31, 2002. In view of that substantial
    additional work performed since the KPMG dismissal, and the
    various adjustments to the previously audited financial
    statements, the Audit Committee has reconsidered the views and
    conclusions expressed in the Form 8-K. The views expressed
    in this proxy statement are the only views on the subject that
    the Audit Committee currently holds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | 
|
| | At the time of its dismissal, KPMG had expressed
    the conclusions that the previously prepared financial
    statements did not reflect either the facts or substance of
    certain transactions, and that it was unable to rely on
    representations that the Companys then-senior management
    had confirmed to the best of its knowledge and belief. The
    Companys Audit Committee and KPMG discussed KPMGs
    conclusion that KPMG was unable to rely on representations of
    the Companys then-senior management. However, after its
    receipt of the KPMG Letter, the Audit Committee was unable to
    discuss with KPMG the specific transactions described in the
    KPMG Letter, because KPMG declined to resume any services on
    behalf of the Company unless and until KPMGs concerns
    regarding its ability to rely on representations of the
    Companys then-senior management had been resolved to
    KPMGs satisfaction. Please note that KPMG has provided to
    the Company the letter included in Appendix Eattached hereto, in which KPMG states, among other things,
    that the preceding sentence is inaccurate in that [KPMG]
    did, in fact, discuss with the Audit Committee many of the
    specific transactions described in the KPMG Letter when it was
    delivered to the Audit Committee on December 11, 2002, and
    as well as on several occasions prior to that date. [KPMG] also
    never expressed to the Audit Committee [KPMGs]
    unwillingness to discuss the specific transactions subsequent to
    that date. | 
|
| | In light of the totality of the information now
    available, including the revised financial statements for 1999
    and subsequent periods, the Audit Committee now agrees with
    KPMGs conclusion that the previously prepared financial
    statements did not reflect either the facts or substance of
    certain transactions. Therefore, under the circumstances, it
    does not disagree with the conclusion that KPMG could not rely
    on certain of the factual statements included in
    managements representations, including those to the effect
    that the financial statements conformed with generally accepted
    accounting principles. With respect to fraud or intentional
    wrongdoing, notwithstanding the additional review and
    investigation, the Audit Committee has not come to the
    conclusion that there was any fraud or intentional wrongdoing
    associated with the activities of the Companys management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|
| | Other than as described above, there have been no
    reportable events (as that term is used in
    Item 304(a)(1)(v) of Regulation S-K) during the
    Companys two most recent fiscal years and the subsequent
    interim period prior to KPMGs dismissal.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 

Statement From KPMG



| |                                                                                                                                                                                      | 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | 
| | As noted above, in response to the description
    included above under Dismissal of KPMG, KPMG
    provided to the Company the letter included in
    Appendix Eattached hereto. | 

We are not aware of any transactions or events
similar to those previously reported and described above which
were accounted for or disclosed in a manner different from that
which our former accountants apparently would have concluded was
required.

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##### Table of Contents






PART III






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

Information is set forth below concerning all of
our directors. On June 19, 2003, our Board of Directors
established a Nominating Committee for purposes of monitoring
the size and composition of our Board of Directors and reviewing
and recommending candidates for board membership. In particular,
our Board of Directors directed the Nominating Committee to
focus on strengthening the Board by searching for candidates
with significant financial, operational and/or sales and
marketing expertise, or health care experience. The Nominating
Committee currently is engaged in a search for director
candidates who possess such expertise and are
independent, as defined in The Nasdaq Stock Market
listing standards. After candidates are identified and selected,
the Nominating Committee expects that one or more directors will
resign as directors and those candidates will be appointed in
their place. Under our Bylaws, vacancies resulting from the
resignation of one or more directors may be filled by a majority
of the directors then in office, without the vote of the our
stockholders.

|                          |  |     |    |                           |  |  |               | 
|------------------------- |  | --- | -- | ------------------------- |  |  | ------------- | 
|Name                      |  | Age |    | Position with the Company
|                          |  |     |    |                          
|Peter F. Bernardoni*      |  |     | 44 |                           |  |  | Director      | 
|Robert F. Byrnes*        |  |     | 59 |                           |  |  | Director      | 
|Benjamin Gerson, M.D.*+   |  |     | 55 |                           |  |  | Director      | 
|Ronald A. Matricaria+     |  |     | 61 |                           |  |  | Lead Director | 
|Terrence A. Noonan       |  |     | 66 |                           |  |  | Director      | 
|Michael J. Strauss, M.D.+ |  |     | 49 |                           |  |  | Director      | 
|Thomas R. Testman+       |  |     | 66 |                           |  |  | Director      | 



---



|  |  |                                                                                                                                                                                                                                                                                  
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Member of the Audit Committee. Mr. Testman
    was appointed to the Audit Committee on May 5, 2003, and
    Mr. Noonan was appointed to the Audit Committee on
    September 30, 2003. Messrs. Bernardoni and Gerson
    resigned from the Audit Committee on September 30, 2003.
| 
|* |  | Member of the Compensation Committee.                                                                                                                                                                                                                                            
| 
|+ |  | Member of the Nominating Committee.                                                                                                                                                                                                                                              

Peter F. Bernardonihas served as a director since
November 1995. Mr. Bernardoni is a Partner of Technology
Funding, a venture investment group. He conducts due diligence
and financial analysis of Technology Fundings investment
opportunities, while maintaining responsibility for ongoing
oversight of several portfolio companies in the lifescience and
technology fields. In addition to serving as one our directors,
Mr. Bernardoni is a member of the Board of Directors of
VenCore Solutions, KeyEye Communications, Capital Valley
Ventures, Sanarus Medical, Inc. and Atherotech, Inc. He is also
Chairman of Innergy Power Corporation, Inc. In 1988, he joined
Technology Funding after several years at IBM Corporation.
Initially he began at IBM as a design engineer and later moved
into sales and marketing where his team targeted pharmaceutical
and healthcare companies. Mr. Bernardoni earned his B.S.
from Santa Clara University and his M.S. from Stanford
University, both in mechanical engineering.

Robert F. Byrneshas
served as a director since August 1997. Mr. Byrnes has
served as President and Chief Executive Officer of Thermage,
Inc., a medical device company, since November 2002. Prior to
that, Mr. Byrnes served as Chief Executive Officer for
Roan, Inc., a healthcare consulting and services company, from
June 1997 to November 2002. From March 1996 until September
1997, he served as President and Chief Executive Officer of
Matria Healthcare, Inc., a medical services company. He also is
on the Board of Directors of Tandem Medical, Advolife, Inc. and
Thermage, Inc. He holds a B.S. from Ferris State University and
an M.B.A. from Loyola University in Chicago.

Benjamin Gerson, M.D.has served as a director since August
1997. Dr. Gerson has served as Clinical Professor of
Pathology and Cellular Biology, and Clinical Professor of
Medicine at Jefferson Medical College since 1999, and Professor
of Medicine, Occupational Health at Boston University School of
Medicine since 1999. Prior to that, Dr. Gerson was
Professor of Pathology and Laboratory Medicine as well Professor
of

50



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##### Table of Contents



Pharmacology and Experimental Therapeutics at
Boston University School of Medicine from 1987 to 1999.
Dr. Gerson also serves as Senior Vice President for
University Services, a position he has held since 1996. He is a
member of the FDA Clinical Chemistry and Clinical Toxicology
Devices Panel, Center for Devices and Radiological Health and
previously has served as Chairman of this Panel. Dr. Gerson
also serves as a director of Atherotech, Inc. He obtained his
M.D. from Thomas Jefferson University.


Ronald A. Matricariahas served as a director since June
2002. Mr. Matricaria has over 30 years of medical
device and pharmaceutical experience at St. Jude Medical,
Inc. and Eli Lilly and Company, Inc. From April 1993 to May
1999, he served as President and Chief Executive Officer of
St. Jude Medical, Inc. and was elected Chairman of the
Board of Directors in January 1995. Prior to joining
St. Jude Medical, Mr. Matricaria spent 23 years
with Eli Lilly and Company, Inc. His last position was Executive
Vice President of the Pharmaceutical Division of Eli Lilly and
Company and President of its North American operations. He also
served as President of Eli Lilly International Corporation since
July 1991. From 1999 to the present, Mr. Matricaria has
been serving as a board member or advisor to several companies.
In addition to serving on our Board of Directors,
Mr. Matricaria currently serves on the boards of
CardioDynamics International Corporation, Cyberonics and
VistaCare, Inc. and is an advisor or board member to several
medically related privately owned companies and a private equity
healthcare fund. Mr. Matricaria is also Chairman of the
Board of Directors of Haemonetics, Inc. Mr. Matricaria
holds a bachelors degree in pharmacy from Massachusetts
College of Pharmacy and was awarded an honorary Doctor of
Science degree in pharmacy in recognition of his contributions
to the practice of pharmacy.

Terrence A. Noonanhas served as a director since
September 2003. From 1991 to 1999, Mr. Noonan was President
and Chief Operating Officer of Furon Company, a New York Stock
Exchange-listed manufacturer of industrial and medical polymer
components. Mr. Noonan served as an executive vice
president of Furon from 1989 to 1991 and as a vice president of
Furon from 1987 to 1989. Prior to joining Furon in 1987,
Mr. Noonan served as a group vice president of Eaton
Corporation, a diversified global manufacturer of transportation
and electrical products. From 1999 to the present,
Mr. Noonan has been serving as a board member to several
companies. In addition to serving on our Board of Directors,
Mr. Noonan currently serves on the boards of Barnes
Marketing, Inc. and Highway Holdings, Ltd. Mr. Noonan
received a B.S. from Miami University and an E.M.B.A. from Case
Western Reserve University.

Michael J. Strauss, M.D., M.P.H.has served as a director since
February 1999. He is currently the Chief Executive Officer of
Naviscan PET Systems, Inc. (formerly PEM Technologies, Inc.), a
developer of compact high-resolution positron emission
tomography (PET) devices. Dr. Strauss was a founder and
officer of Covance Health Economics and Outcomes Services, Inc.,
a healthcare consulting and service firm, from June 1988 through
April 1999. He serves on the Board of Directors of Cyberonics,
Inc. and Naviscan PET Systems, Inc. He obtained an A.B. from
Harvard College, M.D. from Duke University, and M.P.H. from the
University of Washington School of Public Health.

Thomas R. Testmanhas served as a director since May
2003. Mr. Testman is a former managing partner of
Ernst & Young, LLP where, during his tenure from 1962
to 1992, he served as managing partner of both Health Care
Services and Management Consulting Services for the West Coast
and national practices. From 1993 to the present,
Mr. Testman has been serving as a board member to both
public and private companies. In addition to serving on our
Board of Directors, Mr. Testman currently serves on the
Board of Directors of three other public companies, Amylin
Pharmaceuticals, Inc., ChromaVision Medical Systems, Inc., and
Specialty Laboratories, Inc. He also serves on the board of
several private companies, including serving as Chairman of
Covenant Care, Inc. and Pacific Health Corporation. During 1998,
he served as Chairman of the board and interim Chief Executive
Officer of Techniclone Corp. (now Peregrine Pharmaceuticals,
Inc.). Mr. Testman previously was a director and a Chairman
of the Audit Committee of MiniMed Inc., and Mr. Testman
also was Chairman of the special committee that oversaw
MiniMeds acquisition by Medtronic, Inc. He received a B.A.
in Business from Pacific Union College and an M.B.A. from
Trinity University. Mr. Testman is a certified public
accountant.

51



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##### Table of Contents



Our executive officers as of September 30,
2003 are as follows:

|                    |  |     |    |          |  |                                                                 
|------------------- |  | --- | -- | -------- |  | ----------------------------------------------------------------
|Name                |  | Age |    | Position
|                    |  |     |    |         
|William J. Nydam    |  |     | 53 |          |  | President and Chief Operating Officer                           
|Katherine Greenberg |  |     | 51 |          |  | Senior Vice President, Chief Financial Officer
    and Secretary

William J. Nydamhas
served as President and Chief Operating Officer since March
2003. Mr. Nydam also currently is a board member and the
Chairman of the Audit Committee of Specialty Laboratories, Inc.
Prior to joining us, Mr. Nydam was President and Chief
Executive Officer of Pulse Metric, Inc., a cardiovascular device
company, from September 2001 to December 2002. Mr. Nydam
previously served as Senior Vice President for Science
Applications International Corporation, an employee-owned
research and engineering firm, from September 1999 to August
2001. Prior to that time, Mr. Nydam worked for Premier,
Inc., a national alliance of healthcare providers, where he
served as Executive Vice President from April 1996 to August
1999, Chief Operating Officer from May 1992 to March 1996 and
Senior Vice President and Chief Financial Officer from January
1986 to April 1992. Mr. Nydam holds a B.S. degree in
Accounting and an M.B.A. from the University of California at
Berkeley and is a Certified Public Accountant.

Katherine Greenbergjoined us in March 2003 as Senior Vice
President and Chief Financial Officer and has served as
Secretary since June 2003. Prior to joining us,
Ms. Greenberg worked for Junum, Inc., a technology-based
financial services company, where she served as Chief Financial
Officer and financial consultant from October 2002 to November
2003. Prior to that time, she served as Chief Financial Officer
of Fastpoint Communications, Inc., an Internet services
provider, from February 2000 to December 2002. From February
1999 to February 2000, Ms. Greenberg served as Vice
President and Controller, Information Technology Group at The
Capital Group Companies, Inc., a private investment management
firm. From February 1998 to February 1999, Ms. Greenberg
worked as Vice President and Chief Financial Officer of Justice
Technology, Inc., an international telecommunications service
provider. Prior to that time, she worked for DePuy, Inc., an
orthopedic device manufacturer, serving as divisional Chief
Financial Officer and Executive Vice President, Finance and
Operations from March 1994 to February 1998. Ms. Greenberg
holds a B.A. degree in Philosophy from Mount Holyoke College and
an M.B.A. from Columbia Business School and is a Certified
Public Accountant.

Section 16(a) Beneficial Ownership
Reporting Compliance

Section 16(a) of the Securities Exchange Act
of 1934 requires our officers and directors, and persons who own
more than 10% of a registered class of our equity securities, to
file reports of ownership and changes in ownership with the SEC.
Officers, directors and greater than 10% stockholders are
required by SEC regulation to furnish us with copies of all
Section 16(a) reports they file.

Based solely upon the copies of
Section 16(a) reports which we received from such persons
or written representations from them regarding their
transactions in our common stock, we believe that, during the
period from January 1, 2002 through December 31, 2002,
all Section 16(a) filing requirements applicable to our
officers, directors and greater than 10% beneficial owners were
met in a timely manner, with the exception of the inadvertent
failure to file Form 4s for the following stock option
grants, each of which occurred on June 26, 2002 and was
reflected in a Form 5 filing made on June 27, 2003:
(i) grant to Mr. Mikus of an option to purchase
200,000 shares of common stock; (ii) grant to
Mr. Cracchiolo of an option to purchase 35,000 shares
of common stock; (iii) grant to Mr. Eum of an option
to purchase 35,000 shares of common stock; and
(iv) grant to Mr. Quilty of an option to purchase
40,000 shares of common stock.






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

Summary of Cash and Certain Other
Compensation

The following table sets forth summary
information regarding the compensation earned by our former
Chief Executive Officer and each of our other most highly
compensated executive officers employed by us as of
December 31, 2002 and whose salary and bonus for the fiscal
year ended December 31, 2002 was in excess of $100,000 for
their services rendered in all capacities to us. This table also
sets forth summary information

52



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##### Table of Contents



for Ms. Holly H. Williams, our former
General Counsel and Vice President, Human Resources, who would
have otherwise been includable in such table on the basis of
salary and bonus earned for the 2002 fiscal year. No executive
officers who would have otherwise been included in this table on
the basis of salary and bonus earned for the fiscal 2002 year
have been excluded by reason of his or her termination of
employment or change in executive status during that year. The
listed individuals shall be hereinafter referred to as the
Named Executive Officers.


Summary 2002 Compensation Table

|                            |                         |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|--------------------------- | ----------------------- | ---- | ---- | ------------------- |  | ------------ | ------- | ------------ |  | --------------- | ------ | --------------- |  | - | ----- | ------ | ---- |  | ------- | ------- | ---- | - | ----- | ----- | 
|                            |                         |      |      |                     |  |              |         |              |  | Long-Term       |        |                
|                            |                         |      |      |                     |  | Compensation |         |             
|                            |                         |      |      | Annual Compensation |  | Award        |         |             
|                            |                         |      |      |                     |  |              |         |             
|                            |                         |      |      |                     |  | Other        |         | Securities   |  |                
|                            |                         |      |      |                     |  | Annual       |         | Underlying   |  | All Other      
|Name and Principal Position |                         | Year |      | Salary              |  | Bonus(1)     |         | Compensation |  | Options/SARS(2) |        | Compensation(3)
|                            |                         |      |      |                     |  |              |         |              |  |                 |        |                
|Paul W. Mikus(4)            |                         |      | 2002 |                     |  | $            | 239,583 |              |  | $               | 43,600 |                 |  | $ | 6,325 | (9)    |      |  | 200,000 | (12)    |      | $ | 4,970 |      
|                            | Former President and    |      |      | 2001                |  |              | $       | 200,000      |  |                 | $      | 95,260          |  |   | $     | 32,575 | (10) |  |         |        |      |   | $     | 4,981 | 
|                            | Chief Executive Officer |      |      | 2000                |  |              | $       | 200,000      |  |                 | $      | 85,066          |  |   |       |       |      |  |         |        |      |   | $     | 4,380 | 
|John V. Cracchiolo(5)       |                         |      | 2002 |                     |  | $            | 210,833 |              |  | $               | 42,286 |                 |  |   |      |        |      |  | 35,000  | (13)    |      |   |      |      
|                            | Former Chief Operating  |      |      | 2001                |  |              | $       | 95,000       |  |                 | $      | 18,429          |  |   |       |       |      |  |         | 350,000 | (13) |   |       |      | 
|                            | Officer and Chief       |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|                            | Financial Officer       |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|Jay J. Eum(6)               |                         |      | 2002 |                     |  | $            | 172,500 |              |  | $               | 50,130 |                 |  | $ | 3,894 | (11)   |      |  | 35,000  |         |      | $ | 5,509 |      
|                            | Senior Vice President   |      |      | 2001                |  |              | $       | 165,000      |  |                 | $      | 85,705          |  |   | $     | 7,932  | (11) |  |         | 50,000  |      |   | $     | 5,518 | 
|                            | and Chief Technology    |      |      | 2000                |  |              | $       | 142,000      |  |                 | $      | 55,217          |  |   |       |       |      |  |         | 50,000  |      |   | $     | 3,309 | 
|                            | Officer                 |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|Kevin M. Quilty(7)          |                         |      | 2002 |                     |  | $            | 217,667 |              |  | $               | 51,531 |                 |  | $ | 5,025 | (9)    |      |  | 40,000  |         |      |   |      |      
|                            | Senior Vice President,  |      |      | 2001                |  |              | $       | 150,545      |  |                 | $      | 48,143          |  |   | $     | 2,100  | (9)  |  |         | 200,000 |      |   |       |      | 
|                            | Sales and Marketing     |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|Holly H. Williams(8)        |                         |      | 2002 |                     |  | $            | 95,219  |              |  | $               | 15,420 |                 |  |   |      |        |      |  |        |         |      |   |      |      
|                            | Former General Counsel  |      |      | 2001                |  |              | $       | 120,000      |  |                 | $      | 24,350          |  |   |       |       |      |  |         | 65,000  |      |   | $     | 5,452 | 
|                            | and Vice President,     |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 
|                            | Human Resources         |      |      |                     |  |              |         |              |  |                 |        |                 |  |   |       |        |      |  |         |         |      |   |       |       | 



---



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Bonus amounts are earned and accrued for each
    quarter of the fiscal year in which reported, but bonuses for
    the fourth quarter of the fiscal year are paid after the close
    of that fiscal year. The 2000 totals in the column also include
    amounts paid pursuant to forgiveness of notes payable and
    accrued interest for Mr. Mikus and Mr. Eum of $31,066
    and $16,877, respectively.                                                                                                                                  
|
| | (2) | We do not grant Stock Appreciation Rights.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | (3) | The 2000, 2001 and 2002 totals in the column
    reflect the value of our contributions on behalf of each Named
    Executive Officer under our 401(k) Plan and group term life
    insurance. These amounts for the 2000, 2001 and 2002 fiscal
    years, respectively, were as follows: Paul W. Mikus: $4,110 and
    $270; $4,711 and $270; $4,711 and $259; and Jay J. Eum: $3,058
    and $251; $5,250 and $268; $5,250 and $259. These amounts for
    the 2001 fiscal year for Holly H. Williams were $5,250 and $202,
    respectively.
|
| | (4) | Mr. Mikus resigned as our President and
    Chief Executive Officer in March 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | (5) | Mr. Cracchiolo joined us in June 2001 as
    Chief Operating Officer, Chief Financial Officer and Secretary.
    Mr. Cracchiolo resigned as Chief Operating Officer and
    Chief Financial Officer in March 2003 and ceased to serve as
    Secretary in June 2003, but remained an employee in the position
    of President, Radiology Division until July 31, 2003.                                                                                                                                                                        
|
| | (6) | Mr. Eum was our Vice President, Research and
    Development until January 1, 2001, when he was appointed Senior
    Vice President and Chief Technology Officer.                                                                                                                                                                                                                                                                                                                                                                              
|
| | (7) | Mr. Quilty joined us in February 2001 as
    Senior Vice President, Sales and Marketing.                                                                                                                                                                                                                                                                                                                                                                                                                                                       

53



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| |     |                                                                                                                                                                                                   
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (8) | Ms. Williams resigned from her position as
    our General Counsel and Vice President, Human Resources, in
    April 2002, and the options previously granted to
    Ms. William have now expired.
|
| | (9) | This amount represents an automobile allowance.                                                                                                                                                   



|     |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | This amount includes $25,975 in vacation payout
    and $6,600 for automobile allowance.                                                                                                                                                                                                                                                                                                                                           
|    
|(11) | This amount represents vacation payout.                                                                                                                                                                                                                                                                                                                                                                                            
|    
|(12) | These options were cancelled effective
    July 31, 2003, as described below under Employment
    Contracts, Severance Agreements and Change of Control
    Arrangements.                                                                                                                                                                                                                                                        
|    
|(13) | These options were cancelled effective
    March 3, 2003, as described below under Employment
    Contracts, Severance Agreements and Change of Control
    Arrangements. As described below, pursuant to the terms of
    Mr. Cracchiolos employment agreement, options to
    acquire 385,000 shares of our common stock, at an exercise price
    of $4.50 per share, were granted to Mr. Cracchiolo on
    October 30, 2003.

