**U.S. SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.20549**

 

**FORM 10-KSB**

 

**ý****                                ****ANNUAL REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE FISCAL YEARENDED DECEMBER 31, 2003**

 

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILENUMBER 0-32543**

 

**REFOCUS GROUP, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                       |   | **75-2910096**                       |
|--------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)     |   | (I.R.S. Employer Identification No.) |
|                                                               |   |                                 |
| **10300 North Central Expressway, Suite 104, Dallas, Texas**  |   | **75231**                            |
| (Address of principal executive offices)                           |   | (Zip Code)                           |

 

**Registrant’stelephone number, including area code:   214-368-0200**

 

(Formername or former address, if changed since last report)

 

**Securities registered pursuant to Section12(b) of the Act:   None**

 

**Securities registered pursuant to Section12(g) of the Act:**

 

| **Title of  each class**                 |
|------------------------------------------|
| Common Stock, par value $.0001 per share |

 

Check whether the issuer (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý  No  o

 

Check if disclosure ofdelinquent filers in response to Item 405 of Regulation S-B is not contained inthis form, and no disclosure will be contained, to the best of the issuer’sknowledge, in definite proxy or information statements incorporated by referencein Part III of the Form 10-KSB or any amendment to this Form10-KSB.  o

 

Issuer’s revenues for thefiscal year ended December 31, 2003 were $0.

 

On March 26, 2004, theaggregate value of voting stock held by non-affiliates of the registrant wasapproximately $7,862,000 For purposes of this computation, all officers,directors and 10% stockholders were deemed affiliates.  Such determination should not be construedas an admission that such officers, directors and 10% stockholders are affiliates.

 

On March 26, 2004, there were23,382,182 shares of the registrant’s common stock outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE:**

The information called for byPart III is incorporated by reference to the definitive Proxy Statement for theAnnual Meeting of Stockholders of the Company to be filed with the Securitiesand Exchange Commission not later than 120 days after December 31, 2003.

 

Transitional Small BusinessDisclosure Format (check one):  Yes o  No  ý

 

 

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**TABLE OF CONTENTS**

 

**REFOCUS GROUP, INC.**

 
| Part 1.                                    |                                                                                  |
|--------------------------------------------|---------------------------------------------------------------------------------------|
| Item 1.                                    | Description of Business                                                               |   |
|                                       | Business Development                                                                  |   |
|                                       | Business of Refocus Group, Inc.                                                       |   |
|                                       |                                                                                  | General |   |
|                                       |                                                                                  | History of Refocus Ocular, Inc. |   |
|                                       |                                                                                  | Business and Industry Overview |   |
|                                       |                                                                                  | Current and Future Products |   |
|                                       |                                                                                  | Strategic Alliances |   |
|                                       |                                                                                  | Business Strategy and Intellectual Property |   |
|                                       |                                                                                  | Competition |   |
|                                       |                                                                                  | Manufacturing |   |
|                                       |                                                                                  | Government Regulation |   |
|                                       |                                                                                  | Research and Development |   |
|                                       |                                                                                  | Other Material Agreements |   |
|                                       |                                                                                  | Employees |   |
|                                       | Cautionary Statements                                                                 |   |
| Item 2.                                    | Description of Properties                                                             |   |
| Item 3.                                    | Legal Proceedings                                                                     |   |
| Item 4.                                    | Submission of Matters to a Vote of Security  Holders                                  |   |
|                                       |                                                                                  |
| Part II.                                   |                                                                                  |
| Item 5.                                    | Market for Corporation’s Common Equity and  Related Stockholder Matters          |   |
| Item 6.                                    | Management’s Discussion and Analysis or  Plan of Operations                      |   |
|                                       |                                                                                  | Overview |   |
|                                       |                                                                                  | Results of Operations |   |
|                                       |                                                                                  | Liquidity and Capital Resources |   |
|                                       |                                                                                  | Other |   |
| Item 7.                                    | Financial Statements                                                                  |   |
| Item 8.                                    | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |   |
| Item 8A.                                   | Controls and Procedures                                                               |   |
|                                       |                                                                                  |
| Part III.                                  |                                                                                  |
| Item 13.                                   | Exhibits and Reports on Form 8-K                                                      |   |
|                                       | Exhibits                                                                              |   |
|                                       | Reports on Form 8-K                                                                   |   |
| Signatures                                 |                                                                                  |
| Index to Consolidated Financial Statements |                                                                                  |

 

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**PART I**

 

Cautionary Statement under the PrivateSecurities Litigation Reform Act of 1995: This Annual Report on Form 10-KSB contains certain “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995 that are based on the assumptions, beliefs and opinions of ourmanagement.  When used in this document,the words “anticipate”, “believe”, “continue”, “estimate”, “expect”, “intend”,“may”, “should”, “plan”, “potential” and similar expressions are intended toidentify forward-looking statements. Such statements reflect our current views with respect to future eventsand involve known and unknown risks, uncertainties and other factors that maycause our actual results, levels of activity, performance or achievements to bematerially different from what management currently believes.  Such risks and uncertainties include, amongother things, those described in the “*Cautionary Statements*” section below andelsewhere in this Form 10-KSB.  Shouldone or more of those risks or uncertainties materialize, or should underlyingassumptions prove incorrect, our actual results may vary materially from thosedescribed herein.  The forward-lookingstatements made in this document speak only to the date on which suchstatements are made, and we undertake no obligation to update anyforward-looking statement to reflect events or circumstances after the date onwhich such statement is made or to reflect the occurrence of unanticipatedevents.

 

**ITEM 1. DESCRIPTION OF BUSINESS**

 

Refocus Group, Inc. is a medical devicecompany engaged in the research and development of treatments for eyedisorders.  Our principal products arethe patented PresVIEW Scleral Implant (the “PSI”) and the PresVIEW IncisionSystem, which consists of the surgical instruments used to implant the PSI inthe surface of the white of the human eye. The PSI and PresVIEW Incision System are utilized in our surgicalprocedure, the Scleral Spacing Procedure, for the treatment of presbyopia,ocular hypertension and primary open angle glaucoma.  Presbyopia, the Greek word for “old eye”, is the primary reasonthat a substantial portion of the population beginning in their early 40s usedbifocals, reading glasses or removes their distance glasses in order to read ata comfortable distance.  We believe thatour surgical procedure physiologically restores the human eye’s natural abilityto focus at is did at a younger age.  Webelieve the procedure works by reducing the crowding of the underlying tissuessurrounding the crystalline lens, which allows the muscles to once againreshape the lens and thus restore the eye’s ability to accommodate orfocus.  Ocular hypertension, or elevatedpressure within the eye, often leads to primary open angle glaucoma, or theprogressive loss of central vision potentially leading to blindness.  We believe that our same surgical procedurerestores the natural base-line tension of the muscle inside the eye, whichpermits the eye to drain naturally and, thus, lower the intraocular pressure.  We received approval from the United StatesFood and Drug Administration (the “FDA”) to begin Phase II clinical trialsusing the PSI for the treatment of presbyopia in December 2003.  We began those trials in the first quarterof 2004.  We have also conductedclinical trials in Canada using the PSI for the treatment of ocularhypertension and primary open angle glaucoma. Later this year, we plan to continue our clinical trials in Canada andto potentially start our clinical trials in the United States, pending FDAapproval, using the PSI for the treatment of ocular hypertension and primaryopen angle glaucoma.  We may alsoreceive CE Mark certification of the PSI so that we may begin sales of ourproducts in the European Union this year. See “*Businessof Refocus Group, Inc.”* below for a complete discussion.

 

**Business Development**

 

On November 21, 2000,VeryBestoftheInternet.com, the predecessor of Refocus Group, Inc., was incorporatedin the State of Texas.  In February2003, VeryBestoftheInternet.com reincorporated in Delaware and changed its nameto Refocus Group, Inc.