Stock Option Grants

The following table sets forth information
concerning each grant of stock options made during 2002 to each
of the Named Executive Officers.

Option Grants in Last Fiscal Year

|                   |  |                   |         |            |  |              |       |                               |  |                              |       |     |  |  |           |  |  |   |           |  |  |   |           | 
|------------------ |  | ----------------- | ------- | ---------- |  | ------------ | ----- | ----------------------------- |  | ---------------------------- | ----- | --- |  |  | --------- |  |  | - | --------- |  |  | - | --------- | 
|                   |  |                   |         |            |  |             
|                   |  | Individual Grants |         |            |  |             
|                   |  |                   |         |            |  |             
|                   |  |                   |         | Percent of |  |              |       |                              
|                   |  |                   |         | Total      |  |              |       | Potential Realizable Value at
|                   |  | Number of         |         | Options    |  |              |       | Assumed Annual Rates of      
|                   |  | Shares            |         | Granted to |  | Exercise     |       |                               |  | Stock Price Appreciation For
|                   |  | Underlying        |         | Employees  |  | Price Per    |       |                               |  | Option Terms($)(4)          
|                   |  | Options           |         | in Fiscal  |  | Share        |       | Expiration                    |  |                             
|Name               |  | Granted(1)        |         | Year(2)    |  | ($/Share)(3) |       | Date                          |  | 5%                           |       | 10%
|                   |  |                   |         |            |  |              |       |                               |  |                              |       |    
|Paul W. Mikus      |  |                   | 200,000 | (5)        |  |              | 21.66 | %                             |  | $                            | 11.50 |     |  |  | 6/25/2012 |  |  | $ | 1,446,458 |  |  | $ | 3,665,608 | 
|John V. Cracchiolo |  |                   | 35,000  | (6)        |  |              | 3.79  | %                             |  | $                            | 11.50 |     |  |  | 6/25/2012 |  |  | $ | 253,130   |  |  | $ | 641,481   | 
|Jay J. Eum         |  |                   | 35,000  |            |  |              | 3.79  | %                             |  | $                            | 11.50 |     |  |  | 6/25/2012 |  |  | $ | 253,130   |  |  | $ | 641,481   | 
|Kevin M. Quilty    |  |                   | 40,000  |            |  |              | 4.33  | %                             |  | $                            | 11.50 |     |  |  | 6/25/2012 |  |  | $ | 289,292   |  |  | $ | 733,122   | 
|Holly H. Williams  |  |                   |        |            |  |              |      |                               |  |                              |      |     |  |  |          |  |  |   |          |  |  |   |          | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | All options become fully vested and exercisable
    upon (i) a dissolution, liquidation or sale of
    substantially all our assets, (ii) any reorganization,
    merger or consolidation in which we do not survive or in which
    our shares outstanding prior to the transaction are converted
    into other property or (iii) an acquisition of 50% or more
    of our stock. Prior to and in the absence of such merger, sale
    or acquisition, the options vest over a four-year period, with
    25% to vest on the one year anniversary date and the remaining
    75% to vest in equal monthly installments thereafter over the
    following three years. Each option has a maximum term of
    10 years measured from the grant date, subject to earlier
    termination upon the optionees cessation of service with
    us. The shares subject to each option become exercisable only if
    vested.
|   
|(2) | Percentages are based on an aggregate of 923,500
    options granted to our employees under our stock option plans
    during 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|(3) | The exercise price may be paid in cash, in shares
    of common stock valued at fair market value on the exercise date
    or through a cashless exercise procedure involving a same-day
    sale of the purchased shares. We may also finance the option
    exercise by loaning the optionee sufficient funds to pay the
    exercise price for the purchased shares and the federal and
    state tax liability incurred in connection with such exercise.
    The optionee may be permitted, subject to the approval of the
    plan administrator, to apply a portion of the shares purchased
    under the option, or to deliver existing shares of common stock,
    in satisfaction of such tax liability.                                                                                                                                                                                                    

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | The potential realizable value is calculated
    based on the term of the option at its time of grant. It is
    calculated by assuming that the stock price on the date of grant
    appreciates at the indicated annual rate, compounded annually
    for the entire term of the option. We do not provide assurance
    to any Named Executive Officer or any other holder of our
    securities that the actual stock price appreciation over the
    10-year option term will be at the assumed 5% and 10% levels or
    at any other defined level. Unless the market price of the
    common stock does in fact appreciate over the option term, no
    value will be realized from the option grants made to the Named
    Executive Officers.
|   
|(5) | These options were cancelled effective
    July 31, 2003, as described below under Employment
    Contracts, Severance Agreements and Change of Control
    Arrangements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(6) | These options were cancelled effective
    March 3, 2003, as described below under Employment
    Contracts, Severance Agreements and Change of Control
    Arrangements. As described below, pursuant to the terms of
    Mr. Cracchiolos employment agreement, options to
    acquire 385,000 shares of our common stock, at an exercise
    price of $4.50 per share, were granted to Mr. Cracchiolo on
    October 30, 2003.                                                                                                                                                                                                                                                                                                                   

Aggregate Option Exercises in 2002 and Option
Values at December 31, 2002

The following table sets forth certain
information, with respect to the Named Executive Officers,
concerning the exercise of options during our 2002 fiscal year
and unexercised options held by them at the end of that fiscal
year. No stock appreciation rights were exercised by the Named
Executive Officers during such fiscal year, and no stock
appreciation rights were held by them at the end of such fiscal
year.

Aggregated Option Exercises in Last Fiscal
Year

and Fiscal Year-End Option Values


|                   |  |             |   |          |  |                        |   |                            |  |             |         |               |  |  |         |  |  |   |           |  |  |   |       | 
|------------------ |  | ----------- | - | -------- |  | ---------------------- | - | -------------------------- |  | ----------- | ------- | ------------- |  |  | ------- |  |  | - | --------- |  |  | - | ----- | 
|                   |  |             |   |          |  |                        |   |                            |  |            
|                   |  |             |   |          |  | Number of Shares       |   |                           
|                   |  |             |   |          |  | Underlying Unexercised |   | Value of Unexercised      
|                   |  | Number of   |   |          |  | Options as of          |   | In-the-Money Options      
|                   |  | Shares      |   |          |  | December 31, 2002      |   | as of December 31, 2002(1)
|                   |  | Acquired on |   | Value    |  |                        |   |                           
|Name               |  | Exercise    |   | Realized |  | Exercisable            |   | Unexercisable              |  | Exercisable |         | Unexercisable
|                   |  |             |   |          |  |                        |   |                            |  |             |         |              
|Paul W. Mikus      |  |             |  |          |  |                        |  |                            |  |             | 564,167 |               |  |  | 200,833 |  |  | $ | 1,240,178 |  |  | $ | 1,175 | 
|John V. Cracchiolo |  |             |  |          |  |                        |  |                            |  |             | 115,292 |               |  |  | 269,708 |  |  |   |          |  |  |   |      | 
|Jay J. Eum         |  |             |  |          |  |                        |  |                            |  |             | 180,000 |               |  |  | 75,000  |  |  | $ | 223,839   |  |  | $ | 587   | 
|Kevin M. Quilty    |  |             |  |          |  |                        |  |                            |  |             | 91,667  |               |  |  | 148,333 |  |  |   |          |  |  |   |      | 
|Holly H. Williams  |  |             |  |          |  |                        |  |                            |  |             | 38,645  |               |  |  | 46,355  |  |  |   |          |  |  |   |      | 



---



|    |                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Based on the market price of $3.44 per share,
    which was the average of the high and low prices per share of
    common stock on The Nasdaq National Market on the last day our
    common stock was traded on a national exchange during our 2002
    fiscal year, less the exercise price payable upon exercise of
    such options.

Compensation of Directors

Each of our non-employee directors receives an
annual retainer of $18,000 for his service as a director. The
Chairman of the Audit Committee, the Chairman of the
Compensation Committee and the Chairman of the Nominating
Committee each receives an additional annual retainer of
$10,000. Each non-employee director also receives $1,000 for
each meeting of the Board of Directors or any committee thereof
that he attends in person and an additional payment of $500 for
each meeting of the Board of Directors or any committee thereof
that he attends telephonically. In addition, each non-employee
director participates in the Director Plan described below.
Directors also are reimbursed for reasonable expenses incurred
in connection with serving as directors.

Under the automatic option grant program in
effect under the Director Plan, each individual who was serving
as a non-employee Board member (each, an Outside
Director) prior to June 4, 1998, was

55



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automatically granted an option to purchase
10,000 fully vested shares of common stock upon his or her
initial election or appointment as an Outside Director. On
June 4, 1998, at the 1998 Annual Meeting of Stockholders,
our stockholders approved an amendment to the Director Plan
increasing the automatic option grant made to an Outside
Director upon his or her initial appointment or election to the
Board to 20,000 shares of common stock, which grant becomes
exercisable in two equal annual installments over the Outside
Directors first two years of Board service. In addition,
under the Director Plan, after such Outside Directors
initial appointment, he or she receives an automatic option
grant each January 1, or on the first day after January 1
on which national stock exchanges and The Nasdaq Stock Market
are open for trading, with an exercise price equal to the fair
market value of our common stock on such date, to acquire 5,000
shares of common stock, provided that he or she has served on
the Board for at least six months. The 5,000 share annual
option grants become fully vested and exercisable on the first
anniversary of the grant date, provided the Outside Director
continues in Board service through such date.


On January 1 of each of 2001, 2002 and 2003,
or on the first day after January 1 on which national stock
exchanges and The Nasdaq Stock Market were open for trading,
each person then serving as an Outside Director received the
automatic 5,000 share option grant described above. All of
the options granted to Outside Directors were granted at an
exercise price equal to the fair market value of the common
stock on the date the options were granted.

In light of the Sarbanes-Oxley Act and related
regulations, we are currently considering revising our director
compensation policies. If we do so, the compensation paid to
directors may be increased.

Employment Contracts, Severance Agreements and
Change of Control Arrangements

In connection with option grants, we have entered
into stock option agreements with each employee holding one or
more outstanding options under the 1995 Stock Plan, including
our Named Executive Officers, pursuant to which such options
will automatically vest on an accelerated basis in the event of
the following:



| |   |                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a dissolution, liquidation or sale of
    substantially all our assets;                                                                                                                         
|
| |  | any reorganization, merger or consolidation in
    which we do not survive or in which our shares outstanding
    immediately prior to the transaction are converted into other
    property; or
|
| |  | an acquisition of 50% or more of our stock.                                                                                                                                                     

We have not entered into employment or severance
agreements with any of the Named Executive Officers, except as
described below.



| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | Separation Agreement, Consulting Agreement,
    General Release of Claims and Escrow Agreement with
    Mr. Mikus

Mr. Mikus resigned as our President and
Chief Executive Officer in March 2003 to facilitate the
appointment of our new management team. We determined that a new
management team would provide the best opportunity for us to
restore in a timely manner our audited financial statements,
Nasdaq Stock Market listing and good standing in the investment
community, while continuing to manage for growth in our business.

Mr. Mikus resigned as Chairman and a
director and employee of ours on September 23, 2003 in
order to complete an orderly transition of responsibilities to
our new management team and to facilitate the appointment to our
Board of Directors of Terrence A. Noonan, given that our Bylaws
provide that the maximum number of directors is seven.

We have entered into a Separation Agreement and a
Consulting Agreement with Mr. Mikus, each effective as of
July 31, 2003. Under the Separation Agreement,
Mr. Mikus is entitled to receive a $375,000 severance
payment, in addition to all accrued and unpaid wages and unused
vacation time. The Separation Agreement provides that
Mr. Mikus waives all rights to which he is or may at any
time be entitled under our 2002 Separation Benefits Plan, which
is described below.

56



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The Consulting Agreement provides that, during
the one-year term of the Consulting Agreement, Mr. Mikus
will not engage in any activity specifically utilizing
argon-based cryosurgical equipment or technology that directly
competes with our argon-based cryosurgical equipment products,
and Mr. Mikus will not solicit for employment or recommend
for employment any person employed by us during such
persons employment with us (or any our affiliates) or for
one (1) year thereafter. The Consulting Agreement also
requires during its term that Mr. Mikus provide consulting
services at the direction of our management for a minimum of
eight hours per calendar quarter. In exchange for the covenant
not to compete and the consulting services, Mr. Mikus is
entitled to receive a $375,000 upfront payment. In addition, the
Consulting Agreement provides for continued participation in our
fringe benefit plans for 24 months, to the extent permitted
under applicable law and the terms of such plans. In the event
that continued participation in our insurance benefit plans is
not permissible, then Mr. Mikus will receive a monthly
payment from us in an amount sufficient to enable him to
purchase insurance coverage that is substantially equivalent to
what he would have received had he been able to continue to
participate in our plans. This coverage also will extend to
Mr. Mikus spouse and dependents who were covered by
the relevant fringe benefit plan on July 31, 2003. The
Consulting Agreement also provides that 565,000 of
Mr. Mikus outstanding vested stock options will
continue to remain outstanding, and 200,000 of
Mr. Mikus outstanding stock options are cancelled,
effective as of the date of the Consulting Agreement. Under the
Consulting Agreement, we will bear all costs and expenses
incurred in connection with Mr. Mikus performance of
consulting services, provided that Mr. Mikus will not incur
aggregate expenses in excess of $2,500 without our prior written
consent.

The Separation Agreement and the Consulting
Agreement further provide that Mr. Mikus will be required
to repay the severance payment and consulting fees described
above upon either (i) Mr. Mikus conviction in a
court of law, or entering a plea of guilt or no contest to, any
crime directly relating to his activities on our behalf during
his employment with us, or (ii) successful prosecution of
an enforcement action by the Securities and Exchange Commission
against Mr. Mikus.

In connection with the Separation Agreement,
Mr. Mikus also executed a General Release of Claims,
effective September 23, 2003, which provides that
Mr. Mikus releases us and certain other parties from all
claims Mr. Mikus may have against us and such other parties
arising on or prior to September 23, 2003.

Also on September 23, 2003, we entered into
an Escrow Agreement with Mr. Mikus, which provides that the
$375,000 severance payment owed under the Separation Agreement
and the $375,000 upfront consulting fee owed under the
Consulting Agreement will be held in an escrow account and shall
not be released to Mr. Mikus before March 8 or 9, 2004,
unless we have been advised by the Securities and Exchange
Commission before March 1, 2004, that it will not be
initiating a proceeding against Mr. Mikus and no other
repayment event under the Separation Agreement and Consulting
Agreement has occurred. Further, no escrowed funds shall be
released to Mr. Mikus prior to a final resolution of any
proceeding commenced by the Securities and Exchange Commission
against Mr. Mikus, unless such release is consented to in
writing by the Securities and Exchange Commission or unless
otherwise ordered by a court of law, and in no event shall
escrowed funds be released to Mr. Mikus if there has been a
repayment event under the Separation Agreement and Consulting
Agreement.

On October 10, 2003, we amended the
Consulting Agreement with Mr. Mikus to provide that if we
request consulting services in excess of the eight hours per
calendar quarter, Mr. Mikus will perform such services at a
rate of $2,000 per day.



| |                                                                
| | ---------------------------------------------------------------
| | Employment Agreement with and Termination of
    Mr. Cracchiolo

We have entered into an employment agreement,
dated as of March 3, 2003, with Mr. Cracchiolo. Under
this agreement, we are required to pay to Mr. Cracchiolo a base
salary equal to $220,000 per annum, and Mr. Cracchiolo is
eligible to receive a cash bonus of $88,000 per annum. Both the
base salary and the cash bonus are subject to renegotiation
upwards beginning on September 3, 2003.

In addition, Mr. Cracchiolos
employment agreement provides that, as of March 3, 2003,
all of Mr. Cracchiolos outstanding options to acquire
shares of our common stock were cancelled. In exchange for the
cancellation of his options and pursuant to the terms of
Mr. Cracchiolos employment agreement, on

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October 30, 2003 we granted to
Mr. Cracchiolo replacement options to acquire 385,000
shares of our common stock, at an exercise price of $4.50 per
share. The replacement options were fully vested and exercisable
upon grant, subject to compliance with applicable federal and
state securities laws.


Mr. Cracchiolos employment agreement
also provides that, in the case of any Qualified
Termination, as defined below, Mr. Cracchiolo is
entitled to receive the following benefits:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A cash payment of $616,000, payable within three
    business days following the date of the Qualified Termination.
    This cash payment equals 200% of both
    (i) Mr. Cracchiolos annual base salary of
    $220,000 and (ii) Mr. Cracchiolos maximum bonus
    eligibility for fiscal year 2002 of $88,000;                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | Continued participation in our fringe benefit
    plans for 24 months, to the extent permitted under applicable
    law and the terms of such plans. In the event that continued
    participation in our insurance benefit plans is not permissible,
    then Mr. Cracchiolo will receive a monthly payment from us
    in an amount sufficient to enable him to purchase insurance
    coverage that is substantially equivalent to what he would have
    received had he been able to continue to participate in our
    plans. This coverage also will extend to Mr. Cracchiolos
    spouse and dependents who were covered by the relevant fringe
    benefit plan on March 3, 2003;
|
| |  | the exercise period of Mr. Cracchiolos
    replacement options (which are described above) that are
    non-qualified options will be extended until the second
    anniversary of the Qualified Termination; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | as soon as reasonably possible following the date
    of the Qualified Termination, Mr. Cracchiolo will receive a
    $50,000 relocation allowance and an additional payment to cover
    the tax payable on the relocation allowance.                                                                                                                                                                                                                                                                                                                                                                                                                                                     

A Qualified Termination occurs if
(i) we terminate Mr. Cracchiolos employment for
other than cause (as defined in the employment
agreement), (ii) Mr. Cracchiolo terminates his
employment for good reason (as defined in the
employment agreement), (iii) Mr. Cracchiolo terminates
his employment during the thirty-day period following the
expiration of the mandatory access period (which the
employment agreement defines as the period from March 3,
2003 to September 3, 2003, subject to extension by the
parties mutual agreement for an additional period of time
not to extend beyond March 3, 2006), or
(iv) Mr. Cracchiolos employment terminates
during the mandatory access period because of his
death or disability.

Mr. Cracchiolos employment agreement
states that he will be liable to repay all amounts paid by us as
a result of a Qualified Termination upon either
(i) Mr. Cracchiolos conviction in a court of
law, or entering a plea of guilt or no contest to, any crime
directly relating to his activities on our behalf, or
(ii) successful prosecution of an enforcement action
against Mr. Cracchiolo by the Securities and Exchange Commission
relating to his activities on our behalf. The employment
agreement also provides that, should a change in control occur
such that benefits are payable to Mr. Cracchiolo under our
2002 Separation Benefits Plan, Mr. Cracchiolo agrees that
the severance payments due under his employment agreement will
be reduced on a dollar-for-dollar basis by cash benefits paid
pursuant to the 2002 Separation Benefits Plan and we will not be
obligated to provide any fringe benefits that are otherwise
available to Mr. Cracchiolo under the 2002 Separation
Benefits Plan.

Mr. Cracchiolos employment agreement
also states that, if Mr. Cracchiolo complies with all of
his obligations under the employment agreement and all other
agreements with us, then our obligations under the
indemnification agreement, dated October 30, 2001, between
Mr. Cracchiolo and us will continue for a period of at
least seven years from the date of the termination of his
employment or the term provided in the indemnification
agreement, whichever time period is longer.

Mr. Cracchiolo resigned as Chief Operating
Officer and Chief Financial Officer in March 2003 and ceased to
serve as Secretary in June 2003, but remained an employee in the
position of President, Radiology Division until July 31,
2003. Effective July 31, 2003, we terminated
Mr. Cracchiolos employment other than for
cause in order to complete an orderly transition of
responsibilities to our new management team. Accordingly,
Mr. Cracchiolo is entitled to receive the benefits
associated with a Qualified Termination that

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are described above. On September 23, 2003,
we and Mr. Cracchiolo entered into an Escrow Agreement
which provides that the severance payment resulting from
Mr. Cracchiolos termination will be held in an escrow
account and shall not be released to Mr. Cracchiolo before
March 8 or 9, 2004 and then, unless otherwise ordered by a
court of law, only with the written consent of the Securities
and Exchange Commission if an enforcement proceeding has been
commenced against Mr. Cracchiolo.




| |                                      
| | -------------------------------------
| | Employment Agreement with
    Mr. Eum

We have entered into an employment agreement,
dated as of March 25, 2003 and amended as of
August 29, 2003, with Mr. Eum. Under this agreement,
we are required to pay to Mr. Eum a base salary equal to
$180,000 per annum, and Mr. Eum is eligible to receive a cash
bonus of up to 40% of his base salary, subject to his attainment
of corporate goals and objectives to be established in
accordance with our Board-approved bonus plan.

Mr. Eums employment agreement also
provides that, if we terminate Mr. Eums employment other
than for cause (as defined in the employment
agreement) prior to March 25, 2004 or if Mr. Eum
terminates his employment for good reason (as
defined in the employment agreement) prior to March 25,
2004, then, during the period of time from the termination date
until March 25, 2004, we will continue to (i) pay to
Mr. Eum his base salary, and (ii) make available to
Mr. Eum the benefits made generally available by us to our
employees, to the extent permitted under applicable law and the
terms of the benefit plans. Notwithstanding the foregoing, if at
any time (whether before, on or after March 25, 2004) we
terminate Mr. Eums employment other than for
cause or Mr. Eum terminates his employment for
good reason, then Mr. Eum is entitled to a
minimum of six months worth of severance, including
continued payment of his base salary and continued benefits.

Mr. Eums employment agreement also
provides that, should a change in control occur such that
benefits are payable to Mr. Eum under our 2002 Separation
Benefits Plan, Mr. Eum agrees that the amount of base
salary due as severance under his employment agreement will be
reduced on a dollar-for-dollar basis by the gross amount of the
cash payments made or to be made pursuant to the 2002 Separation
Benefits Plan and we will not be obligated to provide any fringe
benefits that are otherwise available to Mr. Eum under the
2002 Separation Benefits Plan.



| |                                         
| | ----------------------------------------
| | Employment Agreement with
    Mr. Quilty

We have entered into an employment agreement,
dated as of March 25, 2003, with Mr. Quilty. Under
this agreement, we are required to pay to Mr. Quilty a base
salary equal to $200,000 per annum, and Mr. Quilty is
eligible to receive a commission equal to 0.3% of gross domestic
revenue, subject to Mr. Quiltys attainment of a
minimum of 70% of the gross revenue objectives mutually agreed
upon between Mr. Quilty and us. In addition,
Mr. Quilty is eligible for an incremental commission of
1.0% of all gross revenues in excess of plan, assuming that he
meets mutually agreed expense containment objectives.

Mr. Quiltys employment agreement also
provides that, if we terminate Mr. Quiltys employment
other than for cause (as defined in the employment
agreement) prior to March 25, 2004 or if Mr. Quilty
terminates his employment for good reason (as
defined in the employment agreement) prior to March 25,
2004, then, during the period of time from the termination date
until March 25, 2004, we will continue to (i) pay to
Mr. Quilty his base salary, and (ii) make available to
Mr. Quilty the benefits made generally available by us to
our employees, to the extent permitted under applicable law and
the terms of the benefit plans. Notwithstanding the foregoing,
if at any time (whether before, on or after March 25, 2004)
we terminate Mr. Quiltys employment other than for
cause or Mr. Quilty terminates his employment
for good reason, then Mr. Quilty is entitled to a
minimum of six months worth of severance, including
continued payment of his base salary and continued benefits.



| |                                            
| | -------------------------------------------
| | 2002 Executive Separation Benefits
    Plan

Effective as of July 17, 2002, we adopted a
2002 Executive Separation Benefits Plan to provide separation
benefits to certain designated employees, including, among
others, Messrs. Mikus, Cracchiolo, Eum and

59



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Quilty. The Plan provides that, in the case of
any covered termination, Messrs. Mikus and
Cracchiolo will receive two times their base pay and
Messrs. Eum and Quilty are entitled to receive one time
their base pay. Messrs. Mikus and Cracchiolo no
longer are eligible to receive benefits under the Plan, given
that their employment with us has been terminated. For purposes
of the Plan, the term base pay means the respective
employees highest annual base salary rate paid during the
24 months immediately preceding termination of the
employees employment due to a covered termination, plus
the maximum amount of any bonus payable to the employee in such
period under a written bonus plan of ours. The Plan defines the
term covered termination as the termination of the
employees employment either (i) by the employee for
good reason (as defined in the Plan) after a change
in control, (ii) by the employee for any reason or no
reason during the 30-day period immediately following the six
month anniversary of the closing of a transaction resulting in a
change in control or (iii) voluntarily by us (or our
successor following a change in control) after a change in
control for a reason other than cause (as defined in
the Plan), death or disability. Each employee participating in
the Plan also is entitled to continued eligibility for our
benefit programs after a covered termination for a period equal
to the number of months of base pay to be received by such
employee under the Plan.


Compensation Committee Interlocks and Insider
Participation

Our compensation committee consists of
Messrs. Bernardoni and Byrnes and Dr. Gerson, none of
whom were at any time during fiscal 2002 or at any other time
our Officer or employee. There are no Compensation Committee
interlocks between us and other entities involving our Executive
Officers and Board members who serve as Executive Officers or
Board members of such other entities.






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

Equity Compensation Plan Information

The following table provides information as of
December 31, 2002 with respect to the shares of our common
stock that may be issued under our existing equity compensation
plans. The table does not include information with respect to
shares subject to outstanding options granted under equity
compensation plans assumed by us in connection with mergers and
acquisitions of the companies which originally granted those
options. Footnote (5) to the table sets forth the total
number of shares of our common stock issuable upon the exercise
of those assumed options as of December 31, 2002, and the
weighted average exercise price of those options. No additional
options may be granted under those assumed plans.

|                                                                  |  |                      |           |                     |  |                           |       |  |  |  |         |    
|----------------------------------------------------------------- |  | -------------------- | --------- | ------------------- |  | ------------------------- | ----- |  |  |  | ------- | ---
|                                                                  |  | A                    |           | B                   |  | C                        
|                                                                  |  |                      |           |                     |  |                          
|                                                                  |  |                      |           |                     |  | Number of Securities     
|                                                                  |  |                      |           |                     |  | Remaining Available for  
|                                                                  |  | Number of Securities |           |                     |  | Future Issuance Under    
|                                                                  |  | to be Issued         |           | Weighted Average    |  | Equity Compensation Plans
|                                                                  |  | Upon Exercise of     |           | Exercise Price of   |  | (Excluding Securities    
|Plan Category                                                     |  | Outstanding Options  |           | Outstanding Options |  | Reflected in Column A)   
|                                                                  |  |                      |           |                     |  |                          
|Equity Compensation Plans Approved by Security
    Holders(1)     |  |                      | 2,368,016 | (3)                 |  | $                         | 7.32  |  |  |  | 360,124 | (4)
|Equity Compensation Plans not Approved by
    Security Holders(2) |  |                      | 735,000   |                     |  | $                         | 12.42 |  |  |  |        |    
|                                                                  |  |                      |           |                     |  |                           |       |  |  |  |         |    
|Total                                                             |  |                      | 3,103,016 |                     |  | $                         | 8.53  |  |  |  | 360,124 |    
|                                                                  |  |                      |           |                     |  |                           |       |  |  |  |         |    



---



|    |                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Consists of the 1995 Stock Plan and 1995 Director
    Option Plan.                                                                                                                                                                    
|   
|(2) | Consists of the 2002 Supplemental Stock Plan and
    an option to purchase 300,000 shares of common stock
    granted to John V. Cracchiolo on June 25, 2001.                                                                         
|   
|(3) | Consists of 2,248,016 shares to be issued
    upon the exercise of options outstanding under the 1995 Stock
    Plan and 120,000 shares to be issued upon the exercise of
    options outstanding under the 1995 Director Option Plan.

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | Consists of shares available for future issuance
    under the 1995 Stock Plan and 1995 Director Option Plan. As of
    December 31, 2002, an aggregate of 255,124 shares of
    common stock were available for issuance under the 1995 Stock
    Plan and 105,000 shares of common stock were available for
    issuance under the 1995 Director Option Plan. The number of
    shares of common stock available for issuance under the 1995
    Stock Plan automatically increases on the first trading day of
    each calendar year by an amount equal to 3% of the total number
    of shares of common stock outstanding on the last trading day of
    the immediately preceding calendar year, but in no event will
    any such annual increase exceed 1,000,000 shares of common
    stock.
|   
|(5) | The table does not include information for equity
    compensation plans assumed by us in connection with mergers and
    acquisitions of the companies which originally established those
    plans. As of December 31, 2002, a total of
    50,411 shares of our common stock were issuable upon
    exercise of outstanding options under those assumed plans. The
    weighted average exercise price of those outstanding options is
    $7.20 per share. No additional options may be granted under
    those assumed plans.                                                                                                                                                                                                                                                                    

Equity Compensation Plans Not Approved by
Security Holders



| |                             
| | ----------------------------
| | 2002 Supplemental Stock Plan

Under our 2002 Supplemental Stock Plan,
employees, consultants and outside directors may be granted
options to purchase shares of our common stock. All options
granted under the 2002 Supplemental Stock Plan are nonstatutory
stock options, i.e., options that do not qualify for
treatment as incentive stock options under Section 422 of
the Internal Revenue Code of 1986, as amended. The exercise
price of each option granted under the 2002 Supplemental Stock
Plan must be at least 85% of the fair market value per share of
our common stock on the date of grant. The maximum aggregate
number of shares of our common stock that may be issued upon the
exercise of options under the 2002 Supplemental Stock Plan is
435,000 shares.

The 2002 Supplemental Stock Plan became effective
on June 25, 2002 and will continue in effect until
June 24, 2012, unless earlier terminated in accordance with
the terms of the Plan. The 2002 Supplemental Stock Plan
terminates automatically upon certain extraordinary events, such
as a sale of all or substantially all of our assets, a merger in
which we do not survive or the acquisition by any person or
group of beneficial ownership of more than 50% of our common
stock. If such an extraordinary event occurs, all options
granted under the 2002 Supplemental Stock Plan become fully
exercisable, and each optionee has the right to exercise any
unexpired options immediately prior to the occurrence of the
extraordinary event.



| |                               
| | ------------------------------
| | Option Grant to Mr. Cracchiolo

On June 25, 2001, we granted to
Mr. Cracchiolo a nonstatutory stock option to purchase up
to 300,000 shares of our common stock with an exercise
price of $13.75 per share. 62,500 of the shares subject to the
option vested on June 25, 2002, and an additional 1/36 of
187,500 of the shares subject to the option were to vest upon
Mr. Cracchiolos completion of each additional month
of service over the 36-month period measured from the first
anniversary of the vesting commencement date. The remaining
50,000 shares subject to the option were to vest upon the
earlier of (i) Mr. Cracchiolos continuation in
service through June 25, 2006, or
(ii) Mr. Cracchiolos attainment of a
performance-based objective mutually agreed between us and
Mr. Cracchiolo. As described above under Employment
Agreement with and Termination of Mr. Cracchiolo, all
of Mr. Cracchiolos options were cancelled on
March 3, 2003, pursuant to the terms of
Mr. Cracchiolos employment agreement, dated as of
March 3, 2003. In exchange for the cancellation of his
options and pursuant to the terms of Mr. Cracchiolos
employment agreement, on October 30, 2003 we granted to
Mr. Cracchiolo replacement options to acquire
385,000 shares of our common stock, at an exercise price of
$4.50 per share. The replacement options were fully vested and
exercisable upon grant, subject to compliance with applicable
federal and state securities laws.

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Principal Stockholders

The following table sets forth information known
to us with respect to the beneficial ownership of our common
stock as of September 30, 2003, unless otherwise noted, by:



| |   |                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------
| |  | each stockholder known to us to own beneficially
    more than 5% of our common stock;                                            
|
| |  | each of our directors, nominees and executive
    officers;                                                                       
|
| |  | each of our Named Executive Officers listed in
    the Summary 2002 Compensation Table included in this
    Proxy Statement; and
|
| |  | all of our current directors and executive
    officers as a group.                                                               

Beneficial ownership is determined in accordance
with the rules of the SEC and generally includes voting or
investment power relating to securities. Shares of common stock
subject to options or convertible securities currently
exercisable or exercisable within 60 days are deemed to be
outstanding for computing the percentage of the person holding
such securities and the percentage ownership of any group of
which the holder is a member, but are not deemed outstanding for
computing the percentage of any other person. Except as
indicated by footnote, and subject to the community property
laws where applicable, the persons or entities named in the
table have sole voting and investment power with respect to all
shares of common stock shown as beneficially owned by them. None
of the directors, nominees, executive officers or named executed
officers listed below owns any shares of common stock of record
but not beneficially. Except as otherwise noted below, the
address of each person or entity listed on the table is 201
Technology Drive, Irvine, California 92618.

|                                                                            |  |              |           |            |  |  |     |  
|--------------------------------------------------------------------------- |  | ------------ | --------- | ---------- |  |  | --- | -
|                                                                            |  | Amount and   |           |           
|                                                                            |  | Nature of    |           |           
|                                                                            |  | Beneficial   |           | Percentage
|Name and Address                                                            |  | Ownership(1) |           | of Total  
|                                                                            |  |              |           |           
|DIRECTORS, NOMINEES AND EXECUTIVE
    OFFICERS                              |  |              |           |            |  |  |     |  
|Peter F. Bernardoni(2)                                                      |  |              | 628,707   |            |  |  | 2.6 | %
|Robert F. Byrnes(3)                                                         |  |              | 296,613   |            |  |  | 1.2 | %
|Benjamin Gerson, M.D.(4)                                                    |  |              | 30,000    |            |  |  | *   |  
|Ronald A. Matricaria(5)                                                     |  |              | 20,000    |            |  |  | *   |  
|Terrence A. Noonan(6)                                                       |  |              |          |            |  |  |    |  
|Michael J. Strauss, M.D.(7)                                                 |  |              | 60,000    |            |  |  | *   |  
|Thomas R. Testman(8)                                                        |  |              |          |            |  |  |    |  
|William J. Nydam(9)                                                         |  |              |          |            |  |  |    |  
|Katherine Greenberg(10)                                                     |  |              |          |            |  |  |    |  
|All current directors and executive officers as a
    group (9 persons)(11) |  |              | 1,035,320 |            |  |  | 4.2 | %
|NAMED EXECUTIVE OFFICERS WHO NO LONGER ARE
    EXECUTIVE OFFICERS           |  |              |           |            |  |  |     |  
|John V. Cracchiolo(12)                                                      |  |              | 385,000   |            |  |  | 1.6 | %
|Jay J. Eum(13)                                                              |  |              | 215,730   |            |  |  | *   |  
|Paul W. Mikus(14)                                                           |  |              | 740,000   |            |  |  | 3.0 | %
|Kevin M. Quilty(15)                                                         |  |              | 141,667   |            |  |  | *   |  
|Holly H. Williams(16)                                                       |  |              |          |            |  |  |    |  

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|                                                               |                       |              |           |            |  |  |      |   | 
|-------------------------------------------------------------- | --------------------- | ------------ | --------- | ---------- |  |  | ---- | - | 
|                                                               |                       | Amount and   |           |           
|                                                               |                       | Nature of    |           |           
|                                                               |                       | Beneficial   |           | Percentage
|Name and Address                                               |                       | Ownership(1) |           | of Total  
|                                                               |                       |              |           |           
|5% STOCKHOLDERS                                                |                       |              |           |            |  |  |      |  
|State of Wisconsin Investment Board(17)                        |                       |              | 2,625,000 |            |  |  | 10.8 | %
|                                                               | P.O. Box 7842         |              |           |            |  |  |      |   | 
|                                                               | Madison, WI 53707     |              |           |            |  |  |      |   | 
|Entities affiliated with SAFECO Corporation(18)                |                       |              | 2,196,645 |            |  |  | 9.0  | %
|                                                               | 4333 Brooklyn Ave, NE |              |           |            |  |  |      |   | 
|                                                               | Seattle, WA 98185     |              |           |            |  |  |      |   | 
|Entities affiliated with Ferrer Freeman &
    Company, LLC(19) |                       |              | 1,443,533 |            |  |  | 5.9  | %
|                                                               | 10 Glenville Street   |              |           |            |  |  |      |   | 
|                                                               | Greenwich, CT 06831   |              |           |            |  |  |      |   | 



---



| |   |                                                                                                   
| | - | --------------------------------------------------------------------------------------------------
| | * | Represents beneficial ownership of less than 1%
    of the outstanding shares of our common stock.



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Beneficial ownership is determined in accordance
    with the rules of the Securities and Exchange Commission and
    generally includes voting or investment power with respect to
    securities. Shares of common stock relating to options or
    convertible securities currently exercisable, or exercisable
    within 60 days of September 30, 2003, are deemed
    outstanding for computing the percentage of the person holding
    such securities but are not deemed outstanding for computing the
    percentage of any other person. As of September 30, 2003,
    there were 24,312,454 shares of our common stock
    outstanding.                                                                       
|
| | (2) | Includes 588,707 shares held by Technology
    Funding Partners III, L.P., Technology Funding Venture Partners
    IV, an Aggressive Growth Fund, L.P. and Technology Funding
    Venture Partners V, an Aggressive Growth Fund, L.P.
    (collectively, the Funds) and 30,000 shares
    subject to options that are exercisable within 60 days
    after September 30, 2003. Mr. Bernardoni is an officer
    of Technology Funding, Inc. and a partner of Technology Funding,
    Ltd., each a general partner of the Funds. Mr. Bernardoni
    has sole voting and shared investment power with respect to all
    shares owned by the Funds, and therefore may be deemed to be
    beneficial owner of such shares.
|
| | (3) | Includes 10,000 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | (4) | Includes 20,000 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | (5) | Represents 20,000 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | (6) | Mr. Noonan has served as a director since
    September 2003. Mr. Noonan received an option to purchase
    20,000 shares of common stock granted on September 23,
    2003, of which no shares are exercisable within 60 days
    after September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | (7) | Includes 45,000 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | (8) | Mr. Testman has served as a director since
    May 2003. Mr. Testman received an option to purchase
    20,000 shares of common stock granted on April 26,
    2003, of which no shares are exercisable within 60 days
    after September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | (9) | Mr. Nydam joined us as President and Chief
    Operating Officer in March 2003. Mr. Nydam received options
    to purchase 750,000 shares of common stock on March 3,
    2003, of which no shares are exercisable within 60 days
    after September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                           



|     |                                                                                                                                                                                                                                                                                                                                                
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Ms. Greenberg joined us as Chief Financial
    Officer in March 2003. Ms. Greenberg received an option to
    purchase 250,000 shares of common stock on March 3,
    2003, of which no shares are exercisable within 60 days
    after September 30, 2003.                                                                                    
|    
|(11) | Includes 125,030 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003. Beneficial ownership of our common
    stock by John V. Cracchiolo, Jay J. Eum, Paul W. Mikus, Kevin M.
    Quilty and Holly H. Williams is not included in this calculation
    as they no longer are our executive officers.

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|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(12) | Represents 385,000 shares subject to options
    that we granted to Mr. Cracchiolo on October 30, 2003
    pursuant to the terms of Mr. Cracchiolos employment
    agreement with us. All of such options were exercisable on the
    date on which such options were granted, subject to compliance
    with applicable federal and state securities laws.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    
|(13) | Represents 215,730 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    
|(14) | Includes 565,000 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    
|(15) | Represents 141,667 shares subject to options
    that are exercisable within 60 days after
    September 30, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    
|(16) | Ms. Williams resigned from her position as
    our General Counsel and Vice President, Human Resources, in
    April 2002, and the options previously granted to
    Ms. William have now expired.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    
|(17) | Pursuant to a Schedule 13G filed on
    February 12, 2003 with the SEC, the State of Wisconsin
    Investment Board reported sole voting and dispositive power over
    2,625,000 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    
|(18) | Pursuant to a joint Schedule 13G filed on
    February 13, 2003 with the SEC, as of February 3,
    2003: (i) SAFECO common stock Trust reported that it had
    shared voting and dispositive power over 1,386,186 shares;
    (ii) SAFECO Asset Management Company reported that it had
    shared voting and dispositive power over 1,331,204 shares
    and disclaimed any beneficial ownership over 1,913,645 of the
    shares reported on the joint Schedule 13G which were
    beneficially owned by registered investment companies for which
    SAFECO Asset Management Company serves as an advisor; and
    (iii) SAFECO Corporation reported shared voting and
    dispositive power over 2,196,645 shares and disclaimed
    beneficial ownership over 2,185,745 of the shares reported on
    the joint Schedule 13G which were owned by registered
    investment companies for which a subsidiary of SAFECO
    Corporation serves as an advisor, and by employee benefit plans
    for which SAFECO Corporation is a plan sponsor.
|    
|(19) | Pursuant to a joint Schedule 13G filed on
    April 1, 2002 with the SEC: (i) FFC Partners I, L.P.
    reported that it had sole voting power over
    1,386,186 shares and sole dispositive power over
    1,331,204 shares; (ii) FFC Executive Partners I, L.P.
    reported sole voting power over 57,347 shares and sole
    dispositive power over 55,072 shares; and (iii) Ferrer
    Freeman & Company, LLC reported shared voting power over
    1,443,533 shares and shared dispositive power over
    1,386,276 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    




Item 13.Certain
Relationships and Related Transactions

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. Mr. Bernardoni, a
current member of our Board of Directors, is an officer of
Technology

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Funding Inc. and a partner of Technology Funding
Ltd., each of which is a general partner of specified funds that
in the aggregate beneficially own more than 10% of the
outstanding Series A Preferred Stock of Sanarus.
Mr. Bernardoni is also currently a member of the Board of
Directors of Sanarus, and Mr. Mikus, a former member of our
Board of Directors, was a member of the Board of Directors of
Sanarus until he resigned effective October 22, 2003.


We received a full recourse promissory note in
the principal amount of $1,028,125 in November 1999 in
connection with the issuance and sale of 175,000 shares of
our common stock at the fair market value on the date of sale to
Jerry W. Anderson, our former Senior Vice President, Sales and
Marketing and the former President of Advanced Medical
Procedures LLC, our wholly owned subsidiary. The note bears
interest at 5.99% per annum, compounded semi-annually. Accrued
and unpaid interest is payable annually each September and the
principal is due and payable in one lump sum in September 2003.
We agreed to forgive principal on the note ratably over four
years subject to Mr. Anderson remaining our employee. The
outstanding principal balance of the note at December 31,
2001 and 2002 totaled $417,292 and $214,292, respectively.
Mr. Andersons employment with us was terminated in
August 2003.

In March 2001, we received a promissory note in
the principal amount of $42,800 from Mr. Quilty. The note
accrued interest at 4.8% per annum, compounded semi-annually,
and became due and payable in one lump sum in March 2003.

In March 2001, we received a promissory note in
the principal amount of $42,800 from Ms. Williams. The note
accrued interest at 4.8% per annum, compounded semi-annually,
and became due and payable in one lump sum in March 2003.

Under the terms of stockholder registration
rights agreements between us and some of our stockholders, if we
propose to register any of our securities under the Securities
Act for our own account, the parties to a registration rights
agreement are entitled to notice of the registration and to
include their shares of common stock in the registration. These
registration rights are subject to limitations and conditions,
including the rights of the underwriters of the offering to
limit the number of shares included in any underwritten
registration. In general, we are required to indemnify the
holders of registrable securities under described circumstances
and to bear the expense of the registrations, except for the
selling stockholders pro rata portion of the underwriting
discounts and commissions.

On June 1, 2001, we entered into a
consulting agreement with Dr. Strauss pursuant to which
Dr. Strauss assisted us with employee recruiting and
insurance reimbursement strategies. In exchange for these
services, we granted to Dr. Strauss an option to purchase
10,000 shares of our common stock. This agreement was
terminated on March 31, 2002, at which time such options
were fully vested.

We have entered into an employment agreement with
Mr. Nydam, dated as of March 3, 2003. Under his
employment agreement, Mr. Nydams initial base salary
is $240,000 per year, and Mr. Nydam is eligible to receive
an annual bonus of up to 40% of his base salary. In addition,
the employment agreement provides for a cash signing bonus of
$15,000, and a cash performance bonus of $10,000 promptly after
we are in full compliance with our obligations as a reporting
company pursuant to the Securities Exchange Act of 1934, as
amended.

Mr. Nydams employment agreement
provides that Mr. Nydam will receive options to purchase
500,000 shares of our common stock, at an exercise price
equal to the fair market value of the common stock on the grant
date. These options vest as to 25% of the shares on the first
anniversary of Mr. Nydams employment and 1/48th of
the shares at the end of each monthly anniversary thereafter.
The vesting will accelerate upon the occurrence of a change in
control of us. These options expire on the tenth anniversary of
Mr. Nydams employment.