 

Refocus Group, Inc. (“Refocus”) completed amerger on March 6, 2003 (the “Merger Closing Date”) of Refocus AcquisitionCorp., a Delaware corporation and newly created, wholly-owned subsidiary ofRefocus, with and into Presby Corp(“Presby”), a Delaware corporation. Presby is a medical device company based in Dallas, Texas, which isengaged principally in the research and development of surgical treatments forhuman vision disorders.  Presby was thesurviving corporation and became a wholly-owned subsidiary of Refocus.  The merger was consummated under Delawarelaw and pursuant to an Agreement of Merger and Plan of Reorganization, dated asof March 6, 2003 (the “Merger Agreement”). In addition, on the Merger Closing Date, Refocus completed the firsttranche of a private placement of its common stock.  See the discussion of the merger and the private placement inManagement’s Discussion and Analysis or Plan of Operations in Item 6 and in theaudited financial statements in Item 7 contained

 

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herein.  Presby changed its nameto Refocus Ocular, Inc. (“Ocular”) in April 2003 after the merger.  Prior to the merger, Refocus was an internetwebsite ranking service that allowed consumers to identify websites that weremost useful to them to minimize the time expended in searching for desiredinformation.

 

All referencesto “Refocus”, “Presby”, “Ocular”, “we”, “us”, “our”, or the “Company” means Refocus or Ocular, as the formerPresby, separately prior to the Merger Closing Date and Refocus, as successorto the business of Ocular, after giving effect to the merger.

 

After the merger, Refocus discontinued itsprevious business as an internet website ranking service, the founders ofRefocus resigned their positions, and Refocus succeeded to the business ofOcular.  For accounting purposes, themerger was accounted for as a reverse merger, whereby Ocular was deemed to bethe accounting acquirer of Refocus since the former stockholders of Ocularowned a majority of the issued and outstanding shares of common stock ofRefocus on the Merger Closing Date, including those shares issued in theprivate placement that closed on that date.

 

Therefore, all financial information includedin this report on Form 10-KSB prior to the Merger Closing Date is that ofOcular as if Ocular had been the registrant. The financial information since the Merger Closing Date is that ofRefocus and Ocular consolidated.

 

In addition, you should be aware that we maynot be able to continue as a going concern over the next twelve months ifadditional funding is not obtained.  Seethe discussion below in Management’s Discussion and Analysis or Plan ofOperations in Item 6 and in the audited financial statements in Item 7contained herein.

 

**Business of Refocu****s Group,Inc.**

 

***Genera******l***

 

We are amedical device company based in Dallas, Texas, engaged in the research anddevelopment of surgical treatments for human vision disorders.  We may also use our research andunderstanding of the human eye to develop and patent technology for use withcommercial optical lens applications.

 

Our principalproducts are the patented PresVIEW Scleral Implant (the “PSI”) and the PresVIEWIncision System, which consists of the surgical instruments used to implant thePSI in the human eye.  The PSI and thePresVIEW Incision System are utilized in our surgical technique, the ScleralSpacing Procedure (the “SSP”), for the treatment of presbyopia, ocularhypertension and primary open angle glaucoma in the human eye.  Presbyopia, the Greek word for “old eye”, isthe primary reason that a substantial portion of the population beginning intheir early 40s uses bifocals, reading glasses or removes their distanceglasses in order to read at a comfortable distance.  We believe that the SSP treats presbyopia by reducing thecrowding of the underlying tissues surrounding the crystalline lens, whichallows the muscles to once again reshape the lens to restore the eye’s abilityto accommodate or focus.  In the case ofocular hypertension and primary open angle glaucoma, we believe that the SSPrestores the natural base-line tension of the muscle inside the eye, whichpermits the eye to drain naturally and, thus, lower the intraocular pressure.

 

Since theearly 1990s, extensive research has been conducted on, and extensiveinvestigational surgeries have been performed utilizing, the PSI.  By 1998, we had obtained the European CEMark and other regulatory approvals necessary to market early versions of ourproducts, including a manual approach to the surgical procedure, in a number ofinternational markets.  In that sameyear, we began selectively selling the early prototypes of the PSI and relatedcustomized manual surgical instruments to key surgeons in the European Unionand other countries.

 

In 2000, wereceived approval from the United States Food and Drug Administration (the“FDA”) to conduct Phase I clinical trials of the PSI for the treatment ofpresbyopia on humans.  In that sameyear, we received approval from Health Canada (the Canadian equivalent of theFDA) to conduct clinical trials of the PSI for the treatment of ocularhypertension and primary open angle glaucoma. We decided to suspend sales in 2001, however, in order to develop anautomated surgical incision device to help simplify, standardize and automatethe surgical procedure and

 

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to make the outcomes of the surgical procedure less dependent on eachphysician’s surgical skill.  Since thattime, we have developed the PresVIEW Incision System, which we believe improvesthe consistency of the results of the SSP.

 

In March 2002,we entered into a license agreement with CIBA Vision AG (“CIBA”) pursuant towhich CIBA obtained an exclusive license to our patents related to the treatmentof presbyopia, ocular hypertension and primary open angle glaucoma ininternational markets.  CIBA also hadthe right in the license agreement (the “CIBA Agreement”) to acquire a licensefor our products in the United States. We were entitled to receive a percentage royalty on CIBA’s worldwidesales of the PSI and related products under the CIBA Agreement.  Upon entering into the CIBA Agreement, CIBApaid us $2.0 million in advance royalties and was committed to purchase equityinterests in us if we obtained certain other investments fromthird-parties.  Simultaneously with ourreceipt of third-party investments in March 2003, CIBA purchased 625,000 sharesof our common stock and a warrant to purchase 312,500 shares of our commonstock at an exercise price of $2.50 per share for an aggregate purchase priceof $1.25 million.

 

Under the CIBAAgreement, CIBA was responsible for manufacturing, marketing and distributingour products worldwide at its expense. CIBA was also responsible for regulatory matters outside the UnitedStates and was committed to jointly manage the FDA clinical trials withus.  In accordance with the CIBAAgreement, we ceased all direct manufacturing and marketing of the PSI andrelated products.  As a result of thetransition of those manufacturing responsibilities to CIBA, the modificationsin the packaging of the PSI and the resultant changes to those processes, theCE Mark certification we obtained in 2000 on the PSI is no longerapplicable.  CIBA has been seeking CEMark certification of the PSI for its planned marketing efforts in the EuropeanUnion in early 2004.  That CE Markcertification is still pending.  Late in2003, a CE Mark certification of the components of the PresVIEW Incision Systemwas obtained by the suppliers of those components.

 

In August2003, CIBA announced that it was seeking strategic alternatives for itssurgical business unit, including the sale of that unit.  CIBA’s surgical business unit marketed avariety of ophthalmic products and was primarily responsible for performing theCIBA Agreement.  On December 29, 2003,CIBA informed us that it was exiting the surgical business and expected tocomplete the sale of the surgical business unit’s various product lines to avariety of parties by early 2004.  In conjunctionwith that sale, CIBA received an offer from a third-party to purchase CIBA’srights under the CIBA Agreement. Pursuant to the CIBA Agreement, the transfer of the license required ourconsent.  As a condition to theassumption of CIBA’s duties associated with that proposed license assignment,the third-party requested the renegotiation of certain key terms of the licenseagreement.  After deliberation, wedeclined to renegotiate the license and did not permit the assignment of thelicense to the third-party.  As aresult, we began negotiations with CIBA for the transfer of CIBA’s rights underthe CIBA Agreement back to us and the termination of the license.

 

In January2004, we entered into an agreement with CIBA, the License Transfer and TransitionServices Agreement (the “Transfer Agreement”). Pursuant to the Transfer Agreement, we reacquired all worldwide licenserights to our patents that were granted to CIBA under the CIBA Agreement, andCIBA was released from all future financial commitments, including itsobligations associated with manufacturing, marketing, distribution andregulatory matters.  Under the TransferAgreement, CIBA has agreed to provide us with certain transition servicesduring 2004, including efforts to finalize the CE Mark certification of thePSI.  These transition services willhelp us transfer the manufacturing, distribution and marketing functions backto us from CIBA.  If CIBA obtains CE Markcertification of the PSI, CIBA and we will enter into a technical agreement, whichwill permit us to directly sell our products in CIBA packaging during 2004 inthe European Union while we seek our own CE Mark certification.  As consideration for the acquisition ofCIBA’s license rights, the forgiveness of the $2.0 million in prepaid royaltieswe received under the CIBA Agreement and the transition services to beperformed by CIBA under the Transfer Agreement, we agreed to pay CIBA an aggregateof $3.0 million in twelve quarterly installments commencing in the firstcalendar quarter of 2006.  We, however,are entitled to prepay and extinguish our payment obligations by paying anaggregate amount of $2.0 million to CIBA prior to January 1, 2006.