Mr. Nydams employment agreement also
provides that Mr. Nydam will receive additional options to
purchase 250,000 shares of our common stock, at an exercise
price equal to the fair market value of the common stock on the
grant date. These options vest upon the attainment of
performance objectives that have been mutually agreed upon by us
and Mr. Nydam, or 5 years, whichever occurs first. The
vesting will

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accelerate upon the occurrence of a change in
control of us. These options expire on the tenth anniversary of
Mr. Nydams employment.


Mr. Nydams employment agreement also
provides that, if we terminate Mr. Nydams employment
other than for cause (as defined in the employment
agreement) or if Mr. Nydam terminates his employment for
good reason (as defined in the employment
agreement), then, during the 12-month period immediately
following the date of Mr. Nydams termination,
(i) we will continue to pay to Mr. Nydam his base
salary and make available to Mr. Nydam the benefits made
generally available by us to our employees, and (ii) his
first group of options, covering 500,000 shares of common
stock, will continue to vest for a one year period
following such termination.

We have entered into an employment agreement with
Ms. Greenberg, dated as of March 25, 2003 and amended
as of September 14, 2003. Under her employment agreement,
Ms. Greenbergs initial base salary is $185,000 per
year, and Ms. Greenberg is eligible to receive an annual
bonus of up to 40% of her base salary.

Ms. Greenbergs employment agreement
provides that Ms. Greenberg will receive options to
purchase 250,000 shares of our common stock, at an exercise
price equal to the fair market value of the common stock on the
grant date. These options vest as to 25% of the shares on the
first anniversary of Ms. Greenbergs employment and
1/48th of the shares at the end of each monthly anniversary
thereafter. The vesting will accelerate upon the occurrence of a
change in control of us. These options expire on the tenth
anniversary of Ms. Greenbergs employment.

Ms. Greenbergs employment agreement
also provides that, if we terminate Ms. Greenbergs
employment other than for cause (as defined in the
employment agreement) or if Ms. Greenberg terminates her
employment for good reason (as defined in the
employment agreement), then, during the 12-month period
immediately following the date of Ms. Greenbergs
termination, (i) we will continue to pay to
Ms. Greenberg her base salary and make available to Ms.
Greenberg the benefits made generally available by us to our
employees, and (ii) her options will continue to vest for a
one year period following such termination.

We have entered into indemnification agreements
with each of our directors and executive officers, as well as
with certain employees and consultants. These indemnification
agreements provide that we hold harmless and indemnify each such
director, officer, employee and consultant to the fullest extent
authorized or permitted by law.

In addition, these indemnification agreements
provide for payment of expenses (including attorneys fees)
actually and reasonably incurred in connection with any
threatened, pending or completed proceeding to which the
indemnified director, officer or employee is, was or at any time
becomes a party, or is threatened to be made a party, by reason
of the fact that he or she is, was or at any time becomes a
director, officer, employee or agent of us, or is or was serving
or at any time serves at the request of us as a director,
officer, employee or agent of another corporation, partnership,
joint venture, trust, employee benefit plan or other enterprise.

As described above under Executive
Compensation, we also have entered into certain agreements
with Messrs. Mikus, Cracchiolo, Eum and Quilty and have
adopted a 2002 Executive Separation Benefits Plan.






|         |                        
|-------- | -----------------------
|Item 14. | Controls and Procedures

(a) Evaluation of Disclosure Controls and
Procedures. Based on their evaluation, as of a date within
90 days of the filing of this Form 10-K (the
Evaluation Date), our President and Chief Operating
Officer and our Senior Vice President and Chief Financial
Officer have concluded our disclosure controls and procedures
(as defined in Rules 13a-14 and 15d-14 under the Securities
Exchange Act of 1934) 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 and 2002, and the resulting
restatements described in note 3 to our consolidated
financial statements, by the development and implementation of
improvements to our internal controls and financial reporting
processes, and by the internal

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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.


Prior to the Evaluation Date, management
implemented significant changes in organization, policies and
procedures designed to enhance our disclosure controls and
procedures and the related internal controls. These included,
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.
Notwithstanding these changes, our controls are not yet as
mature or as formal as management believes they need to be and
intends them to be in the future. 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 Evaluation Date, 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,
2000, 2001 and 2002.

(b) Changes in Internal Controls.
There have been no significant changes in internal controls or
in other factors that could significantly affect these controls
subsequent to the Evaluation Date.




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, 2000,
    2001 and 2002                        |  |      | F-2         | 
|Consolidated Balance Sheets as of
    December 31, 2001 and 2002                                                          |  |      | F-3         | 
|Consolidated Statements of Stockholders
    Equity (Deficiency) for the Years Ended December 31, 2000,
    2001 and 2002 |  |      | F-4 to F-5  | 
|Consolidated Statements of Cash Flows for the
    Years Ended December 31, 2000,
    2001 and 2002                        |  |      | F-6 to F-7  | 
|Notes to the Consolidated Financial Statements                                                                            |  |      | F-8 to F-43 | 

(2) Financial Statement Schedules:

Schedule II  Valuation and
Qualifying Accounts for the years ended December 31, 2000,
2001 and 2002 is included in the consolidated financial
statements at page F-44. 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.

67



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(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.               
|            | 2.3(6)   |             |  | 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(6)   |             |  | 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(7)   |             |  | 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(8)   |             |  | 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.                                                                                                                                                                    
|            | 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(2)   |             |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                      
|            | 10.1(2) |             |  | Promissory Notes, dated August 8, 2001 and
    July 24, 2001, as subsequently amended, by Paul Mikus in
    favor of the Company.                                                                                                                                                                                                                                                                                                
|            | 10.2(2) |             |  | Change in Employment Status and Settlement
    Agreement and Release, effective June 25, 2001, by and
    between the Company and William Hughes.                                                                                                                                                                                                                                                                                
|            | 10.3(2) |             |  | Consulting and Confidentiality Agreement, dated
    June 1, 2001, by and between the Company and Michael
    Strauss, M.D.                                                                                                                                                                                                                                                                                                       
|            | 10.4(2)  |             |  | Note and Warrant Purchase Agreement, dated
    April 1, 2001, by and among the Company, Sanarus Medical,
    Inc. and specified purchasers and related Convertible Promissory
    Note and Warrant to Purchase Series B Preferred Stock,
    dated April 1, 2001.                                                                                                                                                                
|            | 10.5(2) |             |  | Offer of Employment, effective February 16,
    2001, by and between the Company and Kevin Quilty.                                                                                                                                                                                                                                                                                                                               
|            | 10.6(2) |             |  | Offer of Employment, effective September 22,
    2000, by and between the Company and David Battles.                                                                                                                                                                                                                                                                                                                             
|            | 10.7(2) |             |  | Offer of Employment, effective August 14,
    2000, by and between the Company and Holly Williams.                                                                                                                                                                                                                                                                                                                               
|            | 10.8(2) |             |  | Promissory Note, dated November 2, 1999, by
    Jerry Anderson in favor of the Company.                                                                                                                                                                                                                                                                                                                                          
|            | 10.9(2) |             |  | Promissory Note cancellations between the Company
    and each of Paul Mikus, Vincent Cutarelli, Jay Eum and William
    Hughes.                                                                                                                                                                                                                                                                                                 

68



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|            |            |             |  |                                                                                                                                                                                              
|----------- | ---------- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 10.10(2)  |             |  | Consulting Agreement, dated January 6, 1999,
    by and between the Company and Robert Byrnes.                                                                                               
|            | 10.11(2)  |             |  | Consulting Agreement, dated January 6, 1999,
    by and between the Company and Alan Kaganov.                                                                                                
|            | 10.12(2)   |             |  | Loan and Security Agreement, dated
    October 1, 1998, by and between the Company and Advanced
    Medical Procedures, LLC and related Revolving Promissory Note,
    dated October 1, 1998.
|            | 10.13(2)  |             |  | Guarantor Security Agreement, dated
    October 1, 1998, by and between the Company and Robert
    Byrnes.                                                                                   
|            | 10.14(2)   |             |  | Scientific Advisory Board Agreement, dated
    December 2, 1997, by and between the Company and Foundation
    Research, Inc.                                                                
|            | 10.15(2)  |             |  | Consulting Agreement, dated May 27, 1997, by
    and between the Company and Bob Byrnes.                                                                                                     
|            | 10.16(3)  |             |  | Offer of Employment, dated June 11,2001, by
    and between the Company and John V. Cracchiolo.                                                                                              
|            | 10.17(3)  |             |  | Compensation Agreement, dated June 25, 2001,
    by and between the Company and John V. Cracchiolo.                                                                                          
|            | 10.18(4)   |             |  | Global Supply and Market Access Agreement, dated
    September 21, 2001, by and between the Company and CryoCath
    Technologies, Inc.*                                                     
|            | 10.19(4)   |             |  | Distribution Agreement, dated September 25,
    2001, by and between the Company and Qualigen, Inc.*                                                                                         
|            | 10.20(9)   |             |  | Lease Agreement, dated November 26, 2001 by
    and between the Company and the Irvine Company.                                                                                              
|            | 10.21(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its directors.                                                                                                          
|            | 10.22(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its executive officers.                                                                                                 
|            | 10.23(10) |             |  | 1995 Director Option Plan (as amended and
    restated through March 2, 1999).                                                                                                               
|            | 10.24(13) |             |  | 1995 Stock Plan (as amended and restated through
    April 16, 2002).                                                                                                                        
|            | 10.25     |             |  | 2002 Supplemental Stock Plan.                                                                                                                                                                
|            | 10.26(5)  |             |  | Amended and Restated Stock Option Agreement (with
    Notice of Grant of Stock Option), dated November 26, 2001
    by and between the Company and John Cracchiolo.                          
|            | 10.27(7)   |             |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                           
|            | 10.28(8)   |             |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical Development,
    Inc. to the Company.                                                       
|            | 10.29     |             |  | Employment Agreement, effective as of May 1,
    2002, by and between the Company and Holly Williams.                                                                                        
|            | 10.30(12)  |             |  | Registration Rights Agreement, dated as of
    February 21, 2002, by and among the Company and the parties
    listed on Schedule A thereto.                                                 
|            | 10.31      |             |  | Registration Rights Agreement, dated as of
    May 28, 2002, by and between the Company and Cryomedical
    Sciences, Inc.                                                                   
|            | 10.32     |             |  | Letter Agreement, dated June 11, 1999, by
    and between the Company and Jerry Anderson                                                                                                     
|            | 10.33      |             |  | Blanket Purchase Agreement, effective
    April 1, 2002, by and between Timm Medical Technologies,
    Inc. and the U.S. Department of Veterans Affairs                                      
|            | 10.34     |             |  | 2002 Executive Separation Benefits Plan                                                                                                                                                      
|            | 16.1(11)   |             |  | Letter, dated November 17, 2003, from KPMG
    LLP regarding change in certifying accountant.                                                                                                
|            | 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 William J. Nydam.                                                                                                  

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|            |      |             |  |                                                                                               
|----------- | ---- | ----------- |  | ----------------------------------------------------------------------------------------------
|Exhibit No. |      | Description
|            |      |            
|            | 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 William J. Nydam.   
|            | 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 corporate 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, 2001.                                                
|
| | (4) | Previously filed on Form 10-Q for the
    quarter ended September 30, 2001.                                           
|
| | (5) | Previously filed with our Registration Statement
    on Form S-8 filed on January 31, 2002.                           
|
| | (6) | Previously filed on Form 10-Q for the
    quarter ended June 30, 2002.                                                
|
| | (7) | Previously filed on Form 8-K on
    August 16, 2002.                                                                  
|
| | (8) | Previously filed on Form 8-K on
    October 15, 2002.                                                                 
|
| | (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 22, 1999.                             
|    
|(11) | Previously filed with our preliminary proxy
    statement for the 2003 annual meeting filed on November 26,
    2003.
|    
|(12) | Previously filed with our Registration Statement
    on Form S-3 filed on May 15, 2002.                              
|    
|(13) | Previously filed with our definitive proxy
    statement for the 2002 annual meeting filed on April 30,
    2002.    

(b) Reports on Form 8-K

We filed a Form 8-K under Item 5 on
October 15, 2002, announcing that we had consummated the
acquisition of the mobile prostate treatment businesses of USMD
and announcing an amendment to the Partnership and Limited
Liability Company Membership Interest Purchase Agreement between
us and USMD, dated August 12, 2002.

We filed a Form 8-K under Item 5 on
December 19, 2002, announcing that we had terminated the
employment of our acting Vice President of Finance and General
Manager of our Minneapolis operations, Joseph A. Hafermann,
for cause pursuant to the terms of an employment agreement by
and between us and Mr. Hafermann.

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.

70



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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: December 2, 2003 |  | By:            |  | /s/ WILLIAM J. NYDAMWilliam J. NydamPresident and Chief Operating Officer

POWER OF ATTORNEY

Know all men by these present, that each person
whose signature appears below constitutes and appoints William
J. Nydam 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/ WILLIAM J. NYDAMWilliam J. Nydam           |  | President and Chief Operating Officer (principal
    executive officer)                            |  | December 2, 2003
|                                              
|/s/ KATHERINE GREENBERGKatherine Greenberg     |  | Senior Vice President and Chief Financial Officer
    (principal financial and accounting officer) |  | December 2, 2003
|                                              
|/s/ PETER F. BERNARDONIPeter F. Bernardoni     |  | Director                                                                                           |  | December 2, 2003
|                                              
|/s/ ROBERT F. BYRNESRobert F. Byrnes           |  | Director                                                                                           |  | December 2, 2003
|                                              
|/s/ BENJAMIN GERSON, M.D.Benjamin Gerson, M.D. |  | Director                                                                                           |  | December 2, 2003

71



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|                                                     |  |                          |  |                  |  | 
|---------------------------------------------------- |  | ------------------------ |  | ---------------- |  | 
|                                                     |  |                          |  |                 
|Signature                                            |  | Title                    |  | Date            
|                                                     |  |                          |  |                 
|                                                    
|/s/ RONALD A. MATRICARIARonald A. Matricaria         |  | Director (lead director) |  | December 2, 2003
|                                                    
|/s/ TERRENCE A. NOONANTerrence A. Noonan             |  | Director                 |  | December 2, 2003
|                                                    
|/s/ MICHAEL J. STRAUSS, M.D.Michael J. Strauss, M.D. |  | Director                 |  | December 2, 2003
|                                                    
|/s/ THOMAS R. TESTMANThomas R. Testman               |  | Director                 |  | December 2, 2003

72



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##### Table of Contents



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, 2001 and 2002, and the related
consolidated statements of operations, stockholders equity
(deficiency), and cash flows for each of the three years in the
period ended December 31, 2002. Our audits also included
the financial statement schedule listed in the Index at
Item 14(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, 2001 and 2002, and the
consolidated results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2002, 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

September 9, 2003, except for


Note 13, as to
which the


date is
October 1, 2003 and Note 6,


as to which the
date is October 13, 2003


F-1



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |            |            | 
|---------------------------------------------------------- | ------------------------------------- | ------------------------ | ----------- | ---------- | ---------- | ---- | ----------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | 
|                                                           |                                       |                         
|                                                           |                                       | Years Ended December 31 
|                                                           |                                       |                         
|                                                           |                                       | 2000                     |             | 2001       |            | 2002
|                                                           |                                       |                          |             |            |            |     
|                                                           |                                       | Restated                 |             | Restated   |            |     
|Total Revenues                                             |                                       | $                        | 6,567,948   |            |            | $    | 13,036,566  |            |            | $ | 30,916,425  |           
|Costs and expenses:                                        |                                       |                          |             |            |            |      |             |            |            |   |             |           
|                                                           | Cost of revenues                      |                          |             | 3,756,779  |            |      |             | 6,208,258  |            |   |             | 16,484,396 |           
|                                                           | Research and development              |                          |             | 2,371,416  |            |      |             | 2,543,557  |            |   |             | 2,899,866  |           
|                                                           | Selling, general and administrative   |                          |             | 13,435,992 |            |      |             | 15,728,183 |            |   |             | 33,769,442 |           
|                                                           | Goodwill impairment and other charges |                          |             |           |            |      |             |           |            |   |             | 20,311,293 |           
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|                                                           |                                       | Total costs and expenses |             |            | 19,564,187 |      |             |            | 24,479,998 |   |             |            | 73,464,997 | 
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Loss from operations                                       |                                       |                          | (12,996,239 | )          |            |      | (11,443,432 | )          |            |   | (42,548,572 | )         
|Loss on minority investment                                |                                       |                          |            |            |            |      | (250,000    | )          |            |   |            |           
|Interest income                                            |                                       |                          | 589,003     |            |            |      | 771,982     |            |            |   | 1,013,343   |           
|Interest expense                                           |                                       |                          | (1,421,219  | )          |            |      | (531,028    | )          |            |   | (6,839      | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Loss before minority interests                             |                                       |                          | (13,828,455 | )          |            |      | (11,452,478 | )          |            |   | (41,542,068 | )         
|Minority interests                                         |                                       |                          |            |            |            |      |            |            |            |   | (443,678    | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Net loss                                                   |                                       | $                        | (13,828,455 | )          |            | $    | (11,452,478 | )          |            | $ | (41,985,746 | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Net loss per share of common stock 
    basic and diluted |                                       | $                        | (1.08       | )          |            | $    | (0.68       | )          |            | $ | (1.76       | )         
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           
|Weighted-average shares of common stock
    outstanding    |                                       |                          | 12,757,000  |            |            |      | 16,741,000  |            |            |   | 23,822,000  |           
|                                                           |                                       |                          |             |            |            |      |             |            |            |   |             |           

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                               
|                                         |                                                                                                                                                                              |                                           
|                                         |                                                                                                                                                                              | 2001                                       |           | 2002       
|                                         |                                                                                                                                                                              |                                            |           |            
|                                         |                                                                                                                                                                              | Restated                                   |           |            
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         | Cash and cash equivalents                                                                                                                                                    |                                            | $         | 81,886,801  |            |  | $          | 18,177,825  |           
|                                         | Available for sale securities                                                                                                                                                |                                            |           |            |            |  |            | 22,183,160  |           
|                                         | Accounts receivable less allowances for doubtful
    accounts and sales returns of $667,552 and $2,226,432 at
    December 31, 2001 and 2002, respectively                   |                                            |           | 4,832,963   |            |  |            | 4,604,576   |           
|                                         | Inventories                                                                                                                                                                  |                                            |           | 2,129,797   |            |  |            | 4,491,642   |           
|                                         | Prepaid expenses and other current assets                                                                                                                                    |                                            |           | 362,951     |            |  |            | 640,758     |           
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         |                                                                                                                                                                              | Total current assets                       |           |             | 89,212,512 |  |            |             | 50,097,961 | 
|Property and equipment, net              |                                                                                                                                                                              |                                            | 1,749,126 |             |            |  | 8,244,693  |            
|Goodwill                                 |                                                                                                                                                                              |                                            |          |             |            |  | 17,538,224 |            
|Intangibles, net                         |                                                                                                                                                                              |                                            | 656,374   |             |            |  | 15,763,323 |            
|Investments and other assets             |                                                                                                                                                                              |                                            | 3,475,594 |             |            |  | 983,754    |            
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         |                                                                                                                                                                              | Total assets                               |           | $           | 95,093,606 |  |            | $           | 92,627,955 | 
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         | Accounts payable                                                                                                                                                             |                                            | $         | 1,807,500   |            |  | $          | 2,932,439   |           
|                                         | Accrued compensation                                                                                                                                                         |                                            |           | 1,020,462   |            |  |            | 2,816,320   |           
|                                         | Other accrued liabilities                                                                                                                                                    |                                            |           | 1,385,078   |            |  |            | 7,327,703   |           
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         |                                                                                                                                                                              | Total current liabilities                  |           |             | 4,213,040  |  |            |             | 13,076,462 | 
|Minority interests                       |                                                                                                                                                                              |                                            |          |             |            |  | 928,741    |            
|Commitments and Contingencies            |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|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; 22,051,826 and
    24,148,254 shares issued and outstanding at
    December 31, 2001 and 2002, respectively |                                            |           | 22,079      |            |  |            | 24,350      |           
|                                         | Additional paid-in capital                                                                                                                                                   |                                            |           | 138,337,026 |            |  |            | 169,935,487 |           
|                                         | Accumulated deficit                                                                                                                                                          |                                            |           | (46,945,837 | )          |  |            | (88,931,583 | )         
|                                         | Receivable from stockholder                                                                                                                                                  |                                            |           | (471,292    | )          |  |            | (214,292    | )         
|                                         | Accumulated other comprehensive income, net of tax                                                                                                                           |                                            |           |            |            |  |            | 12,466      |           
|                                         | Deferred compensation                                                                                                                                                        |                                            |           |            |            |  |            | (132,045    | )         
|                                         | Treasury stock at cost, 27,000 and
    201,200 shares at December 31, 2001 and 2002, respectively                                                                            |                                            |           | (61,410     | )          |  |            | (2,071,631  | )         
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         |                                                                                                                                                                              | Total stockholders equity                 |           |             | 90,880,566 |  |            |             | 78,622,752 | 
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            
|                                         |                                                                                                                                                                              | Total liabilities and stockholders equity |           | $           | 95,093,606 |  |            | $           | 92,627,955 | 
|                                         |                                                                                                                                                                              |                                            |           |             |            |  |            |            

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   |            | Unearned    |  | Treasury     |             | Equity       
|                                                                                                    |                     | Shares       |            | Capital    |  | Paid-In Capital |        | Deficit         |  | Stockholder   |            | of Tax      |  | Compensation |             | Stock         |   | (Deficiency)
|                                                                                                    |                     |              |            |            |  |                 |        |                 |  |               |            |             |  |              |             |               |   |             
|Balance at December 31, 1999                                                                        |                     |              | 11,248,323 |            |  | $               | 11,248 |                 |  | $             | 20,310,010 |             |  | $            | (19,773,625 | )             |   | $            | (1,028,125 | ) |  | $ |  |   |  | $ |  |   |  | $ |        |   |  | $ | (480,492   | )          
|Restatement adjustments                                                                             |                     |              | (27,000    | )          |  |                 |       |                 |  |               | 2,341,622  |             |  |              | (1,891,279  | )             |   |              | 42,833     |   |  |   |  |   |  |   |  |   |  |   | (61,410 | ) |  |   | 431,766    |            
|                                                                                                    |                     |              |            |            |  |                 |        |                 |  |               |            |             |  |              |             |               |   |              |            |   |  |   |   |   |  |   |   |   |  |   |         |   |  |   |            |            
|Balance at December 31, 1999
    (restated)                                                         |                     |              | 11,221,323 |            |  |                 | 11,248 |                 |  |               | 22,651,632 |             |  |              | (21,664,904 | )             |   |              | (985,292   | ) |  |   |  |   |  |   |  |   |  |   | (61,410 | ) |  |   | (48,726    | )          
|                                                                                                    | Net loss (restated) |              |            |           |  |                 |        |                |  |               |            |            |  |              |             | (13,828,455   | ) |              |            |  |  |   |   |  |  |   |   |  |  |   |         |  |  |   |            | (13,828,455 | )
|Private placement of common stock, net (restated)                                                   |                     |              | 1,509,440  |            |  |                 | 1,509  |                 |  |               | 18,331,889 |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 18,333,398 |            
|Conversion of convertible debentures and accrued
    interest, net (restated)                       |                     |              | 1,588,545  |            |  |                 | 1,589  |                 |  |               | 7,431,124  |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 7,432,713  |            
|Common stock issued for domain name                                                                 |                     |              | 20,000     |            |  |                 | 20     |                 |  |               | 434,980    |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 435,000    |            
|Common stock issued, other (restated)                                                               |                     |              | 7,216      |            |  |                 | 8      |                 |  |               | 100,675    |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 100,683    |            
|Warrants issued for patents (restated)                                                              |                     |              |           |            |  |                 |       |                 |  |               | 353,670    |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 353,670    |            
|Warrants issued to finance debt, net (restated)                                                     |                     |              |           |            |  |                 |       |                 |  |               | 122,444    |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 122,444    |            
|Stock options and warrants exercised                                                                |                     |              | 645,125    |            |  |                 | 645    |                 |  |               | 1,199,386  |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 1,200,031  |            
|Compensation related to issuance of options and
    warrants to consultants for services (restated) |                     |              |           |            |  |                 |       |                 |  |               | 1,513,506  |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 1,513,506  |            
|Forgiveness of receivable from stockholder
    (restated)                                           |                     |              |           |            |  |                 |       |                 |  |               |           |             |  |              |            |               |   |              | 257,000    |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 257,000    |            
|                                                                                                    |                     |              |            |            |  |                 |        |                 |  |               |            |             |  |              |             |               |   |              |            |   |  |   |   |   |  |   |   |   |  |   |         |   |  |   |            |            
|Balance at December 31, 2000
    (restated)                                                         |                     |              | 14,991,649 |            |  |                 | 15,019 |                 |  |               | 52,139,306 |             |  |              | (35,493,359 | )             |   |              | (728,292   | ) |  |   |  |   |  |   |  |   |  |   | (61,410 | ) |  |   | 15,871,264 |            
|                                                                                                    | Net loss (restated) |              |            |           |  |                 |        |                |  |               |            |            |  |              |             | (11,452,478   | ) |              |            |  |  |   |   |  |  |   |   |  |  |   |         |  |  |   |            | (11,452,478 | )
|Secondary offering of common stock, net (restated)                                                  |                     |              | 4,600,000  |            |  |                 | 4,600  |                 |  |               | 72,573,737 |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 72,578,337 |            
|Conversion of convertible debentures and accrued
    interest, net (restated)                       |                     |              | 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 (restated)                                                          |                     |              | 20,921     |            |  |                 | 21     |                 |  |               | 149,979    |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 150,000    |            
|Common stock issued, other (restated)                                                               |                     |              | 20,883     |            |  |                 | 21     |                 |  |               | 73,144     |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 73,165     |            
|Stock options and warrants exercised (restated)                                                     |                     |              | 1,076,630  |            |  |                 | 1,076  |                 |  |               | 2,550,241  |             |  |              |            |               |   |              |           |   |  |   |  |   |  |   |  |   |  |   |        |   |  |   | 2,551,317  |            

F-4



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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   |             | Unearned    |  | Treasury     |             | Equity       
|                                                                                                    |          | Shares       |            | Capital    |  | Paid-In Capital |        | Deficit         |  | Stockholder   |             | of Tax      |  | Compensation |             | Stock         |   | (Deficiency)
|                                                                                                    |          |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |               |   |             
|Compensation related to issuance of options and
    warrants to consultants for services (restated) |          |              |           |            |  |                 |       |                 |  |               | 773,027     |             |  |              |            |               |   |              |         |   |  |   |       |   |  |   |         |   |  |   |           |   |  |   | 773,027     |            
|Forgiveness of receivable from stockholder
    (restated)                                           |          |              |           |            |  |                 |       |                 |  |               |            |             |  |              |            |               |   |              | 257,000  |   |  |   |       |   |  |   |         |   |  |   |           |   |  |   | 257,000     |            
|                                                                                                    |          |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |               |   |              |          |   |  |   |        |   |  |   |          |   |  |   |            |   |  |   |             |            
|Balance at December 31, 2001
    (restated)                                                         |          |              | 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     |            
|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  |            
|                                                                                                    |          |              |            |            |  |                 |        |                 |  |               |             |             |  |              |             |               |   |              |          |   |  |   |        |   |  |   |          |   |  |   |            |   |  |   |             |            

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

F-5



---



##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                               |                                                                      |                                           |             |           |            |      |             |         |            |   |             |            |            |  
|------------------------------------------------------------------------------ | -------------------------------------------------------------------- | ----------------------------------------- | ----------- | --------- | ---------- | ---- | ----------- | ------- | ---------- | - | ----------- | ---------- | ---------- | -
|                                                                               |                                                                      |                                          
|                                                                               |                                                                      | For the Years Ended December 31          
|                                                                               |                                                                      |                                          
|                                                                               |                                                                      | 2000                                      |             | 2001      |            | 2002
|                                                                               |                                                                      |                                           |             |           |            |     
|                                                                               |                                                                      | Restated                                  |             | Restated  |            |     
|Cash flows from operating activities:                                          |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Net loss                                                                       |                                                                      | $                                         | (13,828,455 | )         |            | $    | (11,452,478 | )       |            | $ | (41,985,746 | )         
|Adjustments to reconcile net loss to net cash
    used in operating activities |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|                                                                               | Depreciation and amortization                                        |                                           |             | 824,922   |            |      |             | 716,336 |            |   |             | 3,095,472  |           
|                                                                               | Compensation expense related to issuance of
    options and warrants |                                           |             | 1,513,506 |            |      |             | 773,027 |            |   |             | 601,976    |           
|                                                                               | Goodwill impairment and other charges                                |                                           |             |          |            |      |             |        |            |   |             | 20,311,293 |           
|                                                                               | Loss on minority investment                                          |                                           |             |          |            |      |             | 250,000 |            |   |             |           |           
|                                                                               | Minority interests                                                   |                                           |             |          |            |      |             |        |            |   |             | 443,678    |           
|                                                                               | Forgiveness of receivable from stockholder                           |                                           |             | 257,000   |            |      |             | 257,000 |            |   |             | 257,000    |           
|                                                                               | Amortization of deferred financing costs                             |                                           |             | 540,879   |            |      |             | 229,847 |            |   |             |           |           
|                                                                               | Common stock issued for interest payable                             |                                           |             | 549,098   |            |      |             | 143,337 |            |   |             |           |           
|                                                                               | Changes in operating assets and liabilities:                         |                                           |             |           |            |      |             |         |            |   |             |            |           
|                                                                               |                                                                      | Accounts receivable                       |             |           | (1,052,623 | )    |             |         | (2,770,285 | ) |             |            | 1,366,069  |  
|                                                                               |                                                                      | Inventories                               |             |           | (938,659   | )    |             |         | (808,885   | ) |             |            | (3,508,305 | )
|                                                                               |                                                                      | Prepaid expenses and other current assets |             |           | (26,456    | )    |             |         | (163,842   | ) |             |            | (198,366   | )
|                                                                               |                                                                      | Other assets                              |             |           | 46,970     |      |             |         | (241,428   | ) |             |            | 246,111    |  
|                                                                               |                                                                      | Accounts payable                          |             |           | 727,577    |      |             |         | (437,547   | ) |             |            | 76,123     |  
|                                                                               |                                                                      | Accrued compensation                      |             |           | 199,320    |      |             |         | (88,961    | ) |             |            | 422,608    |  
|                                                                               |                                                                      | Other accrued liabilities                 |             |           | 521,908    |      |             |         | 58,758     |   |             |            | 4,255,072  |  
|                                                                               |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Net cash used in operating activities                                          |                                                                      |                                           | (10,665,013 | )         |            |      | (13,535,121 | )       |            |   | (14,617,015 | )         
|                                                                               |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Cash flows from investing activities:                                          |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Acquisitions, net of cash acquired                                             |                                                                      |                                           |            |           |            |      |            |         |            |   | (24,092,497 | )         
|Purchases of property and equipment                                            |                                                                      |                                           | (325,349    | )         |            |      | (672,738    | )       |            |   | (2,075,575  | )         
|Purchase of minority investment                                                |                                                                      |                                           | (250,000    | )         |            |      |            |         |            |   |            |           
|Intangibles                                                                    |                                                                      |                                           |            |           |            |      | (50,339     | )       |            |   |            |           
|Loan made to investee                                                          |                                                                      |                                           |            |           |            |      | (250,000    | )       |            |   |            |           
|Repayment of loan made to investee                                             |                                                                      |                                           |            |           |            |      | 250,000     |         |            |   |            |           
|Partnership distributions to minority interests                                |                                                                      |                                           |            |           |            |      |            |         |            |   | (776,532    | )         
|Purchases of available-for-sale securities                                     |                                                                      |                                           |            |           |            |      |            |         |            |   | (22,170,694 | )         
|                                                                               |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Net cash used in investing activities                                          |                                                                      |                                           | (575,349    | )         |            |      | (723,077    | )       |            |   | (49,115,298 | )         
|                                                                               |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Cash flows from financing activities:                                          |                                                                      |                                           |             |           |            |      |             |         |            |   |             |           
|Proceeds from credit facility                                                  |                                                                      |                                           | 2,000,000   |           |            |      |            |         |            |   |            |           
|Payments made on credit facility and other debt                                |                                                                      |                                           | (3,078,815  | )         |            |      | (1,074,268  | )       |            |   |            |           
|Proceeds from issuance of debentures                                           |                                                                      |                                           | 8,000,000   |           |            |      |            |         |            |   |            |           
|Debt issuance costs and other                                                  |                                                                      |                                           | (663,438    | )         |            |      |            |         |            |   |            |           
|Proceeds from private placement                                                |                                                                      |                                           | 18,333,398  |           |            |      |            |         |            |   |            |           
|Proceeds from secondary offering                                               |                                                                      |                                           |            |           |            |      | 72,578,337  |         |            |   |            |           
|Proceeds from other issuance of common stock                                   |                                                                      |                                           | 100,683     |           |            |      | 73,165      |         |            |   |            |           

F-6



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF CASH
FLOWS  (Continued)

|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | -------- |  | ---- | ---------- |  |  | - | ----------- | -
|                                                                                                                                                                                                      |  |                                
|                                                                                                                                                                                                      |  | For the Years Ended December 31
|                                                                                                                                                                                                      |  |                                
|                                                                                                                                                                                                      |  | 2000                            |            | 2001     |  | 2002
|                                                                                                                                                                                                      |  |                                 |            |          |  |     
|                                                                                                                                                                                                      |  | Restated                        |            | Restated |  |     
|Stock options and warrants exercised                                                                                                                                                                  |  |                                 | 1,200,031  |          |  |      | 2,551,317  |  |  |   | 2,033,558   |  
|Repurchase of treasury stock                                                                                                                                                                          |  |                                 |           |          |  |      |           |  |  |   | (2,010,221  | )
|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|Net cash provided by financing activities                                                                                                                                                             |  |                                 | 25,891,859 |          |  |      | 74,128,551 |  |  |   | 23,337      |  
|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|Net increase (decrease) in cash and cash
    equivalents                                                                                                                                              |  |                                 | 14,651,497 |          |  |      | 59,870,353 |  |  |   | (63,708,976 | )
|Cash and cash equivalents, beginning of year                                                                                                                                                          |  |                                 | 7,364,951  |          |  |      | 22,016,448 |  |  |   | 81,886,801  |  
|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|Cash and cash equivalents, end of year                                                                                                                                                                |  | $                               | 22,016,448 |          |  | $    | 81,886,801 |  |  | $ | 18,177,825  |  
|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|Non-cash activities:                                                                                                                                                                                  |  |                                 |            |          |  |      |            |  |  |   |             |  
|Convertible debentures and accrued interest
    converted to common stock, net of unamortized deferred financing
    costs of $1,616,385 and $458,694 at December 31, 2000 and
    2001, respectively |  | $                               | 7,432,713  |          |  | $    | 7,241,641  |  |  | $ |            |  
|Warrants issued to finance debt                                                                                                                                                                       |  |                                 | 122,444    |          |  |      |           |  |  |   |            |  
|Warrants issued for patents                                                                                                                                                                           |  |                                 | 353,670    |          |  |      |           |  |  |   |            |  
|Common stock issued for trademark and domain name                                                                                                                                                     |  |                                 | 435,000    |          |  |      |           |  |  |   |            |  
|Transfer of inventory to property and equipment
    for placement at customer sites                                                                                                                   |  |                                 | 781,294    |          |  |      | 10,251     |  |  |   | 2,902,184   |  
|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   |  
|Unrealized gain on available-for-sale securities                                                                                                                                                      |  |                                 |           |          |  |      |           |  |  |   | 12,466      |  
|                                                                                                                                                                                                      |  |                                 |            |          |  |      |            |  |  |   |             |  
|Other supplemental information:                                                                                                                                                                       |  |                                 |            |          |  |      |            |  |  |   |             |  
|Interests paid                                                                                                                                                                                        |  | $                               | 526,238    |          |  | $    | 776,055    |  |  | $ |            |  
|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 cryoablation products with
the potential to improve the treatment of cancer. 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 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 products
and services directly to hospitals and other medical
professional organizations. Internationally, the Company markets
its products through distributors and other third-parties.
Through the Companys subsidiaries, Endocare also contracts
with health plans and hospitals in the United States for the use
of its Cryocare Surgical Systems in cryoablation treatments for
prostate diseases on a per-procedure fee basis.

The Company also offers the ErecAid line of
vacuum therapy systems, which include the SurErec system,
Classic system, and Esteem system  a
non-pharmaceutical treatment of erectile dysfunction and penile
rehabilitation following treatment for cancer. The Company
acquired these product lines in the first quarter of 2002
through the acquisition of the assets of Timm Medical
Technologies, Inc. (Timm Medical), a provider of
vacuum pumps for the treatment of erectile dysfunction. Through
the Timm Medical acquisition, the Company also acquired or
obtained marketing rights to a number of other products, many of
which have been or may be divested, including the urological
prostheses product line and certain products used in the
diagnosis and treatment of erectile dysfunction, urinary
incontinence and benign prostate hyperplasia (BPH).
This acquisition also expanded the Companys sales and
marketing organization (see Note 5).



|   |                                               
|-- | ----------------------------------------------
|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-8



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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 and the
Company charges a per-procedure, or bundled, fee. The bundled
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 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. The medical
facilities and healthcare payors are billed for procedures
performed using Cryocare Surgical Systems owned by the Company
and by third parties that are placed at or transported to the
treatment site. The Company receives procedure fee revenue from
the payors and remits a portion of the fee to a third party for
the use of the Cryocare Surgical System if not owned by the
Company. 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,
2000, 2001, and 2002, totaled $0, $119,000 (restated) and
$1,082,000, respectively (included in other accrued liabilities).

In 2000, sales to Charleson International, Ltd.
accounted for 10% of total revenues. 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 2000 and 2001
and no individual customer accounted for more than 10% of total
revenues in 2002. The Company derives over 85% from sales in the
United States during this three-year period. See Notes 5, 6
and 12.

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,
works-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-9



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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

In August 2001, the Financial Accounting
Standards Board (FASB), issued Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS
No. 144 supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of, and was effective for fiscal years beginning
after December 15, 2001. SFAS No. 144 applies to all
long-lived assets (including discontinued operations) and
consequently amends APB No. 30, Reporting the Results of
Operations  Reporting the Effects of Disposal of a
Segment of a Business and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. SFAS
No. 144 develops an accounting model for long-lived assets
that are to be disposed of by sale and requires the measurement
to be at the lower of book value or fair value, less the cost to
sell the assets. Additionally, SFAS No. 144 expands the
scope of discontinued operations to include all components of an
entity with operations that (1) can be distinguished from
the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. The
adoption of SFAS No. 144 on January 1, 2002, had no
effect on the Companys financial position, operating
results or cash flows.

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, 2002.



| |                       
| | ----------------------
| | 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 two 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.



| |                         
| | ------------------------
| | Deferred Financing Costs

Deferred financing costs are included in other
assets in the consolidated balance sheets and are amortized into
interest expense over the lives of the respective debt.



| |                               
| | ------------------------------
| | 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
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

F-10



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 2000, 2001 and 2002. 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 (see Note
4).

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

|           |  |   |            | 
|---------- |  | - | ---------- | 
|2003       |  | $ | 1,419,514  | 
|2004       |  |   | 1,410,488  | 
|2005       |  |   | 1,325,238  | 
|2006       |  |   | 1,243,488  | 
|2007       |  |   | 1,178,863  | 
|Thereafter |  |   | 9,185,732  | 
|           |  |   |            | 
|           |  | $ | 15,763,323 | 
|           |  |   |            | 

Amortization expense totaled $249,865 (restated),
$288,167 (restated) and $1,201,533 in 2000, 2001 and 2002,
respectively.



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

The Company invests its funds in a diversified
portfolio of marketable debt securities, which consist 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.

Following is a summary of available-for-sale
securities at December 31, 2002 (gross unrealized gains and
losses are not presented as they are immaterial):

|                                              |  |           |            |            |  |   |            | 
|--------------------------------------------- |  | --------- | ---------- | ---------- |  | - | ---------- | 
|                                              |  | Amortized |            | Estimated 
|                                              |  | Cost      |            | Fair Value
|                                              |  |           |            |           
|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 | 
|                                              |  |           |            |            |  |   |            | 

F-11



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The contractual maturities of investments at
December 31, 2002 are as follows:

|                                      |  |           |            |            |  |   |            | 
|------------------------------------- |  | --------- | ---------- | ---------- |  | - | ---------- | 
|                                      |  | Amortized |            | Estimated 
|                                      |  | Cost      |            | Fair Value
|                                      |  |           |            |           
|Due in one year or less               |  | $         | 4,000,000  |            |  | $ | 4,073,770  | 
|Due after one year through five years |  |           | 3,000,000  |            |  |   | 3,009,390  | 
|Due after five years through 10 years |  |           | 3,200,000  |            |  |   | 3,200,000  | 
|Due after 10 years                    |  |           | 11,900,000 |            |  |   | 11,900,000 | 
|                                      |  |           |            |            |  |   |            | 
|Total                                 |  | $         | 22,100,000 |            |  | $ | 22,183,160 | 
|                                      |  |           |            |            |  |   |            | 

There were no available-for-sale securities at
December 31, 2001.



| |                  
| | -----------------
| | 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 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

In November 2002, the FASB issued Financial
Interpretation Number (FIN) 45, Guarantors
Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, which is
effective for all financial statement periods ending after
December 14, 2002. FIN 45 expands the disclosure
requirements for companies providing product warranties and
other guarantee contracts. 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) was 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 $505,599 (restated), $424,402 (restated),
and $1,591,009, for the years ended December 31, 2000, 2001
and 2002, respectively.

F-12



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                          
| | -------------------------
| | 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 and urologists, 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 equivalents,
available-for-sale securities, accounts receivable, accounts
payable and accrued liabilities. At December 31, 2002, 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 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.

F-13



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                 
| | ------------------------------------------------
| | 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

At December 2002, the Company had four
stock-based employee compensation plans, which are described
more fully in Note 10. 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. SFAS No. 123, Accounting
for Stock-Based Compensation, established accounting and
disclosure requirements using a fair-value-based method of
accounting for stock-based employee compensation plans.

In December 2002, SFAS No. 148,
Accounting for Stock-Based Compensation 
Transition and Disclosurewas issued. SFAS No. 148
amends SFAS No. 123 to provide alternative methods of
transition to the fair-value method of accounting for
stock-based employee compensation prescribed in
SFAS No. 123. It also amends and expands the
disclosure provisions of SFAS No. 123 and
APB Opinion No. 28, Interim Financial
Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an
entitys accounting policy with respect to stock-based
employee compensation on reported net income and earnings per
share in annual and interim financial statements. While
SFAS No. 148 does not require companies to account for
employee stock options using the fair-value method, the
disclosure provisions of SFAS No. 148 are applicable
to all companies with stock-based employee compensation,
regardless of whether they account for that compensation using
the fair-value method of SFAS No. 123 or the
intrinsic-value method of APB Opinion No. 25. The Company
has adopted the disclosure requirements of
SFAS No. 148 but has not evaluated the impact of the
remaining elements of SFAS No. 148 on its financial
position, results of operations, or cash flows.

F-14



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table illustrates the effect on net
loss and loss per share if the Company had applied the fair
value recognition provisions to stock-based employee
compensation.

|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |            |  
|----------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ---------------------- | ----------- | ---------- | - | ---- | ----------- | ---------- | - | - | ----------- | ---------- | -
|                                                |                                                                                                                            |                       
|                                                |                                                                                                                            | Year Ended December 31
|                                                |                                                                                                                            |                       
|                                                |                                                                                                                            | 2000                   |             | 2001       |   | 2002
|                                                |                                                                                                                            |                        |             |            |   |     
|                                                |                                                                                                                            | Restated               |             | Restated   |   |     
|Net loss, as reported(a)                        |                                                                                                                            | $                      | (13,828,455 | )          |   | $    | (11,452,478 | )          |   | $ | (41,985,746 | )         
|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     |  
|                                                | Less: Stock-based compensation expense
    determined under the fair-value-based method for all awards
    expense         |                        |             | (1,190,625 | ) |      |             | (2,020,142 | ) |   |             | (4,075,475 | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Net adjustment                                  |                                                                                                                            |                        | (1,190,625  | )          |   |      | (2,020,142  | )          |   |   | (4,042,406  | )         
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Net loss, as adjusted                           |                                                                                                                            | $                      | (15,019,080 | )          |   | $    | (13,472,620 | )          |   | $ | (46,028,152 | )         
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|Basic and diluted loss per share:               |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|                                                | As reported                                                                                                                |                        | $           | (1.08      | ) |      | $           | (0.68      | ) |   | $           | (1.76      | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           
|                                                | As adjusted                                                                                                                |                        |             | (1.18      | ) |      |             | (0.80      | ) |   |             | (1.93      | )
|                                                |                                                                                                                            |                        |             |            |   |      |             |            |   |   |             |           



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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.                        
|   
|(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, 2002 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, 2002.