 

Under theTransfer Agreement, CIBA has also agreed to return the warrant to purchase312,500 shares of our common stock that it acquired in the March 2003 privateplacement.  While it will retain the625,000 shares of common stock acquired at the same time, these shares will besubject to certain restrictions on their transfer.

 

We expect thatthe transition under the Transfer Agreement will result in a significantincrease in costs for us related to performing functions that CIBA had assumedunder the CIBA Agreement.  Conversely,however, we will be

 

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entitled to all gross proceeds from the sale of our products instead ofa royalty based on a percentage of sales as previously specified in the CIBAAgreement.  Even assuming that CIBAobtains the CE Mark certification of the PSI, our ability to directly marketour products in the European Union is currently limited.  The anticipated date of the initial sale ofour products in the European Union is likely to be delayed, and the number ofPresVIEW Incision System and PSI units sold is likely to be reduced, in theshort term and especially in 2004, relative to the number of unit sales thatcould have been achieved by CIBA.  Wemay seek to market the PSI and PresVIEW Incision System in the European Unionand elsewhere directly or through other distribution, license or strategicarrangements.  Therefore, as a result ofthe increased expenses and potential for delayed revenues, we believe that theTransfer Agreement may have a material adverse impact on our financialcondition in the short term.  We believethe reacquisition of the license will be in the best long-term interest of ourstockholders.

 

In November 2002, we, along with CIBA, submitted to Health Canada anapplication seeking approval to commercialize the PSI in surgery for thetreatment of ocular hypertension, primary open angle glaucoma andpresbyopia.  In June 2003, Health Canadainformed us that it had determined that the sample size submitted in ourapplication was insufficient for approval, and denied the application.  Based on further discussions with HealthCanada in October 2003, we will need to perform further clinical trials at moresites and with significantly more patients in order to receive approval forcommercial sales.  We are uncertain, atthis time, as to when we may receive Health Canada’s approval, but we believeit will not be until at least 2005 before the results of these additionalclinical trials can be resubmitted.  Weremain committed to reinitiating the clinical trials in Canada at such time asfunding is available and we establish the ability to coordinate those trialswith the planned United States FDA clinical trials for the treatment of ocularhypertension and primary open angle glaucoma. Our immediate focus, however, is currently on the FDA clinical trialsfor the treatment of presbyopia.

 

In March 2003,we filed an investigational device exemption application with the FDA to obtainapproval to initiate our Phase II clinical trials for the surgical treatment ofpresbyopia utilizing the PSI and SSP.  Thisapplication was followed by later amendments. In December 2003, we received approval to begin our Phase II clinical trialsof the PSI and SSP for the treatment of presbyopia.  The FDA approval was conditioned on our submittal of certainfinal documentation concurrent with the initiation of the clinical study.  We started these clinical trials during thefirst quarter of 2004.

 

We haveadditional products in early-stage research, including a medical device for thetreatment of dry age-related macular degeneration (“ARMD”) and a single elementvariable focus lens (“SEVFL”) for use in commercial optical lens applications.

 

We have had nosignificant revenue since 2000 from our core lines of business.  We have incurred losses every year since webegan operations.  Those losses resultedprimarily from expenses associated with research and development activities,clinical trials, obtaining regulatory approvals in international markets andgeneral and administrative expenses.  Tobecome profitable, we must generate sufficient income from future productsales, either directly or through potential future strategic partners.

 

We have alimited operating history and have not commercially produced any significantquantities of our products to date.  Wehave not yet achieved, and may never achieve, profitability.  In addition, we expect to incur net lossesin the foreseeable future, and those losses may be substantial.  Moreover, we have significant future capitalrequirements related to the regulatory approval of our products.  If we are unable to fund these requirements,our business could be seriously harmed.

 

You should beaware that we may not be able to continue as a going concern for the nexttwelve months if additional financing is not obtained.  There can be no assurances, however, thatadditional financing will be obtained on reasonable terms, or at all.  We may seek a merger partner or sale ofassets if additional financing is not available.  Our inability to obtain additional financing could have amaterial adverse effect on us.

 

***History of Refocus******Ocular, Inc.***

 

Ocular wasincorporated in 1994 to conduct research on, and develop a surgical treatmentfor, presbyopia in the human eye. Extensive research and investigational surgeries were conducted, and by1998, Ocular had obtained the

 

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European CE Mark and other regulatory approvals necessary to marketversions of the technology in a number of international markets.  Ocular began selectively selling the earlyprototypes of the PSI and related customized surgical instruments to keysurgeons in the European Union and other countries.  Ocular marketed the medical device as the “Scleral ExpansionBand”.  We intend to market the deviceunder a new name, the “PresVIEW Scleral Implant”.  References to the PSI in periods prior to the change to thecurrent name should be understood to refer to the medical device under itsprevious name.

 

On March 6,2003, Refocus completed the merger of Refocus Acquisition Corp., a Delawarecorporation and newly-created, wholly-owned subsidiary of Refocus, with andinto Ocular. Ocular was the surviving corporation and became a wholly-ownedsubsidiary of Refocus.

 

***Business and Industry Overview***

 

*Presbyopia.*  Presbyopia (the Greek word for “old eye”) isthe primary reason that nearly everyone beginning in their early 40s usesbifocals, reading glasses or removes their distance glasses in order to read ata comfortable distance.  According toDain Rauscher Wessels in May 2001, presbyopia ultimately affects 100% of thepopulation, with the first effects of presbyopia generally occurring at aboutthe age of 40 and nearly fully prevalent after age 45.  There are approximately 120 millionAmericans who currently suffer from presbyopia and, based on widely availableestimates, the United States population over the age of 40 continues togrow.  External lenses such as bifocalsand reading glasses are currently the principal alternatives available tocounter the effects of presbyopia. We believe the SSP will be particularlyattractive to the approximately 4 million Americans who, since 1996, havealready demonstrated a willingness to reduce or eliminate their need forglasses via LASIK and laser vision correction procedures—only to find that theyneed glasses again for reading as they become presbyopic after age 40.

 

A February1999 study conducted by Business Valuation Services, an independent consultingfirm commissioned by us, revealed that while only about 40% of the UnitedStates population under age 40 wear vision corrective lenses, over 90% of theUnited States population over the age of 55 require vision correction,including reading glasses.  Thisincreased need for vision correction is primarily due to the onset of presbyopia.  We believe that a significant segment of thepopulation from ages 40 to 65 will benefit significantly from the SSP and maybe able to discontinue or reduce the need for vision correction.  The study commissioned by us estimated thenumber of patients ideally suited, by age, vision and income qualifications, tobe in excess of 50 million people worldwide. We believe that this market will continue to refresh and grow as morepeople reach the age of 40.

 

Widelypublicized laser surgical techniques, such as LASIK  and LASEK, are generally designed to treat other refractiveimperfections of the eye, primarily nearsightedness (myopia), farsightedness(hyperopia) and astigmatism.  Thesetechniques generally do not compete with the SSP and do not directly treat presbyopia.  In fact, the SSP is complementary to theselaser surgical procedures.  We expectthat ophthalmologists, optometrists and other eye care professionals willaggressively market this elective procedure in similar fashion to laserprocedures, especially since it complements those laser surgery procedures,which are marketed to the baby-boomer population.

 

*Ocular Hypertensionand Primary Open Angle Glaucoma.*  Ocular hypertension is a medical conditioninvolving elevated pressure within the eye and may lead to serious damage tovision.  Ocular hypertension is causedby a buildup of fluid pressure in the eye and is primarily associated with theinability of the eye to properly drain itself of fluids. Just as with highblood pressure, abnormally high levels of ocular pressure must be medicallytreated.  Advanced or prolonged ocularhypertension is believed to damage the optic nerve in the back of the eye andcan result in an initial loss of peripheral vision.  This condition is deemed primary open angle glaucoma as loss ofvision begins to occur.  Continued lossof peripheral vision shrinks the person’s field of vision and eventually leadsto tunnel vision and then blindness. Ocular hypertension and primary open angleglaucoma are considered to be genetic and related to the tissue of the eye.  The initial stages of ocular hypertensionare not noticeable to a patient.  Consequently,early diagnosis is extremely important because damage from primary open angleglaucoma is irreversible.