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

F-15



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 $362,000 (restated),
$693,000 (restated) and $1,887,000 during 2000, 2001 and
2002, respectively, and are included in selling, general and
administrative expenses. Taxes payable at December 31, 2001
and 2002 were $742,000 (restated) and $2,194,000,
respectively (included in other accrued liabilities).



| |                                              
| | ---------------------------------------------
| | Accounting Pronouncements Not Yet
    Adopted

In June 2001, SFAS No. 143,
Accounting for Asset Retirement Obligations, was
issued. This statement requires an enterprise to record the fair
value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the
retirement of tangible long-lived assets. Since the requirement
is to recognize the obligation when incurred, approaches that
have been used in the past to accrue the asset retirement
obligation over the life of the asset are no longer acceptable.
SFAS No. 143 also requires the enterprise to record
the contra to the initial obligation as an increase to the
carrying amount of the related long-lived asset, i.e., the
associated asset retirement costs, and to depreciate that cost
over the life of the asset. The liability is increased at the
end of each period to reflect the passage of time, i.e.,
accretion expense, and changes in the estimated future cash
flows underlying the initial fair value measurement.
SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002.

In May 2002, SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections as of April 2002 was issued. As a result of the
rescission of SFAS No. 4, gains and losses related to
the extinguishment of debt should be classified as extraordinary
only if they meet the criteria outlined under APB Opinion
No. 30, Reporting the Results of Operations 
Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 64, Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements, was an
amendment to SFAS No. 4 and is no longer necessary.
SFAS No. 44, Accounting for Intangible Assets of
Motor Carriers, defined accounting requirements for the
effects of the transition to the Motor Carrier Act of 1980. The
transitions are complete and SFAS No. 44 is no longer
necessary. SFAS No. 145 amends SFAS No. 13,
Accounting for Leases, requiring that any capital lease
that is modified resulting in an operating lease should be
accounted for under the sale-leaseback provisions of
SFAS No. 98, Accounting for Leasesor
SFAS No. 28, Accounting for Sales with
Leasebacks, as applicable. SFAS No. 145 is
effective for fiscal years beginning after May 15, 2002.

In June 2002, SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities, which requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred, was issued. This statement nullifies
Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring), which required that a liability for an exit
cost be recognized upon the entitys commitment to an exit
plan. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002.

In November 2002, SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued.
SFAS No. 150 requires that certain financial
instruments previously reported as equity be reported as
liabilities (such as mandatorily redeemable equity instruments
and buy-sell arrangements). Depending on the type of financial
instrument, it will be accounted for at either fair value or
present value of future cash flows determined at each balance
sheet date with the change in that value reported as interest
expense in the income statement. In the past, either those
financial instruments were not required to be recognized, or if
recognized were reported in the balance sheet as equity and
changes in the value of those instruments were normally not
recognized in net income. The statement is effective for
instruments entered into or altered after May 31, 2003, and
is otherwise effective for interim periods ending after
June 15, 2003.

F-16



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In addition to the disclosure requirements of
FIN No. 45 as described above in Product Warranties,
FIN No. 45 requires that a guarantor recognize, at the
inception of the guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provision of FIN No. 45
does not apply to certain guarantee contracts, such as
warranties, derivatives or guarantees between either parent and
subsidiaries or corporations under common control, although
disclosures of such guarantees is required. For contracts that
are within the initial recognition and measurement provisions of
FIN No. 45, the provisions are to be applied to
guarantees issued or modified after December 31, 2002.

In January 2003, FIN No. 46,
Consolidation of Variable Interest Entities, was issued.
FIN 46 clarifies existing accounting principles that
determine when a company should include in its financial
statements the assets, liabilities and activities of another
entity when the equity investors do not have the characteristics
of a controlling financial interest or when the equity at risk
is not sufficient for the entity to finance its activities
without additional subordinated financial support from other
parties. The consolidation requirements of FIN No. 46
apply to variable interest entities (commonly evidenced by a
guarantee arrangement or other commitment to provide financial
support) created after January 31, 2003. The Company is
required to perform this assessment by September 30, 2003,
and consolidate any variable interest entities for which it will
absorb a majority of the entities expected losses or
receive a majority of the expected residual gains.

The adoption of the provisions of these
pronouncements is not expected to have a material impact on the
Companys results of operations, financial position, cash
flows and related disclosures. Management has not yet performed
the assessment required under FIN No. 46; however, it
is not aware of any material variable interest entity that it
may be required to consolidate.



|   |                                    
|-- | -----------------------------------
|3. | Restatement of Financial Statements

On October 24, 2002, the former General
Manager of Timm Medical reported to the Board of Directors his
concerns regarding the accounting for several transactions. The
Companys Audit Committee promptly directed outside legal
counsel to investigate the accounting concerns. On
October 31, 2002, the Audit Committees legal counsel
engaged an accounting firm independent of the Companys
auditors to investigate the complaints. On December 11,
2002, the Companys independent auditors notified the
Company that their audit report on the Companys
consolidated financial statements as of December 31, 2001,
and for the year then ended, had been withdrawn and could no
longer be relied upon. In addition, the independent auditors
advised that the consolidated financial statements for the
quarters ended March 31, 2002 and June 30, 2002 should
not be relied upon. Trading of the Companys stock on The
Nasdaq Stock Market was halted on December 12, 2002. The
Company was delisted effective January 16, 2003 and has
been trading in the so-called pink-sheets since that
date.

The Company hired a new President and Chief
Operating Officer and a new Chief Financial Officer in March
2003. The Companys Board of Directors, upon recommendation
of the Audit Committee, approved dismissal of the Companys
independent auditors effective March 7, 2003. On
April 1, 2003, the Company appointed new independent
auditors and engaged them to re-audit the Companys
consolidated financial statements for years ended
December 31, 2000 and 2001 and to audit its consolidated
financial statements for the year ended December 31, 2002.
In September 2003, the Companys former auditors notified
the Company that they were withdrawing their reports on the
Companys consolidated financial statements for the years
ended December 31, 1999 and 2000 and that these financial
statements could no longer be relied upon.

To address the matters discovered in the
investigations, the Company has implemented remedial actions,
including improved controls over sales representatives and sales
orders, new and more stringent credit approval policies, the
adoption of improved expense recognition and approval policies,
improved controls and documentation over the issuance of options
and warrants in financial transactions, and new internal
reporting procedures.

F-17



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The discovery of accounting errors required the
Company to restate previously issued financial statements.
Following are explanations of the restatement adjustments and
presentation of affected accounts in the consolidated statements
of financial position and results of operations as previously
reported and as restated



| |         
| | --------
| | Revenues

The Company discovered that its revenue had been
overstated relating to the sale of Cryocare Surgical System
units and cryoprobes because certain sales did not meet all
revenue recognition criteria required under Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial
Statements. The Company restated previously recognized
revenues related to certain Cryocare Surgical Systems and
cryoprobes transactions by $103,000 for 2000, $2,685,000 for
2001, $1,133,000 (unaudited) for the quarter ended
March 31, 2002, and $2,592,000 (unaudited) for the quarter
ended June 30, 2002. These adjustments primarily relate to
the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a.     Revenues
    previously recorded in the period in which certain Cryocare
    Surgical Systems were shipped to a company-controlled facility.
    These revenues were restated to record such revenues in the
    period the customer actually took possession.                                                                                                                                                                                    
|
| | b.     Concessions
    provided to certain customers purchasing Cryocare Surgical
    Systems that were not accounted for in the period the revenues
    were recorded. Restated revenues include recording concessions
    for advertising allowances, grants, interest buy-downs, extended
    warranties, free equipment and upgrades, in the period the
    Cryocare Surgical Systems were sold.                                                     
|
| | c.     Guarantees made
    to certain customers for minimum procedure fee revenue from the
    use of purchased Cryocare Surgical Systems for which the future
    cost of providing the guarantee was not appropriately accrued.
    Restated revenues reflect the deferral of the portion of
    Cryocare Surgical Systems revenues associated with the minimum
    procedure fees until the minimum procedure fee guarantees were
    fulfilled.      
|
| | d.     Revenues
    previously recorded for certain Cryocare Surgical Systems sales
    where the customers commitment or ability to pay was
    contingent upon the customers arranging financing, the
    sale to a newly formed partnership, or the re-sale by a
    distributor to a third-party. Restated revenues reflect the
    recording of Cryocare Surgical Systems sales in the period the
    contingency was removed or payment received.
|
| | e.     The sale of a
    Cryocare Surgical System to a customer where the Company failed
    to record a customer trade-in of a competitors equipment
    at the appropriate value and in the proper period. Restated
    revenues and property and equipment reflect the customer
    trade-in at the lower fair-value of the equipment received in
    the period of the exchange.                                                                    
|
| | f.     Sales of
    cryoprobes in June 2002 to USMD pursuant to a pre-existing
    distribution agreement and subsequent repurchase of the unused
    inventory following the acquisition of interests in certain
    cryosurgical partnerships in September 2002 (see Note 5).
    The repurchased cryoprobes are reported as a reduction in June
    2002 revenues, and reductions in cost of sales for September
    2002 and subsequent periods.     
|
| | g.     Receipt of
    certain licensing fees and milestone payments where these
    licensing fees were recorded as revenue in the period received,
    and payments for volume discounts determined on a retrospective
    basis where these payments were recorded as cost of sales when
    paid. Licensing fees and milestone payments are recorded net of
    volume discounts as restated revenues in the period they were
    earned.             

F-18



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                 
| | ----------------
| | Cost of Revenues

The Company made certain adjustments to increase
cost of revenues, which totaled $744,000 for 2000, $785,000 for
2001, $544,000 (unaudited) for the first quarter of 2002, and
$751,000 (unaudited) for the second quarter of 2002. These
adjustments primarily relate to the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a.     Failure to
    properly apply standard costing to its inventory, or to allow
    for shrinkage, excess and obsolescence. Additionally,
    depreciation of Cryocare Surgical Systems placed at hospital
    locations was not consistently recorded. Restated cost of
    revenues reflects the effects of properly valuing inventory and
    depreciating placed Cryocare Surgical Systems.
|
| | b.     Incorrect
    omission from the preliminary purchase price allocation for the
    Timm Medical acquisition of certain amortizable developed
    technology (see Note 5). Restated cost of revenues reflects
    increased amortization since the date of the Timm Medical
    acquisition.                                                                                                  
|
| | c.     Reclassification
    to cost of revenues certain research and development and quality
    assurance expenses related to routine manufacturing operations.                                                                                                                                                                                                                                   



| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Selling, General and Administrative Expenses
    and Research and Development Costs

The Company made certain adjustments to increase
selling, general and administrative expenses (S,G&A), which
totaled $1,206,000 for 2000, $2,557,000 for 2001, $2,193,000
(unaudited) for the first quarter of 2002 and $3,417,000
(unaudited) for the second quarter of 2002, and to reduce
research and development costs by $832,000 in 2000, $995,000 in
2001, $213,000 (unaudited) in the first quarter of 2002, and
$214,000 (unaudited) in the second quarter of 2002. These
adjustments primarily relate to the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a.     Failure to
    consistently accrue expenses in the periods when the obligations
    were incurred, including accrual of expenses in the period
    invoices were received rather than in the period the expenses
    were incurred; capitalization of legal, transactional and
    advertising expenses normally expensed; and establishing and
    recording unsupported general reserves.                                                                                                                                                                                                                                                 
|
| | b.     Insufficient
    accrual of capital, sales and use taxes, and state and local
    taxes, which are assessed on a basis other than taxable income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | c.     Incorrect
    recording of: (1) expenses associated with stock options
    and warrants issued as compensation to consultants; (2) the
    assets and related amortization where warrants were issued to
    acquire certain patents; and (3) the deferred financing
    costs and related amortization expense for warrants issued to
    lenders in connection with debt financings. Adjustments were
    recorded to expense the fair value of consultant stock options
    and warrants in the period services were provided, and
    capitalize and amortize the fair value of warrants issued to
    acquire patents and finance debt.
|
| | d.     Forgiveness of an
    interest-bearing loan made to a Company executive (see
    Note 14) for the purchase of Company common stock.
    Adjustments were recorded to write-off the principal and
    interest over a 4-year period as compensation expense.                                                                                                                                                                                                                                                                                                                                                                                 
|
| | e.     Reclassification
    from research and development to S,G&A of certain expenses
    related to collection of clinical data for marketing purposes,
    consulting and patent litigation. (see Cost of Revenues,
    paragraph c. above).                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | f.     Incorrect
    capitalization of certain costs related to acquisition
    activities, which should have been expensed as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | g.     Absence of
    substantiation for the existence and/ or carrying values of
    certain property and equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

F-19



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                      
| | ---------------------
| | Other income and loss

The Company made certain adjustments to increase
(decrease) other income, net, which totaled ($208,000) for
2000, ($497,000) for 2001, $17,000 (unaudited) for the
first quarter of 2002, and $207,000 (unaudited) for the
second quarter of 2002. These adjustments primarily relate to
the following:



| |                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------
| | a.     Recording an
    impairment in the value of a minority investment in 2002, when
    the investment was actually impaired in 2001. 
|
| | b.     Incorrect
    recording of interest income related to a forgivable loan to a
    Company executive (see S,G&A paragraph d. above).



| |                                                                 
| | ----------------------------------------------------------------
| | Cumulative Restatement Adjustments Through
    December 31, 1999

Adjustments were made to increase additional
paid-in capital, accumulated deficit and treasury stock, and to
reduce receivable from stockholder at December 31, 1999.
The net effect of these adjustments decreased stockholders
deficiency at December 31, 1999 by $432,000 in the
aggregate as a result of the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a.     Failure to record
    the full effect of stock options and warrants issued as
    compensation to consultants for services, to acquire patents and
    to finance debt. Adjustments were made to increase additional
    paid-in capital by $2,281,000 for the fair value of these equity
    instruments and to increase the accumulated deficit by
    $1,820,000 for the cumulative compensation and amortization
    expenses.
|
| | b.     Failure to record
    compensation expense of $53,000 relating to the forgiveness of a
    note receivable due from a Company executive during the periods
    the employee provided services to the Company (see S,G&A
    paragraph d. above).                                                                                                                                                                                  
|
| | c.     Reclassification
    of treasury stock in the amount of $61,000 from additional
    paid-in capital.                                                                                                                                                                                                                                                                                                                              
|
| | d.     Other
    miscellaneous adjustments that reduced the accumulated deficit
    by a total of $192,000.                                                                                                                                                                                                                                                                                                                              

F-20



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The consolidated financial statements as of
December 31, 2001, and for the years ended
December 31, 2000 and 2001, and notes thereto have been
restated to include the items described above. The following
financial statement line items were impacted:

Consolidated Balance Sheet

|                                          |  |               |             |              |  |   |             |    
|----------------------------------------- |  | ------------- | ----------- | ------------ |  | - | ----------- | ---
|                                          |  | As Previously |             |             
|                                          |  | Reported      |             | Restated    
|                                          |  | December 31,  |             | December 31,
|                                          |  | 2001          |             | 2001        
|                                          |  |               |             |             
|Cash and cash equivalents                 |  | $             | 83,238,915  |              |  | $ | 81,886,801  | (a)
|Accounts receivable, net                  |  |               | 5,733,563   |              |  |   | 4,832,963   |    
|Inventories                               |  |               | 2,415,744   |              |  |   | 2,129,797   |    
|Prepaid expenses and other current assets |  |               | 793,025     |              |  |   | 362,951     |    
|Total current assets                      |  |               | 92,181,247  |              |  |   | 89,212,512  |    
|Property and equipment                    |  |               | 1,814,714   |              |  |   | 1,749,126   |    
|Intangibles, net                          |  |               | 329,972     |              |  |   | 656,374     |    
|Investments and other assets              |  |               | 3,708,009   |              |  |   | 3,475,594   |    
|Total assets                              |  |               | 98,033,942  |              |  |   | 95,093,606  |    
|Accounts payable                          |  |               | 1,260,214   |              |  |   | 1,807,500   |    
|Accrued compensation                      |  |               | 1,334,168   |              |  |   | 1,020,462   |    
|Other accrued liabilities                 |  |               | 826,119     |              |  |   | 1,385,078   |    
|Total current liabilities                 |  |               | 3,420,501   |              |  |   | 4,213,040   |    
|Common stock                              |  |               | 22,058      |              |  |   | 22,079      |    
|Additional paid-in capital                |  |               | 133,716,105 |              |  |   | 138,337,026 |    
|Accumulated deficit                       |  |               | (38,096,597 | )            |  |   | (46,945,837 | )  
|Receivable from stockholder               |  |               | (1,028,125  | )            |  |   | (471,292    | )  
|Treasury stock                            |  |               |            |              |  |   | (61,410     | )  
|Total stockholders equity                |  |               | 94,613,441  |              |  |   | 90,880,566  |    



---



|    |                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | The restated balance primarily reflects an
    adjustment to reclassify $1,388,042 in funds previously reported
    as deposits in transit to accounts receivable. This amount
    represents receivable collections, which were not received and
    deposited until after December 31, 2001.

F-21



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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Consolidated Statements of
Operations

|                                                           |  |                   |             |                   |  |                   |             |                   |  |   |            |   |  |   |             |  
|---------------------------------------------------------- |  | ----------------- | ----------- | ----------------- |  | ----------------- | ----------- | ----------------- |  | - | ---------- | - |  | - | ----------- | -
|                                                           |  | As Previously     |             |                   |  | As Previously     |             |                  
|                                                           |  | Reported          |             | Restated Year     |  | Reported          |             | Restated Year    
|                                                           |  | Year Ended        |             | Ended             |  | Year Ended        |             | Ended            
|                                                           |  | December 31, 2000 |             | December 31, 2000 |  | December 31, 2001 |             | December 31, 2001
|                                                           |  |                   |             |                   |  |                   |             |                  
|Revenues                                                   |  | $                 | 6,670,948   |                   |  | $                 | 6,567,948   |                   |  | $ | 15,721,089 |   |  | $ | 13,036,566  |  
|Cost of revenues                                           |  |                   | 3,012,449   |                   |  |                   | 3,756,779   |                   |  |   | 5,423,240  |   |  |   | 6,208,258   |  
|Research and development                                   |  |                   | 3,203,717   |                   |  |                   | 2,371,416   |                   |  |   | 3,538,499  |   |  |   | 2,543,557   |  
|Selling, general and administrative                        |  |                   | 12,230,294  |                   |  |                   | 13,435,992  |                   |  |   | 13,171,112 |   |  |   | 15,728,183  |  
|Total costs and expenses                                   |  |                   | 18,446,460  |                   |  |                   | 19,564,187  |                   |  |   | 22,132,851 |   |  |   | 24,479,998  |  
|Loss from operations                                       |  |                   | (11,775,512 | )                 |  |                   | (12,996,239 | )                 |  |   | (6,411,762 | ) |  |   | (11,443,432 | )
|Loss on minority investment                                |  |                   |            |                   |  |                   |            |                   |  |   |           |   |  |   | (250,000    | )
|Interest income                                            |  |                   | 652,331     |                   |  |                   | 589,003     |                   |  |   | 883,360    |   |  |   | 771,982     |  
|Interest expense                                           |  |                   | (1,276,445  | )                 |  |                   | (1,421,219  | )                 |  |   | (394,944   | ) |  |   | (531,028    | )
|Net loss                                                   |  |                   | (12,399,626 | )                 |  |                   | (13,828,455 | )                 |  |   | (5,923,346 | ) |  |   | (11,452,478 | )
|Net loss per share of common stock 
    basic and diluted |  |                   | (0.97       | )                 |  |                   | (1.08       | )                 |  |   | (0.35      | ) |  |   | (0.68       | )

4.     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 effective 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 as of
October 1, 2002 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 the manufacturers. At the time of the acquisition,
these arrangements were expected to account for 60% of Timm
Medicals annual revenue growth.

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 12). 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.

5.     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 months). In addition, the Company assumed certain
outstanding options of Timm Medical, which are exercisable into
168,162 shares of Endocare common stock at $7.25 per share.
These options are valued at $1,936,000 using the Black-Scholes
option pricing model, of which $1,770,000 related to vested
options and $166,000 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 believes will be a valuable
assets as the Company divests non-core product lines and
redeploys existing resources in the area of cancer treatment.
Intangible assets relating to developed technology and trade
name are amortized over estimated useful lives of 15 years.

F-23



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 6).



| |                                     
| | ------------------------------------
| | 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 an exclusive
distributor of the Companys Cryocare Surgical Systems and
cryoprobes in certain states (see Note 12). 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 terms of the purchase agreement,
the $7,700,000 combined principal balance of the note, and the
earnest deposit (the Indebtedness), will be forgiven
upon the achievement of $12,000,000 in gross revenues by the
Mobile Businesses during the period between October 1, 2002
and December 31, 2005 (the Forgiveness Period).
During each of three measurement periods during the Forgiveness
Period, the Company shall forgive an amount equal to the product
obtained by multiplying the gross revenues of the Mobile
Businesses by .64166666. Any indebtedness that remains
outstanding at December 31, 2005 shall be paid to the
Company. 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

F-24



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 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 years ended December 31, 2002
and 2001 assuming the Timm Medical and Mobile Business
acquisitions occurred as of January 1, 2001:

|                                     |  |                        |             |      |  |   |             |  
|------------------------------------ |  | ---------------------- | ----------- | ---- |  | - | ----------- | -
|                                     |  |                       
|                                     |  | Year Ended December 31
|                                     |  |                       
|                                     |  | 2001                   |             | 2002
|                                     |  |                        |             |     
|Revenues                             |  | $                      | 29,468,000  |      |  | $ | 34,876,000  |  
|                                     |  |                        |             |      |  |   |             |  
|Net loss                             |  | $                      | (14,906,000 | )    |  | $ | (43,773,000 | )
|                                     |  |                        |             |      |  |   |             |  
|Net loss per share basic and diluted |  | $                      | (.81        | )    |  | $ | (1.82       | )
|                                     |  |                        |             |      |  |   |             |  
|Weighted average shares outstanding  |  |                        | 18,362,000  |      |  |   | 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, stock compensation expense related to
employee options assumed, elimination of intercompany profit
between the Company and the Mobile Businesses relating to the
purchase of certain Cryocare Surgical Systems by U.S.M.D., Ltd.
in 2001 and increased weighted average shares outstanding to
reflect the issuance of common stock in the Timm Medical
acquisition. The 2001 adjustments also reflect amortization of
goodwill in accordance with generally accepted accounting
principles applicable at that time.



| |                
| | ---------------
| | 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),

F-25



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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

consisting primarily of a portfolio of patents
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 13.

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
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 14).

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.

In March 2000, the Company acquired the rights to
the ENDOCARE.com domain name for 20,000 shares
of the Companys common stock valued at $435,000, which is
amortized over five years.