 

Ocularhypertension and primary open angle glaucoma are currently treated primarilywith pharmaceutical drops and pills with varying success.  These medications have substantial sideeffects, are costly, not continuous in their action and are not fully effectivedue to the patient’s lack of compliance with the proper use of the medication.

 

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Many of these medications have to be taken several times each day on astrict schedule for the rest of the patient’s life.

 

Patients withmore advanced stages of primary open angle glaucoma must undergo other types ofsurgical treatments that involve artificial methods to drain the fluid from theeye.  These surgical methods may havesignificant complications and side effects and typically have varying success.

 

According to theNational Institutes of Health in June 2002, it is estimated that more than fivemillion Americans have ocular hypertension. It also estimated that glaucoma affects three million Americans and manymore people worldwide and is the second leading cause of irreversibleblindness.  According to a recent studyby SG Cowen, glaucoma medications represent approximately 40% of ophthalmicmedication revenues.  According to publishedreports by Alcon and SG Cowen in 2000, the ophthalmic pharmaceutical industryhas annual revenues exceeding $2.0 billion in the United States.

 

We believethat the SSP treats ocular hypertension and primary open angle glaucoma byrestoring the natural spacing between the muscle and the lens, which alsorestores the natural base-line tension of the muscle inside the eye.  Assuming that a significant number ofpatients that undergo the SSP for the treatment of ocular hypertension demonstratethe same surgical results that has been shown in clinical studies, the SSPcould become the first-line preferred treatment for ocular hypertension andprimary open angle glaucoma.  Sincethese eye disorders are considered to be genetic, the SSP could become thefirst preventive procedure in ophthalmology.

 

*Age-Related MacularDegeneration*. ARMD is estimated to affect up to 10 million Americans and is the leadingcause of irreversible severe central vision loss in Caucasians 50 years andolder in the United States and in most of the developed world.  The incidence and progression of ARMDincrease significantly with age. According to the 2001 American Academy of Ophthalmology PreferredPractice Pattern, approximately 10% of patients age 66 to 74 have ARMD, and theprevalence increases to approximately 30% of patients age 75 to 85.  Certain companies have developed drugrelated treatments for “Wet” ARMD.  WetARMD involves the growth of abnormal blood vessels under the central part ofthe retina, called the macula.  Thesevessels cause photoreceptor damage and a loss of central vision.  According to the American MacularDegeneration Foundation in 2001, about 85% of patients, however, suffer from“Dry” ARMD.  Dry ARMD involves similardamage to photoreceptors; however, the cause is unclear and is the subject ofextensive medical debate.  Our researchhas resulted in the development of the Macular Enhancing Device (“MED”), whichmay be the first device designed for use in the treatment of Dry ARMD.  We have received three issued United Statespatents on the device.  Considerableadditional research and development needs to be conducted on this device.  Due to our funding limitations, we have notdevoted any resources to this project since 2002, other than research that maybe conducted by Dr. Ronald A. Schachar, our founder and former Chief Scientist,under his consulting agreement.  If weobtain adequate funding, we may resume additional research on this project inorder to develop the device for later commercialization.

 

***Current and Future******Products***

 

**PresVIEWScleral Implant and PresVIEW Incision System**

 

The PSIconsists of four separate tiny plastic segments, each about the size of a grainof rice, made from polymethylacrylate, or PMMA.  PMMA has been implanted in the eye for other types of surgicalprocedures (intraocular lenses, hard contact lenses) for over fifty years.  The PresVIEW Incision System, which consistsof the surgical instruments used to implant the PSI in the human eye, containsa mechanized device used to make incisions in the human eye for implant of thePSI.  The PresVIEW Incision System includesa control box, cabling, incision hand piece, disposable blade, footplateactuator and other related items.  Thesurgeon uses the PresVIEW Incision System to make four superficial incisions inthe quadrants of the sclera (white of the eye).  The PSI is inserted into the superficial tunnels, causing aslight lift in the sclera that in turn reduces the crowding of the underlyingmuscles.  The surgery is an outpatientsurgical procedure performed under topical or local anesthesia.

 

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We believethat the SSP provides:

 

•                                            long-termimproved near or reading vision;

•                                            alow risk surgical solution for presbyopia;

•                                            aminimally invasive procedure, which we believe is fully reversible; and

•                                            areduction in intraocular pressure in patients with ocular hypertension and/orprimary open angle glaucoma.

 

**Macular EnhancingDevice**

 

MED is adevice in early stage research developed for the treatment of Dry ARMD.  We have received three issued United Statespatents on the device.   Considerableadditional research is required for the project, and assuming the availabilityof adequate funding, we may conduct further research and may develop the devicefor commercialization or licensing in the future.  To date, we have not licensed this device.

 

**SingleElement Variable Focus Lens**

 

Our researchand understanding of the human lens has led to the development of the SEVFL,which we believe duplicates the functionality of the human eye.  Variable focus commercial lens systems incameras and other applications currently involve multiple lenses, which must bemoved relative to each other in order to produce variations in opticalpower.  We may try to develop a SEVFLprototype that will demonstrate that these same large optical effects can beproduced with microscopic movement in a single uniquely shaped lens.  SEVFL is expected to be smaller, lighter andless complex than a multiple lens system. Commercial applications may include cameras, robotics or otheruses.  We have obtained domestic andinternational patents on this technology. A considerable amount of the research conducted to date on this projectwas conducted under our supervision at a local university.  Due to our funding limitations, we suspendedresearch on this project in 2002; however, we may resume work on this promisingtechnology upon receiving adequate funding. To date, we have not licensed this technology.

 

***Strategic Alliances***

 

**CIBA Vision Corp.**

 

In the summerof 2001, CIBA began an extensive period of due diligence on our SSP andconcluded that the PSI and the related SSP represented significant marketpotential.

 

Negotiationsbetween CIBA and us concluded with a license agreement in March 2002, pursuantto which CIBA had the right to obtain an exclusive worldwide license to market,distribute and sell the PSI, the PresVIEW Incision System and related productsdeveloped for the surgery.  The CIBAAgreement was subject to a number of terms and conditions, including arequirement for CIBA to purchase equity interests in us.  Our products were to be marketed under thePresVIEW trademark.

 

Under the CIBAAgreement, we were to receive a percentage royalty on CIBA’s worldwide sales ofthe PSI and related products.  CIBA hadthe option to make minimum royalty payments totaling approximately $13.6million during years two through six of its agreement with us if it wished tomaintain its rights to an exclusive license of the PSI, the PresVIEW IncisionSystem and related products.  CIBA paidus $2.0 million in advance for future royalties.  CIBA also purchased 625,000 shares of our common stock and awarrant to purchase 312,500 shares of our common stock for an aggregate cost of$1.25 million in the first tranche of a March 2003 private placement, and hadcommitted to purchase, subject to the satisfaction of certain conditionsprecedent, an additional $1.25 million of our common stock and warrants in thesecond tranche of that private placement. Subject to certain conditions precedent, CIBA was also to purchase anadditional $2.5 million of our common stock within 60 days following theenrollment of the first patient in our Phase III FDA clinical trial.  Further, CIBA had agreed to pay usadditional amounts totaling $4.0 million upon the achievement of certainFDA-related milestones.  In addition,CIBA had agreed to assume responsibility for the legal defense of our worldwidePresVIEW patent portfolio against patent infringement, subject to mutualagreement between CIBA and us.  CIBAalso assumed full responsibility for the manufacturing, distribution andmarketing of our products at their expense.

 

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At the timethe CIBA Agreement was executed in March 2002, we had invented and produced aprototype of an incision device to simplify the surgical procedure and improvethe surgical outcomes.  In preparationfor future marketing, we and CIBA decided to make further enhancements andimprovements to the incision device. CIBA invested a significant amount of time and money in the further developmentof the device resulting in the PresVIEW Incision System.  Late in 2003, a CE Mark certification of thecomponents of the PresVIEW Incision System was obtained by the suppliers ofthose components.

 

In August2003, CIBA announced that it was seeking strategic alternatives for itssurgical business unit, including the sale of that unit.  CIBA’s surgical business unit marketed avariety of ophthalmic products and was primarily responsible for performing theCIBA Agreement.  On December 29, 2003,CIBA informed us that it was exiting the surgical business and expected tocomplete the sale of the surgical business unit’s various product lines to avariety of parties by early 2004.  Inconjunction with that sale, CIBA received an offer from a third-party topurchase CIBA’s rights under the CIBA Agreement.  Pursuant to the CIBA Agreement, the transfer of the licenserequired our consent.  As a condition tothe assumption of CIBA’s duties associated with that proposed licenseassignment, the third-party requested the renegotiation of certain key terms ofthe license agreement.  Afterdeliberation, we declined to renegotiate the license and did not permit theassignment of the license to the third-party. As a result, we began negotiations with CIBA for the transfer of CIBA’srights under the CIBA Agreement back to us and the termination of the license.

 

On January 30,2004, we entered into the Transfer Agreement. Pursuant to the Transfer Agreement, we reacquired all worldwide licenserights to our patents that were granted to CIBA under the CIBA Agreement, andCIBA was released from all future financial commitments, including itsobligations associated with manufacturing, marketing, distribution andregulatory matters.  Under the TransferAgreement, CIBA has agreed to provide us with certain transition servicesduring 2004, including efforts to finalize the CE Mark certification of thePSI.  The transition services will helpin the transfer of manufacturing, distribution and marketing functions to usfrom CIBA.  As consideration for theacquisition of CIBA’s license rights, the forgiveness of the $2.0 million inprepaid royalties we received under the CIBA Agreement and the transitionservices to be performed by CIBA under the Transfer Agreement, we agreed to payCIBA an aggregate of $3.0 million in twelve quarterly installments commencingin the first calendar quarter of 2006. We, however, are entitled to prepay and extinguish our paymentobligations by paying an aggregate amount of $2.0 million to CIBA prior toJanuary 1, 2006.

 

Under theTransfer Agreement, CIBA has also agreed to return the warrant to purchase312,500 shares of our common stock that it acquired in the March 2003 privateplacement.  While it will retain the625,000 shares of common stock acquired at the same time, these shares will besubject to certain restrictions on their transfer.

 

CIBA’stransition services include the continuation of sterilization and packagingprocesses to result in the delivery to us of all existing PSI inventory.  Prior to the CIBA Agreement executed inMarch 2002, we manufactured a significant quantity of the PSI for futureuse.  We no longer have thosemanufacturing arrangements in place because CIBA assumed responsibility formanufacturing under the CIBA Agreement.  Due to the sufficient PSI inventory, CIBA did not establish aninjection molding manufacturing arrangement during the term of the CIBAAgreement.  We believe that we will haveadequate inventory of the PSI for our expected requirements over the next 12 to24 months.  As a result of thetransition of those manufacturing responsibilities to CIBA, the modificationsin the packaging of the PSI and the resultant changes to those processes, theCE Mark certification we had obtained in 2000 on the PSI no longer applies.

 

CIBA has beenseeking CE Mark certification of the PSI for its planned marketing efforts inthe European Union in early 2004.  TheCE Mark certification of the PSI is still pending.  The Transfer Agreement requires CIBA to continue its efforts to obtainCE Mark certification of the PSI.  IfCIBA obtains CE Mark certification for the PSI, CIBA and we will enter into atechnical agreement, which will allow us to directly sell our products in CIBApackaging during 2004 in the European Union. We cannot be assured, however, that all regulatory requirements will befinalized, and that CIBA can finalize the issuance of the CE Mark certificationfor our current PSI inventory, since the certification process requiresextensive documentation of the manufacturing, packaging and otherprocesses.  However, by the end of 2004,we will have to establish our own CE Mark certification on the PSI in order tocontinue any sales in the European Union. Additionally, we must reestablish an injection molding manufacturingsource for additional production of the PSI after existing inventory isexhausted.  The PSI is a preciselydesigned micro-

 

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engineered part that requires special manufacturing expertise,especially to meet the regulatory requirements for use as a medical implant.

 

We expect thatthe transition under the Transfer Agreement will result in a significantincrease in costs for us related to performing functions that CIBA had assumedunder the CIBA Agreement.  Conversely,however, we will be entitled to all gross proceeds from the sale of ourproducts instead of a royalty based on a percentage of sales as previouslyspecified in the CIBA Agreement.  Evenassuming that CIBA obtains the CE Mark certification of the PSI, our ability todirectly market our products in the European Union is currently limited.  The anticipated date of the initial sale ofour products in the European Union is likely to be delayed, and the number ofPresVIEW Incision System and PSI units sold is likely to be reduced, in theshort term and especially in 2004, relative to the number of unit sales thatcould have been achieved by CIBA.  Wemay seek to market the PSI and PresVIEW Incision System in the European Unionand elsewhere directly or through other distribution, license or strategicarrangements.  Therefore, as a result ofthe increased expenses and potential for delayed revenues, we believe that theTransfer Agreement may have a material adverse impact on our financialcondition in the short term.  We believethe reacquisition of the license will be in the best long-term interest of ourstockholders.

 

***Business Strategyand Intellectual Property***

 

One of ourprimary strategies has been to develop strong proprietary patents for our products,including the PSI, the PresVIEW Incision System, the MED and the SEVFL.  We have 18 issued United States patents and20 issued or published international patents. We have 14 pending United States patent applications and 56 pendinginternational patent applications. Related only to the PresVIEW technology, we have 11 issued United Statespatents, 15 issued or published international patents, 9 pending United Statespatent applications and 51 pending international patent applications.  The patents associated with the PresVIEWtechnology have expiration dates ranging from 2012 to 2020.  The patents and patent applications relatedto our early stage products generally do not expire until after 2015.

 

We have soughtintellectual property rights for the PSI in significant economic marketsthroughout the world that have a legal system that tends to recognize theserights, and we intend to continue to submit additional patent applications andamendments to maintain and strengthen our patent protection.  Our patents protect the PSI, as well asvariations of the PSI and the custom hand piece and disposable blade in thePresVIEW Incision System, which are used in the SSP for the treatment ofpresbyopia, primary open angle glaucoma and ocular hypertension.  Due to the nature of the medical discovery,we believe that we have unusually broad patent protection.  In 2003, we reduced the number of pendingand issued international patents being maintained as a result of a cost-benefitanalysis conducted with the assistance of our patent counsel.  We also seek to protect our proprietarytechnology, in part, through confidentiality and nondisclosure agreements withemployees, consultants and other parties. In a severance and consulting agreement with Dr. Ronald A Schachar, ourfounder and former Chief Scientist, we granted a non-exclusive securityinterest in our patent rights relating to the ARMD device and the SEVFL assecurity for the payment of his consulting fees under that agreement.

 

***Competition***

 

We believe that the SSPprovides a physiological or natural improvement in the human eye’s ability tofocus at all near points.  Glasses,contact lenses and other optical changes to the eye only compensate for the inabilityof the older eye to focus.  Many peopleremain dissatisfied with the alternatives discussed below:

 

•                  *Glasses. *Presbyopia was initially treatedwith near vision optical aids using magnifying lenses, reading glasses, andmonocles.  Patients are constantlyremoving reading glasses and losing them because the reading glasses interferewith vision at all other distances.  Inthe 1700’s, Benjamin Franklin fused the distance lens with the near readinglens to give us bifocals that were later modified to trifocals.  The problem with these reading aids is thatthey only allow sharp near vision at a given distance and the near visual fieldis limited by the lens.  Patients mustlearn to rotate their eyes downward when reading with bifocals instead ofrotating their head.  It usually takesweeks for patients to get used to wearing bifocals and most patients remaindissatisfied.  Trifocals can be evenmore of a problem for many patients. Trifocals are needed as the advancement of presbyopia in patients intheir 50s also necessitates correction at intermediate distances.

 

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Trifocals take even more time to get used to and still do not providedynamic clear vision for most distances.