On January 3, 2000, the Company issued
warrants to purchase 40,000 shares of the Companys
common stock in conjunction with a patent licensing agreement.
The warrants have a term of five years, vest in four equal
installments annually beginning January 3, 2001, and are
exercisable at $9 per share. Based on the value of the warrants
calculated using the Black-Scholes option pricing model, the
patent was valued at $354,000 and is amortized over three years.



|   |                                              
|-- | ---------------------------------------------
|6. | 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, the Companys Board of
Directors 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 sale of cardiac-related
product manufacturing operations and license of related
technology, the closure of the Timm Medical manufacturing
facility and the divestiture of 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

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 $2,1500,000 in cash. Assets sold include developed
technology, intellectual property, customer lists, production
equipment and Dura II inventory. The sale resulted in a
loss of $106,000 in the second quarter of 2003.



| |                                                   
| | --------------------------------------------------
| | 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
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 receive payments
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. Total consideration is payable $2,500,000 at the
purchase date, plus three equal quarterly installments of
$2,500,000 before December 31, 2003. The Company is also
required to provide 315 hours of consulting for the purpose
of technology transfer and training assistance to be completed
within three to nine months of the sale and to attend quarterly
and annual technical update meetings through 2014. The royalty
stream decreases from 10% to 3% of net sales from the
SurgiFrostTM system during the period 2004 to 2012.

Since the performance requirements are
perfunctory in nature and CryoCaths sole remedy, in the
event of non-compliance, is reperformance of the required
services, the Companys ability to receive the full
consideration is not contingent upon the completion of such
services. 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 approximately $10,000,000. The
royalty payments will be recorded in the periods earned.



| |                   
| | ------------------
| | 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. With the exception of
certain marketing and financial functions, all operations were
transferred to the Companys Irvine, California,
headquarters in June 2003. 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 $998,000 in property and equipment
that 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

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

useful life of the assets to be abandoned to
amortize their carrying value, less estimated salvage, through
the scheduled abandonment date of April 2004. The Company is in
the process of evaluating a manufacturing strategy for the Timm
Medical product lines for future periods.



| |                                     
| | ------------------------------------
| | 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
$1,388,000 on the date of sale.



| |                                     
| | ------------------------------------
| | 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 was discontinued 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.

In accordance with SFAS No. 142, the
Company has engaged an independent firm to perform an interim
goodwill impairment test to determine the effect of the
partnership dissolutions on the recoverability of the goodwill
from the USMD acquisition. Based on a preliminary review of test
results, management does not anticipate that a charge will be
taken for goodwill impairment associated with its aggregate
interest in the partnerships acquired from USMD.

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|7. | Balance Sheet Supplemental
    Information

|                           |                                               |                                       |           |            |           |   |           |            |            | 
|-------------------------- | --------------------------------------------- | ------------------------------------- | --------- | ---------- | --------- | - | --------- | ---------- | ---------- | 
|                           |                                               |                                      
|                           |                                               | December 31                          
|                           |                                               |                                      
|                           |                                               | 2001                                  |           | 2002      
|                           |                                               |                                       |           |           
|                           |                                               | Restated                              |           |           
|Inventories:               |                                               |                                       |           |            |           |   |           |           
|                           | Raw materials                                 |                                       | $         | 1,218,778  |           |   | $         | 1,391,161  |           
|                           | Work in process                               |                                       |           | 501,687    |           |   |           | 176,011    |           
|                           | Finished goods                                |                                       |           | 409,332    |           |   |           | 2,924,470  |           
|                           |                                               |                                       |           |            |           |   |           |           
|                           |                                               | Total inventories                     |           | $          | 2,129,797 |   |           | $          | 4,491,642  | 
|                           |                                               |                                       |           |            |           |   |           |           
|Property and equipment:    |                                               |                                       |           |            |           |   |           |           
|                           | Equipment                                     |                                       | $         | 1,644,597  |           |   | $         | 5,498,473  |           
|                           | Cryosurgical systems placed at customer sites |                                       |           | 1,194,407  |           |   |           | 4,260,653  |           
|                           | Furniture and fixtures                        |                                       |           | 352,834    |           |   |           | 1,118,852  |           
|                           | Leasehold improvements                        |                                       |           | 100,034    |           |   |           | 487,812    |           
|                           |                                               |                                       |           |            |           |   |           |           
|                           |                                               | Total property and equipment, at cost |           |            | 3,291,872 |   |           |            | 11,365,790 | 
|                           | Accumulated depreciation and amortization     |                                       |           | (1,542,746 | )         |   |           | (3,121,097 | )         
|                           |                                               |                                       |           |            |           |   |           |           
|                           |                                               | Property and equipment, net           |           | $          | 1,749,126 |   |           | $          | 8,244,693  | 
|                           |                                               |                                       |           |            |           |   |           |           
|Amortizable intangibles:   |                                               |                                       |           |            |           |   |           |           
|                           | Trade name                                    |                                       | $         |           |           |   | $         | 500,000    |           
|                           | Domain name                                   |                                       |           | 435,000    |           |   |           | 435,000    |           
|                           | Covenant not to compete                       |                                       |           |           |           |   |           | 592,500    |           
|                           | Patents                                       |                                       |           | 770,494    |           |   |           | 5,734,733  |           
|                           | Developed technology                          |                                       |           |           |           |   |           | 10,000,000 |           
|                           |                                               |                                       |           |            |           |   |           |           
|                           |                                               | Total intangibles                     |           |            | 1,205,494 |   |           |            | 17,262,233 | 
|                           | Accumulated amortization                      |                                       |           | (549,120   | )         |   |           | (1,498,910 | )         
|                           |                                               |                                       |           |            |           |   |           |           
|                           | Amortizable intangibles, net                  |                                       | $         | 656,374    |           |   | $         | 15,763,323 |           
|                           |                                               |                                       |           |            |           |   |           |           
|Other accrued liabilities: |                                               |                                       |           |            |           |   |           |           
|                           | Professional fees                             |                                       | $         | 25,935     |           |   | $         | 277,617    |           
|                           | State and local taxes                         |                                       |           | 741,592    |           |   |           | 2,193,548  |           
|                           | Litigation reserve                            |                                       |           |           |           |   |           | 1,500,000  |           
|                           | Deferred revenue                              |                                       |           | 118,750    |           |   |           | 1,081,566  |           
|                           | Warranty reserves                             |                                       |           | 175,000    |           |   |           | 431,947    |           
|                           | Discounts payable to distributor              |                                       |           |           |           |   |           | 557,890    |           
|                           | Other                                         |                                       |           | 323,801    |           |   |           | 1,285,135  |           
|                           |                                               |                                       |           |            |           |   |           |           
|                           |                                               | $                                     | 1,385,078 |            |           | $ | 7,327,703 |           
|                           |                                               |                                       |           |            |           |   |           |           



|   |     
|-- | ----
|8. | Debt



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

In June and July 1999, the Company received
$8 million 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,

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 million from the sale of additional 7% convertible
debentures, of which $0.5 million of these debentures were
converted into 74,074 shares of the Companys common
stock during the fourth quarter of 2000, $1 million of
these debentures were converted into 148,148 shares of the
Companys common stock during the first quarter of 2001,
$4.2 million of these debentures were converted into
622,222 shares of the Companys common stock during
the second quarter of 2001, and the final $2.3 million 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 million 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 million in convertible debentures if the closing bid
price for the common stock as listed was more than $9 to $10 per
share for both (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 million 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.

9.     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 to the underwriters in
the public offering. The Company raised $78.2 million in
proceeds through the public offering before deducting
commissions and offering expenses of $5.6 million.

Private
Placements

In November 2000, the Company sold
1,509,440 shares of its common stock at a price of $13.25
per share in a private placement. In addition, warrants to
purchase up to an aggregate of 188,680 shares of the

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Companys common stock were issued to the
investors at an exercise price of $13.9125 per share. The
warrants are exercisable for a term of five years from the date
of issuance. After transaction fees, legal, accounting, filing
fees and other associated expenses of approximately $1,667,000,
the net contribution to the Companys capital was
approximately $18,350,000.

10.     Equity
Incentive Plans

Stock
Options

At December 31, 2002, 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. A total of
2,503,140 shares of common stock have been reserved for
issuance under the 1995 Stock Plan, subject to an automatic
annual share increase to which the number of shares available
for issuance under the plan will automatically increase on the
first trading day of each calendar year by 3% of the total
number of shares of the Companys common stock outstanding
at the end of the preceding calendar year, to a maximum of
1,000,000 shares each year. As of December 31, 2002,
options to purchase a total of 5,688,800 shares of the
Companys common stock have been granted under the 1995
Stock Plan.

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. A
total of 300,000 shares of common stock have been reserved
for issuance under the Director Plan. As of December 31,
2002, options to purchase a total of 200,000 shares of the
Companys common stock have been granted under the Director
Plan.

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. Up to
435,000 common shares may be issued upon the exercise of the
options under the 2002 Plan, which expires June 24, 2012,
unless earlier terminated in accordance with plan provisions.
The 2000 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. A total of 435,000 shares of common stock have
been reserved for issuance under the 2002 Plan. At
December 31, 2002, options to purchase a total of
435,000 shares of the Companys common stock have been
granted under the 2002 Plan.

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 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 13 
Employment and Severance Agreements.

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

|                               |  |                        |           |                |  |           |       |                |  |           |           |                |  |   |       |  |  |  |           |   |  |   |       | 
|------------------------------ |  | ---------------------- | --------- | -------------- |  | --------- | ----- | -------------- |  | --------- | --------- | -------------- |  | - | ----- |  |  |  | --------- | - |  | - | ----- | 
|                               |  |                       
|                               |  | Year Ended December 31
|                               |  |                       
|                               |  |                        |           |                |  |          
|                               |  | 2000                   |           | 2001           |  | 2002     
|                               |  |                        |           |                |  |          
|                               |  |                        |           | 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    
|                               |  |                        |           |                |  |           |       |                |  |           |           |               
|                               |  | Restated               |           | Restated       |  | Restated  |       | Restated       |  | Restated  |           |               
|Outstanding, beginning of year |  |                        | 3,005,854 |                |  | $         | 2.23  |                |  |           | 2,743,293 |                |  | $ | 3.37  |  |  |  | 2,700,057 |   |  | $ | 6.70  | 
|Granted                        |  |                        | 428,500   |                |  |           | 11.09 |                |  |           | 1,041,000 |                |  |   | 11.45 |  |  |  | 1,145,507 |   |  |   | 11.90 | 
|Cancelled                      |  |                        | (187,669  | )              |  |           | 5.67  |                |  |           | (136,282  | )              |  |   | 6.43  |  |  |  | (272,649  | ) |  |   | 10.99 | 
|Exercised                      |  |                        | (503,392  | )              |  |           | 2.18  |                |  |           | (947,954  | )              |  |   | 2.28  |  |  |  | (419,488  | ) |  |   | 4.52  | 
|Outstanding, end of year       |  |                        | 2,743,293 |                |  | $         | 3.37  |                |  |           | 2,700,057 |                |  | $ | 6.70  |  |  |  | 3,153,427 |   |  | $ | 8.50  | 

|               |               |                     |         |                     |           |                |            |                   |            |                |      |       |      |  |         |         |           |   |      |       |      | 
|-------------- | ------------- | ------------------- | ------- | ------------------- | --------- | -------------- | ---------- | ----------------- | ---------- | -------------- | ---- | ----- | ---- |  | ------- | ------- | --------- | - | ---- | ----- | ---- | 
|               |               |                     |         |                     |           |               
|               |               | 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, 2002   |         | (Number of Years)   |           | Exercise Price |            | December 31, 2002 |            | Exercise Price
|               |               |                     |         |                     |           |                |            |                   |            |               
|$ 0.18 -  2.00 |               |                     | 471,084 |                     |           |                | 3.30 years |                   |            | $              | 0.45 |       |      |  | 471,084 |         |           | $ | 0.45 |      
|               |               | 2.03 -  4.00        |         |                     | 476,060   |                |            |                   | 5.51       |                |      |       | 2.65 |  |         |         | 467,957   |   |      |       | 2.65 | 
|               |               | 4.50 -  6.19        |         |                     | 422,783   |                |            |                   | 7.75       |                |      |       | 5.11 |  |         |         | 213,010   |   |      |       | 5.10 | 
|               |               | 6.93 -  9.00        |         |                     | 150,976   |                |            |                   | 7.47       |                |      |       | 8.33 |  |         |         | 111,741   |   |      |       | 8.43 | 
|               | 11.75 - 13.88 |                     |         | 1,186,956           |           |                |            | 8.84              |            |                |      | 12.42 |      |  |         | 214,300 |           |   |      | 13.17 |     
|               | 14.00 - 21.30 |                     |         | 431,864             |           |                |            | 8.72              |            |                |      | 16.40 |      |  |         | 101,281 |           |   |      | 16.40 |     
|               |               |                     |         |                     |           |                |            |                   |            |                |      |       |      |  |         |         |           |   |      |      
|               |               | 0.18 - 21.30        |         |                     | 3,153,427 |                |            |                   | 7.26 years |                |      | $     | 8.50 |  |         |         | 1,579,373 |   |      | $     | 5.03 | 
|               |               |                     |         |                     |           |                |            |                   |            |                |      |       |      |  |         |         |           |   |      |      

The weighted average fair value of the
Companys options at the grant date was approximately $7.27
in 2000, $7.58 in 2001, and $9.54 in 2002.

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:

|                        |  |      |         |      |  |      |         |   |  |  |         |  
|----------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  |  | ------- | -
|                        |  | 2000 |         | 2001 |  | 2002
|                        |  |      |         |      |  |     
|Stock volatility        |  |      | .8      |      |  |      | .8      |   |  |  | 1.14    |  
|Risk-free interest rate |  |      | 6.1     | %    |  |      | 4.8     | % |  |  | 4.3     | %
|Expected life in years  |  |      | 5 years |      |  |      | 5 years |   |  |  | 5 years |  
|Stock dividend yield    |  |      |        |      |  |      |        |   |  |  |        |  

During 2000, 2001 and 2002, the Company incurred
employment taxes associated with the exercise of employee stock
options and loan forgiveness totaling $117,000 (restated),
$182,000 (restated) and $870,000,

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

respectively. Employment related taxes payable at
December 31, 2001 and 2002 were $299,000 and $1,169,000,
respectively (included in accrued compensation).



| |         
| | --------
| | Warrants

The Company issued warrants in conjunction with
debt financing transactions, underwriting agreements, patent
licenses and service contracts. Warrants to purchase 176,506 and
50,390 shares of the Companys common stock were
issued in 1999 and 2000, respectively. No warrants were granted
in 2001 and 2002. 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,
2002, the Company had warrants outstanding to purchase 110,000
shares of the Companys common stock, of which 77,500 are
exercisable. During 2000, 2001 and 2002, warrants to purchase
231,247, 106,896 and 30,000 shares of common stock,
respectively, were exercised.

The fair value of each warrant is estimated on
the date of grant using the Black-Scholes option pricing model,
with the assumptions similar to option grants above. The Company
amortizes the fair values of warrants associated with non-equity
transactions to expense over the service period of the related
warrants. Warrants issued in connection with equity transactions
are recorded to additional paid in capital. Compensation expense
recorded in 2000 for consulting related warrants totaled
$390,000. No expense was incurred in 2001 and 2002. The weighted
average fair value of the Companys warrants at the grant
date was approximately $10.97 in 2000.

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 9). These warrants have a five-year
term and are immediately exercisable at $13.91 per share. 12,500
shares were exercised in 2001. At December 31, 2002,
176,180 warrants remain outstanding.

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.

F-33



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

11.     Income
Taxes

The Company reported no income tax expense for
each of the three years in the period ended December 31,
2002 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:

|                                            |                                                          |                         |            |             |   |  |            |             |   | 
|------------------------------------------- | -------------------------------------------------------- | ----------------------- | ---------- | ----------- | - |  | ---------- | ----------- | - | 
|                                            |                                                          | 2001                    |            | 2002       
|                                            |                                                          |                         |            |            
|                                            |                                                          | Restated                |            |            
|Deferred tax assets (liabilities):          |                                                          |                         |            |             |   |  |            |            
|                                            | Investment valuation reserves                            |                         | $          | 106,000     |   |  | $          | 1,074,000   |  
|                                            | Basis difference in intangible assets                    |                         |            | 33,000      |   |  |            | (1,314,000  | )
|                                            | Property and equipment allowances and depreciation       |                         |            | (43,000     | ) |  |            | 570,000     |  
|                                            | Inventory obsolescence and related allowances            |                         |            | 317,000     |   |  |            | 1,087,000   |  
|                                            | Accounts receivable allowances and revenue
    deferrals |                         |            | 1,463,000   |   |  |            | 2,951,000   |  
|                                            | Other accrued liabilities                                |                         |            | 546,000     |   |  |            | 2,462,000   |  
|                                            | Accrued compensation                                     |                         |            | 196,000     |   |  |            | 654,000     |  
|Net operating loss and credit carryforwards |                                                          |                         | 15,145,000 |             |   |  | 23,274,000 |            
|                                            |                                                          |                         |            |             |   |  |            |            
|                                            |                                                          |                         | 17,763,000 |             |   |  | 30,758,000 |            
|                                            | Valuation allowance                                      |                         |            | (17,763,000 | ) |  |            | (30,758,000 | )
|                                            |                                                          |                         |            |             |   |  |            |            
|                                            |                                                          | Net deferred tax assets |            | $           |  |  |            | $           |  | 
|                                            |                                                          |                         |            |             |   |  |            |            

Due to continuing operating losses, the valuation
allowance increased by $4,617,000 (restated) and $8,877,000
during the years ended December 31, 2001 and 2002,
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 acquisition of Timm Medical. 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, 2001
and 2002.

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.

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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,
|                                |                    |                         
|                                |                    | 2000                     |            | 2001     |  | 2002
|                                |                    |                          |            |          |  |     
|                                |                    | Restated                 |            | Restated |  |     
|Computed expected tax benefit   |                    | $                        | (4,702,000 | )        |  | $    | (3,894,000 | ) |  | $ | (14,275,000 | )
|Nondeductible expenses          |                    |                          | 379,000    |          |  |      | 177,000    |   |  |   | 244,000     |  
|Goodwill impairment             |                    |                          |           |          |  |      |           |   |  |   | 6,115,000   |  
|Increase in valuation allowance |                    |                          | 4,323,000  |          |  |      | 3,655,000  |   |  |   | 7,916,000   |  
|Other                           |                    |                          |           |          |  |      | 62,000     |   |  |   |            |  
|                                |                    |                          |            |          |  |      |            |   |  |   |             |  
|                                | Actual tax expense |                          | $          |         |  |      | $          |  |  |   | $           |  | 
|                                |                    |                          |            |          |  |      |            |   |  |   |             |  

As of December 31, 2002, the Company has
federal and state net operating loss carryforwards of
$59,162,000 and $30,726,000, 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 $435,000 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.

12.     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 terms of the related
agreements included an equity investment by the Company in
Sanarus totaling $300,000, which represents 200,041
Series A voting convertible Preferred Shares or 6.8% of the
total outstanding voting securities at the investment date
(included in investments and other assets). 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 Supply and License
Agreement). The 1999 Supply and License Agreement provided
Sanarus an exclusive, royalty-free, world-wide 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 Supply and
License 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 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 with
Sanarus in which Sanarus issued to the Company a convertible
promissory note in the aggregate amount of $600,000 and a
warrant to purchase common shares in Sanarus with an aggregate
exercise price of up to $300,000. The $600,000 bridge loan and
related interests were canceled in exchange for 908,025 shares
of Series C voting Preferred Stock upon completion of a
$19.1 million equity

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

financing by Sanarus in October 2003. 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, 2001 and
2002 to 2.7% on an as converted basis (7.9% on an as converted,
fully diluted basis) at October 31, 2003. The investment is
recorded at cost since the Company does not have significant
influence over the operations of Sanarus. In addition, in June
2001, the Company and Sanarus entered into a license agreement
(the 2001 License Agreement) amending the terms and
conditions of the 1999 Supply and License Agreement to provide
for, among other things: (i) the termination of
Sanarus exclusive, royalty-free, world-wide
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 that was
granted in the 1999 Supply and License 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;
(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; (iv) various additional licensing terms,
including reciprocal rights of first refusal with respect to
certain new cryosurgical technology developed by the other
party; and (v) the amendment or deletion of certain terms
set forth in the 1999 Supply and License Agreement.

During 2000, 2001 and 2002, the Company provided
manufacturing services to Sanarus pursuant to the 1999 Supply
and License Arrangement and 2001 License Agreement. Under the
arrangement, Sanarus contracted with the Company to manufacture
customized cryoprobes for the treatment of breast diseases at
cost plus a profit margin. Certain proprietary components were
purchased directly from Sanarus and were included in cost of
revenues. Revenues and cost of revenues totaled $93,000 and
$17,000, respectively in 2001 and $333,000 and $182,000,
respectively in 2002. There were no transactions with Sanarus in
2000. Effective December 2002, the Company is no longer
supplying or manufacturing 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 current 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.



| |                               
| | ------------------------------
| | 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 $525,000, $4,105,000 and $2,257,000 in 2000, 2001 and
2002, respectively. As discussed in Note 5, the distributor
agreement was terminated upon the Companys acquisition of
certain Mobile Businesses from USMD on September 30, 2002.
As of December 31, 2001,

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

U.S.M.D., Ltd. accounted for approximately
$905,000 of net accounts receivable. No amounts were due from
U.S.M.D., Ltd. at December 31, 2002.

The carrying value of the investment in U.S.
Medical Development, Inc. at December 31, 2001 and 2002 was
$2,837,000 and $510,000, respectively.



| |         
| | --------
| | 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 6, the
distribution agreement was terminated in April 2003 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

F-37



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

warranty policy, and in some cases for unsold
inventory within a limited time period upon the termination of
the distribution agreement.

13.     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 non-cancelable operating leases consist
of the following:

|                        |  |   |           | 
|----------------------- |  | - | --------- | 
|Year ending December 31 |  |   |           | 
|2003                    |  | $ | 947,182   | 
|2004                    |  |   | 671,622   | 
|2005                    |  |   | 498,374   | 
|2006                    |  |   | 479,804   | 
|2007                    |  |   | 85,718    | 
|                        |  |   |           | 
|                        |  | $ | 2,682,700 | 
|                        |  |   |           | 



| |                                    
| | -----------------------------------
| | 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 40% 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 a $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 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.

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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 options to be granted
between September 4, 2003 and November 3, 2003. The
replacement options were issued on October 30, 2003, have
an exercise price of $4.50 per share, which is equal to the fair
market value of the common stock as of October 30, 2003,
and are fully vested and exercisable upon grant, subject to
compliance with applicable federal and state securities laws.
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 and he is entitled to receive
the payments due under the Qualified Termination provisions.

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.

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). The former Timm Medical employees continue to be
covered under the Timm Medical Plan. Management has combined the
two plans effective September 30, 2003. Employer matching
contributions to the Endocares Plan totaled approximately
$135,732 and $153,846 for the years ended December 31, 2000
and 2001, respectively. No matching contribution was made in
2002.

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 5). 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

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 fair value of the shares
to be surrendered. That ruling became an appealable final order
and judgment on October 10, 2003 and the Company has filed
a notice of appeal.

In November 2002, the Company was named as a
defendant, together with certain other current and former
officers, including 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.

In December 2002, the Company and certain of its
officers and directors were named as defendants in a purported
derivative action filed 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.

Plaintiffs in the two class-action 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 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 against a former employee who was terminated in
December 2002 under his employment agreement for misconduct that
was demonstrably and materially injurious to the Company,
including disclosure of confidential information relevant to a
proposed business transaction that ultimately did not occur. The
employee counterclaimed alleging that the Company defamed him,
failed to provide his employment file, and violated the federal
Sarbanes-Oxley whistleblower and Minnesota whistleblower laws.
Discovery is ongoing and the arbitration is scheduled for
February 23, 2004. The Company will vigorously defend such
action.

In March 2003, the Company was notified by the
United States Department of Labor (the DOL) of a
letter of complaint by the former employee against the Company
and certain former officers, one of whom was also a former board
member, alleging improper retaliation against the former
employee. The Company is cooperating fully with this preliminary
inquiry being conducted by the DOL.

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.

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 the purported class action lawsuits,
will not have a material adverse effect on its consolidated
financial condition, results of operations or cash flows. At
December 31, 2002, 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.

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.

During 2002, the Company incurred $1,148,000 in
legal, accounting and professional fees (included in selling,
general and administrative expenses) related to the
investigation and litigation matters discussed above. Unpaid
professional fees of $414,000 were included in accounts payable
and other accrued liabilities at December 31, 2002.

14.     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 August 1998, the Company extended full
recourse loans to five employees totaling $87,500 which were due
at the earlier of the second anniversary or the employment
termination date. The loans bore interest at 5.41%. In the first
quarter of 2001, the Company forgave these loans and recorded
the outstanding principal and interest as a compensation charge
(included in selling, general and administrative expense).

In November 1999, the Company received a full
recourse promissory note for $1,028,125 in connection with the
sale of 175,000 shares of its common stock to the Companys
then-Senior Vice President, Sales and Marketing. The note bears
interest at 5.99% per annum, payable annually, and the principal
was payable in September 2003. The shares were sold at the fair
market value of the common stock on the date of sale. The
Company also agreed to forgive principal on the note ratably
over four years subject to that individual remaining an employee
of the Company. The outstanding principal balance at
December 31, 2001 and 2002 totaled $471,292 and $214,292
(restated), respectively, and is recorded as a reduction in
stockholders equity. Principal forgiven totaled $257,000
(restated) in each of the years ended December 31,
2000, 2001 and 2002, and the forgiveness was recorded as a
compensation charge (included in selling, general and
administrative expense). Interest has not been recorded on the
note. In August 2003, the individuals employment with the
Company was terminated.

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

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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

15.     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
    (restated) 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 product 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, 2001 and 2002 was $150,000 and
    $72,000, respectively.                                                                                                                                                                                                                                 

F-42



---



##### 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, 2002
and 2001. See Note 3 for discussion regarding restatement
adjustments.

|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |            |           | 
|-------------------------------------------------------- | ------------------------------------- | ------------------------ | ---------- | ---------- | --------- | ---------- | ---------- | ---------- | --------- | ------------- | ---------- | ------------- | --------- | ------------ | ---------- | ------------ | --------- | - | ---------- | ---------- | --------- | - | ---------- | ---------- | --------- | - | --------- | ---------- | --------- | - | ---------- | ---------- | --------- | 
|                                                         |                                       | As                       |            |            |           | As         |            |            |           | As            |            |               |           | As           |            |             
|                                                         |                                       | Previously               |            |            |           | Previously |            |            |           | Previously    |            |               |           | Previously   |            |             
|                                                         |                                       | Reported                 |            | Restated   |           | Reported   |            | Restated   |           | Reported      |            | Restated      |           | Reported     |            | Restated    
|                                                         |                                       | Quarter                  |            | Quarter    |           | Quarter    |            | Quarter    |           | Quarter       |            | Quarter       |           | Quarter      |            | Quarter     
|                                                         |                                       | Ended                    |            | Ended      |           | Ended      |            | Ended      |           | Ended         |            | Ended         |           | Ended        |            | Ended       
|                                                         |                                       | March 31,                |            | March 31,  |           | June 30,   |            | June 30,   |           | September 30, |            | September 30, |           | December 31, |            | December 31,
|                                                         |                                       | 2001                     |            | 2001       |           | 2001       |            | 2001       |           | 2001          |            | 2001          |           | 2001         |            | 2001        
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |             
|Revenues                                                 |                                       | $                        | 2,755,587  |            |           | $          | 2,505,587  |            |           | $             | 3,537,849  |               |           | $            | 3,233,849  |              |           | $ | 4,214,766  |            |           | $ | 3,783,075  |            |           | $ | 5,212,887 |            |           | $ | 3,514,055  |           
|Costs and expenses:                                      |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|                                                         | Cost of revenues                      |                          |            | 1,173,890  |           |            |            | 1,364,946  |           |               |            | 1,272,403     |           |              |            | 1,432,119    |           |   |            | 1,289,414  |           |   |            | 1,580,084  |           |   |           | 1,687,533  |           |   |            | 1,831,109  |          
|                                                         | Research and development              |                          |            | 902,819    |           |            |            | 648,898    |           |               |            | 923,445       |           |              |            | 732,416      |           |   |            | 766,417    |           |   |            | 526,029    |           |   |           | 945,818    |           |   |            | 636,214    |          
|                                                         | Selling, general and administrative   |                          |            | 3,024,120  |           |            |            | 3,091,842  |           |               |            | 3,440,374     |           |              |            | 4,402,006    |           |   |            | 3,527,527  |           |   |            | 4,397,892  |           |   |           | 3,179,091  |           |   |            | 3,836,443  |          
|                                                         | Goodwill impairment and other charges |                          |            |           |           |            |            |           |           |               |            |              |           |              |            |             |           |   |            |           |           |   |            |           |           |   |           |           |           |   |            |           |          
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|                                                         |                                       | Total costs and expenses |            |            | 5,100,829 |            |            |            | 5,105,686 |               |            |               | 5,636,222 |              |            |              | 6,566,541 |   |            |            | 5,583,358 |   |            |            | 6,504,005 |   |           |            | 5,812,442 |   |            |            | 6,303,766 | 
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|Loss from operations                                     |                                       |                          | (2,345,242 | )          |           |            | (2,600,099 | )          |           |               | (2,098,373 | )             |           |              | (3,332,692 | )            |           |   | (1,368,592 | )          |           |   | (2,720,930 | )          |           |   | (599,555  | )          |           |   | (2,789,711 | )         
|Loss on minority investment                              |                                       |                          |           |            |           |            |           |            |           |               |           |               |           |              | (250,000   | )            |           |   |           |            |           |   |           |            |           |   |          |            |           |   |           |           
|Interest income (expense), net                           |                                       |                          | 3,074      |            |           |            | (34,429    | )          |           |               | 34,467     |               |           |              | (563       | )            |           |   | 110,546    |            |           |   | 46,996     |            |           |   | 340,329   |            |           |   | 228,950    |           
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|Loss before minority interest                            |                                       |                          | (2,342,168 | )          |           |            | (2,634,528 | )          |           |               | (2,063,906 | )             |           |              | (3,583,255 | )            |           |   | (1,258,046 | )          |           |   | (2,673,934 | )          |           |   | (259,226  | )          |           |   | (2,560,761 | )         
|Minority interests                                       |                                       |                          |           |            |           |            |           |            |           |               |           |               |           |              |           |              |           |   |           |            |           |   |           |            |           |   |          |            |           |   |           |           
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|Net loss                                                 |                                       | $                        | (2,342,168 | )          |           | $          | (2,634,528 | )          |           | $             | (2,063,906 | )             |           | $            | (3,583,255 | )            |           | $ | (1,258,046 | )          |           | $ | (2,673,934 | )          |           | $ | (259,226  | )          |           | $ | (2,560,761 | )         
|                                                         |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|Net income (loss) per share of common stock:             |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|                                                         | Basic                                 |                          | $          | (0.15      | )         |            | $          | (0.17      | )         |               | $          | (0.13         | )         |              | $          | (0.23        | )         |   | $          | (0.07      | )         |   | $          | (0.16      | )         |   | $         | (0.01      | )         |   | $          | (0.14      | )        
|                                                         | Diluted                               |                          |            | (0.15      | )         |            |            | (0.17      | )         |               |            | (0.13         | )         |              |            | (0.23        | )         |   |            | (0.07      | )         |   |            | (0.16      | )         |   |           | (0.01      | )         |   |            | (0.14      | )        
|Weighted average shares of common stock
    outstanding: |                                       |                          |            |            |           |            |            |            |           |               |            |               |           |              |            |              |           |   |            |            |           |   |            |            |           |   |           |            |           |   |            |           
|                                                         | Basic                                 |                          |            | 15,154,000 |           |            |            | 15,154,000 |           |               |            | 15,602,000    |           |              |            | 15,602,000   |           |   |            | 16,921,000 |           |   |            | 16,921,000 |           |   |           | 18,833,474 |           |   |            | 18,833,474 |          
|                                                         | Diluted                               |                          |            | 15,154,000 |           |            |            | 15,154,000 |           |               |            | 15,602,000    |           |              |            | 15,602,000   |           |   |            | 16,921,000 |           |   |            | 16,921,000 |           |   |           | 18,833,474 |           |   |            | 18,833,474 |          

|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |            |            | 
|-------------------------------------------------------- | ------------------------------------- | ------------------------ | --------- | ------------- | --------- | ------------- | ---------- | ------------- | ---------- | ------------- | ---------- | ------------- | ---------- | - | ---------- | ---------- | ---------- | - | ---------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | 
|                                                         |                                       | As Previously            |           |               |           | As Previously |            |               |            |               |            |              
|                                                         |                                       | Reported                 |           | Restated      |           | Reported      |            | Restated      |            |               |            |              
|                                                         |                                       | Quarter Ended            |           | Quarter Ended |           | Quarter Ended |            | Quarter Ended |            | Quarter Ended |            | Quarter Ended
|                                                         |                                       | March 31,                |           | March 31,     |           | June 30,      |            | June 30,      |            | September 30, |            | December 31, 
|                                                         |                                       | 2002                     |           | 2002          |           | 2002          |            | 2002          |            | 2002          |            | 2002         
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |              
|Revenues                                                 |                                       | $                        | 7,773,064 |               |           | $             | 6,640,026  |               |            | $             | 11,378,006 |               |            | $ | 8,785,887  |            |            | $ | 8,381,793  |            |            | $ | 7,108,719   |           
|Costs and expenses:                                      |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|                                                         | Cost of revenues                      |                          |           | 2,760,755     |           |               |            | 3,304,736     |            |               |            | 3,437,194     |            |   |            | 4,188,170  |            |   |            | 4,525,786  |            |   |             | 4,465,704  |           
|                                                         | Research and development              |                          |           | 947,867       |           |               |            | 734,575       |            |               |            | 1,041,191     |            |   |            | 827,279    |            |   |            | 489,890    |            |   |             | 848,122    |           
|                                                         | Selling, general and administrative   |                          |           | 4,214,632     |           |               |            | 6,407,163     |            |               |            | 5,842,309     |            |   |            | 9,259,520  |            |   |            | 8,408,328  |            |   |             | 9,694,431  |           
|                                                         | Goodwill impairment and other charges |                          |           |              |           |               |            |              |            |               |            |              |            |   |            |           |            |   |            |           |            |   |             | 20,311,293 |           
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|                                                         |                                       | Total costs and expenses |           |               | 7,923,254 |               |            |               | 10,446,474 |               |            |               | 10,320,694 |   |            |            | 14,274,969 |   |            |            | 13,424,004 |   |             |            | 35,319,550 | 
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|Loss from operations                                     |                                       |                          | (150,190  | )             |           |               | (3,806,448 | )             |            |               | 1,057,312  |               |            |   | (5,489,082 | )          |            |   | (5,042,211 | )          |            |   | (28,210,831 | )         
|Loss on minority investment                              |                                       |                          |          |               |           |               |           |               |            |               | (250,000   | )             |            |   |           |            |            |   |           |            |            |   |            |           
|Interest income                                          |                                       |                          | 316,163   |               |           |               | 333,167    |               |            |               | 327,244    |               |            |   | 284,030    |            |            |   | 317,314    |            |            |   | 78,832      |           
|Interest expense                                         |                                       |                          |          |               |           |               |           |               |            |               |           |               |            |   |           |            |            |   |           |            |            |   | (6,839      | )         
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|Income (loss) before minority interest                   |                                       |                          | 165,973   |               |           |               | (3,473,281 | )             |            |               | 1,134,556  |               |            |   | (5,205,052 | )          |            |   | (4,724,897 | )          |            |   | (28,138,838 | )         
|Minority interests                                       |                                       |                          |          |               |           |               |           |               |            |               |           |               |            |   |           |            |            |   |           |            |            |   | 443,678     |           
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|Net income (loss)                                        |                                       | $                        | 165,973   |               |           | $             | (3,473,281 | )             |            | $             | 1,134,556  |               |            | $ | (5,205,052 | )          |            | $ | (4,724,897 | )          |            | $ | (28,582,516 | )         
|                                                         |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|Net income (loss) per share of common stock:             |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|                                                         | Basic                                 |                          | $         | 0.01          |           |               | $          | (0.15         | )          |               | $          | 0.05          |            |   | $          | (0.22      | )          |   | $          | (0.19      | )          |   | $           | (1.18      | )         
|                                                         | Diluted                               |                          |           | 0.01          |           |               |            | (0.15         | )          |               |            | 0.05          |            |   |            | (0.22      | )          |   | $          | (0.19      | )          |   | $           | (1.18      | )         
|Weighted average shares of common stock
    outstanding: |                                       |                          |           |               |           |               |            |               |            |               |            |               |            |   |            |            |            |   |            |            |            |   |             |           
|                                                         | Basic                                 |                          |           | 22,163,000    |           |               |            | 22,808,000    |            |               |            | 24,000,000    |            |   |            | 24,000,000 |            |   |            | 24,279,000 |            |   |             | 24,297,000 |           
|                                                         | Diluted                               |                          |           | 23,032,000    |           |               |            | 22,808,000    |            |               |            | 25,178,000    |            |   |            | 24,000,000 |            |   |            | 24,279,000 |            |   |             | 24,297,000 |           

F-43



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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 |  | (a)   |           |            |  | the End of
|                                                         |  | the Period     |         | Operations |  | Other |           | Deductions |  | the Period
|                                                         |  |                |         |            |  |       |           |            |  |           
|2000                                                     |  |                |         |            |  |       |           |            |  |            |         |  |  |   |          |   |  |   |           | 
|Allowance for Doubtful Receivables and Sales
    Returns |  | $              | 270,000 |            |  | $     | 379,885   |            |  | $          |        |  |  | $ | (243,246 | ) |  | $ | 406,639   | 
|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 | 



---



|    |  |                                                                                                                                                                    
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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-44



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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(6)    |             |  | 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(6)    |             |  | 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(7)    |             |  | 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(8)    |             |  | 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.                                                                                                                                                                    
|            | 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(2)    |             |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                      
|            | 10.1(2)  |             |  | Promissory Notes, dated August 8, 2001 and
    July 24, 2001, as subsequently amended, by Paul Mikus in
    favor of the Company.                                                                                                                                                                                                                                                                                                
|            | 10.2(2)  |             |  | Change in Employment Status and Settlement
    Agreement and Release, effective June 25, 2001, by and
    between the Company and William Hughes.                                                                                                                                                                                                                                                                                
|            | 10.3(2)  |             |  | Consulting and Confidentiality Agreement, dated
    June 1, 2001, by and between the Company and Michael
    Strauss, M.D.                                                                                                                                                                                                                                                                                                       
|            | 10.4(2)   |             |  | Note and Warrant Purchase Agreement, dated
    April 1, 2001, by and among the Company, Sanarus Medical,
    Inc. and specified purchasers and related Convertible Promissory
    Note and Warrant to Purchase Series B Preferred Stock,
    dated April 1, 2001.                                                                                                                                                                
|            | 10.5(2)  |             |  | Offer of Employment, effective February 16,
    2001, by and between the Company and Kevin Quilty.                                                                                                                                                                                                                                                                                                                               
|            | 10.6(2)  |             |  | Offer of Employment, effective September 22,
    2000, by and between the Company and David Battles.                                                                                                                                                                                                                                                                                                                             
|            | 10.7(2)  |             |  | Offer of Employment, effective August 14,
    2000, by and between the Company and Holly Williams.                                                                                                                                                                                                                                                                                                                               
|            | 10.8(2)  |             |  | Promissory Note, dated November 2, 1999, by
    Jerry Anderson in favor of the Company.                                                                                                                                                                                                                                                                                                                                          
|            | 10.9(2)  |             |  | Promissory Note cancellations between the Company
    and each of Paul Mikus, Vincent Cutarelli, Jay Eum and William
    Hughes.                                                                                                                                                                                                                                                                                                 
|            | 10.10(2) |             |  | Consulting Agreement, dated January 6, 1999,
    by and between the Company and Robert Byrnes.                                                                                                                                                                                                                                                                                                                                   



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##### Table of Contents



|            |            |             |  |                                                                                                                                                                                              
|----------- | ---------- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |            | Description
|            |            |            
|            | 10.11(2)  |             |  | Consulting Agreement, dated January 6, 1999,
    by and between the Company and Alan Kaganov.                                                                                                
|            | 10.12(2)   |             |  | Loan and Security Agreement, dated
    October 1, 1998, by and between the Company and Advanced
    Medical Procedures, LLC and related Revolving Promissory Note,
    dated October 1, 1998.
|            | 10.13(2)  |             |  | Guarantor Security Agreement, dated
    October 1, 1998, by and between the Company and Robert
    Byrnes.                                                                                   
|            | 10.14(2)   |             |  | Scientific Advisory Board Agreement, dated
    December 2, 1997, by and between the Company and Foundation
    Research, Inc.                                                                
|            | 10.15(2)  |             |  | Consulting Agreement, dated May 27, 1997, by
    and between the Company and Bob Byrnes.                                                                                                     
|            | 10.16(3)  |             |  | Offer of Employment, dated June 11,2001, by
    and between the Company and John V. Cracchiolo.                                                                                              
|            | 10.17(3)  |             |  | Compensation Agreement, dated June 25, 2001,
    by and between the Company and John V. Cracchiolo.                                                                                          
|            | 10.18(4)   |             |  | Global Supply and Market Access Agreement, dated
    September 21, 2001, by and between the Company and CryoCath
    Technologies, Inc.*                                                     
|            | 10.19(4)   |             |  | Distribution Agreement, dated September 25,
    2001, by and between the Company and Qualigen, Inc.*                                                                                         
|            | 10.20(9)   |             |  | Lease Agreement, dated November 26, 2001 by
    and between the Company and the Irvine Company.                                                                                              
|            | 10.21(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its directors.                                                                                                          
|            | 10.22(9)  |             |  | Form of Indemnification Agreement by and between
    the Company and its executive officers.                                                                                                 
|            | 10.23(10) |             |  | 1995 Director Option Plan (as amended and
    restated through March 2, 1999).                                                                                                               
|            | 10.24(13) |             |  | 1995 Stock Plan (as amended and restated through
    April 16, 2002).                                                                                                                        
|            | 10.25     |             |  | 2002 Supplemental Stock Plan.                                                                                                                                                                
|            | 10.26(5)  |             |  | Amended and Restated Stock Option Agreement (with
    Notice of Grant of Stock Option), dated November 26, 2001
    by and between the Company and John Cracchiolo.                          
|            | 10.27(7)   |             |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                           
|            | 10.28(8)   |             |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical Development,
    Inc. to the Company.                                                       
|            | 10.29     |             |  | Employment Agreement, effective as of May 1,
    2002, by and between the Company and Holly Williams.                                                                                        
|            | 10.30(12)  |             |  | Registration Rights Agreement, dated as of
    February 21, 2002, by and among the Company and the parties
    listed on Schedule A thereto.                                                 
|            | 10.31      |             |  | Registration Rights Agreement, dated as of
    May 28, 2002, by and between the Company and Cryomedical
    Sciences, Inc.                                                                   
|            | 10.32     |             |  | Letter Agreement, dated June 11, 1999, by
    and between the Company and Jerry Anderson                                                                                                     
|            | 10.33      |             |  | Blanket Purchase Agreement, effective
    April 1, 2002, by and between Timm Medical Technologies,
    Inc. and the U.S. Department of Veterans Affairs                                      
|            | 10.34     |             |  | 2002 Executive Separation Benefits Plan                                                                                                                                                      
|            | 16.1(11)   |             |  | Letter, dated November 17, 2003, from KPMG
    LLP regarding change in certifying accountant.                                                                                                
|            | 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 William J. Nydam.                                                                                                  
|            | 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 William J. Nydam.                                                                                                  
|            | 32.2       |             |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                                                               



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##### Table of Contents





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



| |   |                                                         
| | - | --------------------------------------------------------
| |  | Management contract or corporate 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, 2001.                                                
|   
|(4) | Previously filed on Form 10-Q for the
    quarter ended September 30, 2001.                                           
|   
|(5) | Previously filed with our Registration Statement
    on Form S-8 filed on January 31, 2002.                           
|   
|(6) | Previously filed on Form 10-Q for the
    quarter ended June 30, 2002.                                                
|   
|(7) | Previously filed on Form 8-K on
    August 16, 2002.                                                                  
|   
|(8) | Previously filed on Form 8-K on
    October 15, 2002.                                                                 
|   
|(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 22, 1999.                             
|    
|(11) | Previously filed with our preliminary proxy
    statement for the 2003 annual meeting filed on November 26,
    2003.
|    
|(12) | Previously filed with our Registration Statement
    on Form S-3 filed on May 15, 2002.                              
|    
|(13) | Previously filed with our definitive proxy
    statement for the 2002 annual meeting filed on April 30,
    2002.