 

•                  *Multifocal Glasses.*  Multifocal lenses producemultiple images at various focal points.  Light reflected or emitted by an object must be dispersed by themultifocal lens over all the focal points. This scattering of the light rays entering the eye causes an increase inthe number of images hitting the retina. Therefore, the intensity at any given focal point is reduced and thecontrast sensitivity diminished.  Inorder to reduce these prismatic effects, the visual field of a multifocal lensis reduced.  The patient must learn toselect the appropriate image of the several images produced by the lens.  Additionally, to avoid image distortion,patients need to look only through the center of the lens reading corridor,which is only a few millimeters in width in many multifocal designs.  This requires the patient to learn to movetheir head instead of their eyes when reading.

 

•                  *Bifocal andMultifocal Contact Lenses*. In order to avoid the problems of external bifocal and trifocal glasses,bifocal contact lenses have been developed. Bifocal contact lenses have generally been unsuccessful because thedistance and near power of the contact lens must be crowded into an area thatcan barely cover the pupil.  The bifocalmust be fit so that the lens translates up to allow the patient to look throughthe near portion of the contact lens (the bottom of the contact lens) when thepatient shifts their gaze down.  Theselenses are very difficult to fit. Multifocal contact lenses are also available but have the same significantdrawbacks as multifocal glasses.  Analternate treatment to bifocal or multifocal contact lenses for  presbyopia is to wear contact lenses inmonovision, i.e., with one lens in one eye for near vision, and one lens in theother eye for distance vision.  Monovisioncan compromise depth perception, as the brain needs both eyes for optimalstereo vision.  After 30 years ofcontact lens usage, we believe that contact lenses remain largely ineffectivein addressing presbyopia.

 

•                  *LaserSurgery Alternatives.*  Someresearchers have developed plans for the use of laser refractive surgery to createa bifocal or multifocal cornea.  Inother words, the laser technique is intended to shape the cornea in the samemanner as a multifocal contact lens. This alternative has essentially the same limitations and problems asmultifocal glasses and contact lenses. The patient will see multiple images ofreduced light intensity, i.e., with decreased contrast sensitivity.  This approach would be an irreversiblesurgical treatment.

 

•                  *Monovision*.  The use of monovision, or correction of oneeye for near vision and correction of the second eye for distance vision, canprovide functional vision for some presbyopes. Monovision relies on the brain’s ability to recognize the moreappropriate image; although, it is important to note that not every patient isable to adjust adequately.  Monovisioncan be achieved through contact lenses and LASIK.  While many patients are satisfied with this method, the drawbacksof monovision include reduced night vision, difficulty driving in some cases, asignificant decrease in depth perception and less than optimal vision at bothnear and far distances.

 

•                  *ConductiveKeratoplasty, or CK.* CK usesa controlled release of radio frequency energy to shrink corneal tissue, whichsteepens the cornea, reducing farsightedness. CK is not reversible, but does regress over time.  CK has been used primarily for the treatmentof farsightedness to restore normal distance vision.  In March 2004, the FDA approved the use of CK for the treatmentof presbyopia.  However, reading visionwould be improved only if one eye is overcorrected to become near-sighted, andthus, the patient would have monovision.

 

•                  *MultifocalIOLs*.  During 1997, Allerganreceived FDA approval for its *Array*TM multifocal intraocular lens(“IOL”), the first multifocal lens indicated for cataract replacement.  An IOL is a plastic lens placed inside theeye as a replacement of the natural human lens.  As a result of cataract patient satisfaction with the Array**lens,some market observers have suggested that non-cataract presbyopes could undergothe procedure (off-label) to help provide some near vision.  The implant of an IOL in a patient withoutcataracts is a procedure called a clear lensectomy.  All multifocal IOL designs reduce contrast sensitivity, causesome halo symptoms at night and mildly distort color vision.  Some reports have indicated that thesepatients experience a higher incidence of retinal detachments, which raisesethical concerns surrounding the removal of a healthy lens.  An article in the January 2004 issue of *Review ofOphthalmology* reported that, among a survey

 

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of 750cataract surgeons, 84% of respondents indicated that they do not use multifocalIOLs and two-thirds indicated that they are not interested in using them in thenext two years.  The reasons cited bythe surgeons for their low interest in multifocal IOLs included, among otherreasons: constant blur from slight malpositioning, poor optics and decreasedcontrast sensitivity and visual acuity.

 

•                  *AccommodatingIOLs*.  A handful ofcompanies, including eyeonics, Inc., are investigating the use of an accommodatingIOL, which attempts to magnify the accommodative ability of the eye through theuse of hinges on either side of the IOL.  Eyeonics’ *Crystalens*TM  IOL wasapproved by the FDA in late 2003 for use only with cataract patients.  Eyeonics believes that changes in vitreouspressure associated with accommodative effort moves the lens forward andbackward, effectively providing some limited ability to focus.  Surgeons are now considering the use of amodified version of monovision with these lenses to overcome the limitedaccommodative ability found with this lens system.  In the FDA approval, it stated that the Crystalens providesapproximately one diopter of monocular accommodation.  It is generally recognized that a minimum of 2.5 to 3.0 dioptorsof accommodation improvement are required before a patient can becomeindependent of reading glasses for most near reading activities.  Problems with the accommodating IOL, asreported in the approved Crystalens “Summary of Safety and Effectiveness Data”,include postoperative capsular fibrosis of the lens capsule, or cystoid macularedema, and iritis, a persistent inflammation of the iris, which may limit or retardadoption among cataract patients.  Theeye care community also has significant ethical and medical issues regardingthe removal of healthy or pre-cataract lenses for such purposes.  The risks associated with clear lensextraction to treat presbyopia in patients who do not have a cataract and thelack of reversibility and the limited gain in accommodative amplitude mitigateagainst accommodating IOLs offering any significant competition to the SSP.

 

•                  *AnteriorCiliary Sclerotomy (ACS)*. ACS is a procedure whereby eight incisions are made in the sclera eitherwith a diamond blade or with a laser, allowing it to expand due to intraocularpressure and ideally produce an accommodative effect.  Results are generally limited to less than 1.50 diopters of gain inaccommodation, and any benefit appears to be negligible after approximately oneyear as a result of the healing ability of the sclera.  We own issued patents that we believeinclude this technology; however, due to the limited accommodation achieved withthis technique, we do not believe it represents significant competition to theSSP.  SurgiLight, Inc (“SurgiLight”) hasannounced that it is developing laser systems for the treatment ofpresbyopia.  Generally, SurgiLightintends to use a laser to perform the ACS procedure, which weakens thesclera.  We believe that this procedurestructurally weakens the globe of the eye, subjecting it to risk of rupture viaa severe blow to the eye or head.  Webelieve that, while SurgiLight’s approach is based on our scientific theory,the use of a laser to weaken the sclera will provide only a modest benefit,which will regress with healing.  InMarch 2000, we filed a patent infringement suit against SurgiLight (see “*Item 3.Legal Proceedings*”).

 

Glaucomamedications remain the predominant “standard of care” in many countries,including the United States, for the treatment of primary open angle glaucomaand ocular hypertension.  While no glaucomamedication can cure or restore vision loss due to glaucoma, most of these medicationsare generally effective in the temporary reduction of intraocular pressure(“IOP”).  It is generally believed thatthe primary cause of these conditions is elevated IOP over time.  Glaucoma medications are believed to helpmaintain a patient’s current vision by avoiding or reducing the likelihood ofadditional vision loss due to high IOP. Merck’s *Timoptic*, Alcon Laboratories’ *Betoptic*, Allergan’s *Betagan*and Pharmacia’s *Xalatan*are four of the leading glaucoma medicationsworldwide.  While generally effective,selection of a patient drug regimen and therapy remains highly individualizedand based on a number of factors such as:

 

•                  efficacy,

•                  ocular orsystemic safety and tolerance,

•                  availability inhealth plans,

•                  cost, and

•                  side effects.

 

Many of thesemedications have to be taken several times each day on a strict schedule forthe rest of the patient’s life, are not continuous in their action and are notfully effective due to the patient’s lack of compliance with proper use of themedication.  In a study conducted in2002, approximately 21% of once daily users of a particular

 

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glaucoma medication did not refill their subscription after oneyear.  In another study, approximately12% of glaucoma patients on once or twice daily medication regimes reportedmissing a significant number of doses of their medication and 15% did notproperly administer their medication.

 

Glaucomamedications represent approximately 40% of all ophthalmic medications and 16%of all ophthalmology revenues worldwide, according to a recent study by SGCowen.  As such, they represent thesingle largest competition to SSP for the treatment of ocular hypertension andprimary open angle glaucoma.  However,we believe that the SSP will prove to have several significant advantages overglaucoma medications:

 

•                  maintenance oflower IOP versus the temporary reduction from medications,

•                  a one-timesurgery as compared to a lifetime of daily drug use,

•                  less expensiveover time,

•                  fewer sideeffects,

•                  no daily drugcompliance issues,

•                  avoidance ofdrug effectiveness/intolerance issues, and

•                  at the sametime, a reduction or elimination of presbyopia along with IOP reduction.

 

While avariety of surgical techniques and medical devices exist for the treatment ofocular hypertension and primary open angle glaucoma, we believe that none ofthese surgical treatments work in the same manner as the SSP and do not offerstable, continuous therapy with the added benefit of an improvement in nearvision:

 

•                  *Argon LaserTrabeculoplasty (ALT)* is the most common procedure for glaucoma andinvolves using a laser to increase the drainage of aqueous through thetrabecular meshwork.  However, the IOPlowering effect is not lasting and, thus, requires multiple treatments.  A new procedure similar to ALT is selectivelaser trabeculoplasty, which may hold more promise than ALT but actuallyrequires more treatments than ALT.

 

•                  *Trabeculectomyor filtering surgery* is the most common surgical procedure performedfor uncontrolled glaucoma.  Itessentially involves making a drainage hole in the eye.  The procedure has significant potentialadverse reactions with a relatively high failure rate.

 

•                  *Glaucomavalves* involve making a drainage site in the eye whose rate ofoutflow is controlled by a valve.  Thisprocedure is usually only performed for very severe cases of glaucoma and wheretrabeculectomy has failed.  Glaucomavalves have high failure rates and can cause significant adversereactions.  A newer drainage valve, theOptonol, consists of a miniature stainless steel pipe to drain fluid from theeye.  This device is used foruncontrolled glaucoma.  Since it is newto the market, the long-term failure rates and potential complications areunknown.

 

***Manufacturing***

 

CIBA had soleresponsibility for manufacturing our products and the selection ofmanufacturing contractors subsequent to the March 2002 CIBA Agreement and untilthe January 2004 Transfer Agreement. Historically, the PSI had been manufactured to our specifications by anindependent contractor using a standard injection molding process.  The customized surgical instruments andother equipment previously sold by us were manufactured by independentcontractors that specialize in the production of these types of instruments andequipment.  As a result of the TransferAgreement, we will have to reestablish our own manufacturing capabilities.  However, we believe we have sufficientquantities of PSIs on hand to meet expected demand for the next 12 to 24 months.

 

***GovernmentRegulation***

 

Our primaryproducts are subject to regulation by governmental authorities in the UnitedStates and most other countries.  ThePSI received European Union CE Mark certification, which was issued to us, andother regulatory approvals were subsequently obtained in a variety of countriesaround the world.  As contemplated bythe CIBA Agreement, CIBA assumed responsibility for manufacturing and marketingthe PSI.  As a result of the transitionof

 

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our manufacturing responsibilities to CIBA, the modifications in thepackaging of the PSI and the resultant changes to those processes, the CE Markcertification we had obtained in 2000 on the PSI no long applies.

 

Under theTransfer Agreement, CIBA will provide certain transition support until December31, 2004, including continuing assistance to obtain CE Mark certification ofthe PSI for sale in the European Union. If CIBA obtains CE Mark certification, CIBA and we will enter into a technicalagreement, which will permit us to directly sell our products in CIBA packagingduring 2004 in the European Union. However, by the end of 2004, we will have to establish our own CE Markcertification on the PSI in order to continue any sales in the European Union.

 

**United States**

 

The PSI andthe PresVIEW Incision System are not currently approved for sale in the U.S.

 

In the UnitedStates, medical devices are subject to regulation by the FDA under the Food,Drug, and Cosmetic Act (the “FD&C Act”). The FDA regulates, among other things, the manufacture, distribution,study, and marketing of medical devices sold in the United States.  Under the FD&C Act, the FDA classifiesmedical devices into one of several classes depending on the risks that the FDAbelieves are associated with the device and the types of controls necessary toassure safety and effectiveness.  ThePSI is a Class III device and subject to the FDA’s most rigorous review.  The hand piece, as well as the blade, thatare part of the PresVIEW Incision System are also subject to the same review aspart of the FDA approval process.

 

Before the PSIcan be sold in the United States, FDA approval must be obtained through aPre-Market Approval (“PMA”) application. A PMA must be supported by extensive data, including preclinical andclinical trial data, that demonstrates the safety and effectiveness of thedevice.  Among other requirements, we orour contractors are required to manufacture and test our products in accordancewith Good Manufacturing Practices as specified in the regulations for suchdevices.  Both the manufacturer’sfacilities and the facilities used for packaging and testing of the PSI will besubject to periodic inspections by the FDA.

 

Prior toconducting the clinical trials in the United States, we were required to applyto the FDA for an Investigational Device Exemption (“IDE”). The IDE applicationmust include, among other things, a complete report of prior investigations,copies of all labeling, copies of all forms and informational materials used asa basis for obtaining informed consent, a description of the methods ofmanufacture, and a detailed description of the proposed clinical trial,including by way of example, the protocol, a risk analysis, monitoringprocedures and sites where the device will be tested.

 

We receivedapproval from the FDA in 2000 to conduct feasibility clinical trials of the PSIin the United States for the treatment of presbyopia.  The feasibility clinical trials were conducted at theBarnes-Jewish Hospital at Washington University School of Medicine in St.Louis, Missouri, the Dean A. McGee Eye Institute at the University of Oklahomain Oklahoma City, Oklahoma, the New York Eye and Ear Infirmary in New YorkCity, New York, the Jules Stein Eye Institute at UCLA in Los Angeles,California, the Stanford University School of Medicine in Stanford, Californiaand the Storm Eye Institute at the Medical University of South Carolina inCharleston, South Carolina.

 

The Phase Iclinical surgeries were performed during 2000 on 29 eyes at these sixsites.  We believe that the resultscontinue to demonstrate the safety of the SSP, since no significantcomplications were observed at any of the six clinical sites.  Patient data from three of the sitesgenerally demonstrated a good effect in improving near vision, while patientdata from the other three sites generally demonstrated much less of an effector no effect.  The Phase I surgicalprotocol required the surgeons to make the incisions to create the scleralpockets using manual diamond blades. The surgeons also attempted to place the incision at a predeterminedstandard distance behind the limbus (the line between the colored cornea andthe white of the eye).  While skilledsurgeons were selected to perform the clinical trials, subsequent observationdetermined that the location of the implant on the sclera and the depth of thescleral pockets varied from patient to patient.  Early during the study, we determined that a more consistentmeans of making the scleral incision would be required to provide consistentlygood surgical results.  As discussed, wehave developed an automated incision device, the PresVIEW Incision System,which more consistently determines the placement of the implant andautomatically makes an incision of the correct depth in the sclera.

 

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Of the 29patients, 14 patients had an increase in accommodative amplitude of 1.5diopters or more with a mean increase for these patients of more than 3.0diopters.  These results include 24month data for most of the 14 patients, but a minimum of 12 month follow-up onall 14 patients. The remaining 15 patients had a lesser effect or no effect.  The range of accommodative improvement forthe 14 successful patients was from 1.5 to 5.0 diopters.  A diopter is a measurement of the ability ofthe eye to accommodate or focus on close objects.  Generally, for a patient with normal distance vision, a 1.5diopter increase in the amplitude of accommodation will allow the patient tocomfortably read newspaper size print in good light.  An increase of more than 1.5 diopters will increase the patient’scomfort, and a higher increase in diopters of accommodation will allow the patientto read progressively smaller print in less than ideal lightingconditions.  Published investigationalstudies of “accommodating intraocular lenses” have generally reportedimprovements in accommodation limited to about 1.5 diopters.  We believe that the 14 successful cases demonstratethe potential for our surgical treatment. The next phase of the FDA clinicaltrials will include the use of the PresVIEW Incision System to try to improvethe outcomes of the SSP.

 

Thesecond-year annual IDE progress report relaying the 18-month patient results fromthe feasibility phase was submitted to the FDA in March 2002.  Modifications to the Phase II clinical trialprotocol and indications for use were proposed to the FDA in July 2002.  An IDE application was submitted to the FDAin March 2003 followed by amendments later in 2003.  The IDE protocol changes incorporated requests for a Phase IIclinical study population of 150 patients with a two-year follow-upperiod.  In December 2003, the FDAapproved the start of Phase II clinical trials conditioned on the submittal ofcertain final documentation.  In thisprospective, multi-center, randomized study, 100 patients will receive the SSPwith the PSI and 50 patients will be designated as control patients.  Phase II clinical trials began in the firstquarter of 2004.  The initial clinicaldata from the trials is expected to be submitted to the FDA within three to sixmonths after commencement.  Uponsubmission of the initial Phase II data to the FDA, and assuming successfuloutcomes, we anticipate that we will request FDA approval to start Phase III ofthe trials, resulting in a total of 330 eyes in the study.  Depending on the timing of the Phase IIsurgeries and the surgical results, the Phase III trial could begin in late2004 and would run concurrent with the initial stage of 150 patients.

 

The Phase IIIclinical results would be submitted to the FDA as soon as all patients in thetrial reach the one-year point.  At thispoint, it is anticipated that we will also have two-year follow-up results fromour Phase II clinical trial.  Allpatients would continue to be followed for a required two-year period.  After submission of the final PMA, includingthe clinical results, the FDA generally takes one year or longer to review andapprove a Class III device for sale in the United States.  For equivalent medical devices, the clinicaland regulatory process to FDA approval and commercialization can take three tofive years from the initiation of Phase II clinical trials.

 

We will alsobe required to submit an IDE, conduct separate clinical trials and submit afinal PMA to obtain approval of the PSI for the treatment of ocularhypertension and primary open angle glaucoma. If adequate funding is available, we will submit an IDE to the FDAduring 2004 requesting approval to begin a clinical trial of the SSP for thetreatment of primary open angle glaucoma and ocular hypertension.

 

**Europe**

 

The regulatoryenvironment in Europe for medical devices differs significantly from that inthe United States.  A total of 15European countries are grouped in a union with the objective of establishing asingle market without internal borders among the member countries andeliminating divergent national requirements. The members of the European Union (the “EU”) include Austria, Belgium, Denmark,Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands,Portugal, Spain, Sweden, and the United Kingdom.  In May 2004, Cyprus, the Czech Republic, Estonia, Hungary,Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia will join the current15 members.  Iceland, Liechtenstein,Norway and Switzerland are members of the European Free Trade Association.  Iceland, Norway and Liechtenstein are alsomembers of the European Economic Area.

 

Products thatcomply with the requirements of a specified EU medical directive are entitledto bear the CE Mark.  All commercialmedical device products are required to bear CE Mark certification.  It is illegal to market these products inthe EU without CE Mark certification. To obtain a CE Mark, the product must be assessed and found to conformto the applicable directive.  Thisassessment is carried out by the manufacturer, in most cases with the assistanceof a third-party certification organization known as a “notified body.”  The notified body assessment may consist ofan audit of the manufacturer’s quality system or specific testing of theproduct.  A manufacturer can sell aproduct throughout the EU once it secures an assessment by a notified body inone of the EU countries.

 

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The EU hasadopted several directives to regulate medical devices such as the PSI.  A manufacturer may affix the CE Mark after adetermination that the product complies with the essential requirements of theapplicable directives and completion of the appropriate conformity assessmentprocedures as specified by the directives. The conformity assessment requirements are based upon a given product’sclassification within the directive. Products within the scope of the directive are grouped within fourclasses: Class I, IIA, IIB and III.  Aproduct with a higher classification is considered to have higher risk, andwill, therefore, be subject to more controls in order to obtain the CEMark.  The PSI has been designated as aClass III device.

 

Essentialrequirements under the directives for the most stringent device, the Class IIIPSI, include substantiating that the device meets the manufacturer’sperformance claims and that any undesirable side effects of the device constitutean acceptable medical risk when weighed against the intended benefits of thedevice.  Certification under the ISO9000 series of standards for quality assurance and manufacturing processes isone of the CE Mark requirements.

 

There are twobasic options for assessing conformity of devices designated as Class III.  The first option allows a manufacturer toseek a decision from the notified body that the processes employed in thedesign and manufacture of a device qualify as a full quality system.  Alternatively, manufacturers can seekproduct certification based on various control schemes.  The full quality system encompasses theorganizational structure, responsibilities, procedures, processes and resourcesnecessary to assure quality assurance in design, development, production,installation and servicing of its medical devices.  Once a manufacturer has satisfactorily completed the regulatorycompliance tasks required by the directive and received a favorable decisionfrom the notified body, it may affix the CE Mark to its product.

 

Manufacturersare required to report serious adverse incidents concerning CE Marked devicesto the authorities of the countries where the incidents take place.  If such incidents occur, the manufacturermay have to take remedial action, perhaps even withdrawal of the product fromthe European market.

 

Our EUdistributor obtained “Own Brander” CE Mark certification for the PSI inNovember 1997.  This certificationinvolved a limited amount of clinical testing and review of the distributor’squality system.  The significance of theOwn Brander CE Mark is that the EU distributor is responsible for certainquality control issues and record keeping. For regulatory purposes, the product is considered to “originate” fromthe EU distributor, and we, in the United States, served as a manufacturingsubcontractor.

 

We wereawarded ISO 9001 and E46001 certification and our own CE Mark certification forthe PSI in January 2000.  We obtainedqualification of our processes as a full quality system.  During 2001, we formed a wholly-ownedsubsidiary, Presby Corp – Europe SPRL, organized under the laws ofBelgium.  The purpose of Presby Corp –Europe SPRL was to obtain and maintain “Own Brander” CE Mark certification onour products.  Presby Corp - Europe SPRLwas awarded the Own Brander CE Mark certification for the PSI in 2001.  Presby Corp - Europe SPRL was awarded CEMark certification for an early prototype of the PresVIEW Incision System andthe disposable blades in 2002.  We soldour products in the EU from late 1997, based on the EU distributor’s CE Markcertification, until termination of the distributor agreement in late2000.  Product sales in 2000 and 2001were based on our own certifications. We ceased direct sales of our products in 2001.  As a result of the transition of thosemanufacturing responsibilities to CIBA, the modifications in the packaging ofthe PSI and the resultant changes to those processes, the CE Mark certificationwe obtained on the PSI no longer applies.

 

CIBA has beenseeking CE Mark certification of the PSI for planned marketing in the EU byCIBA in early 2004.  The CE Markcertification of the PSI is still pending. The Transfer Agreement includes CIBA’s continuing efforts to obtain CEMark certification of the PSI, and if obtained, CIBA and we will enter into atechnical agreement whereby we can directly sell our products in CIBA packagingduring 2004 in the EU.  We cannot beassured that all regulatory requirements will be finalized and that CIBA canfinalize issuance of the CE Mark certification for our current PSI inventorysince the certification process requires extensive documentation of themanufacturing, packaging and other processes.

 

The PresVIEWIncision System is comprised of several components, which include the customdesigned snap-on drive unit and disposable blade that are covered by patentsheld by us.  The remaining components ofthe PresVIEW 

 

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Incision System include a power box, cable, hand held base driveassembly and footplate.  In late 2003,the manufacturers of these components received CE Mark certification forophthalmic applications.

 

**Canada**

 

The PSI is notcurrently approved for sale in Canada by Health Canada, the applicable Canadianregulatory agency.  Clinical trials ofthe PSI for the treatment of ocular hypertension and/or primary open angleglaucoma have been conducted at one Canadian facility.  The study of 27 patients was conducted byAaron Rifkind, M.D., Associate Clinical Professor of Ophthalmology at McMasterUniversity in Hamilton, Ontario.  Thestudy indication was “the reduction of IOP in patients with ocular hypertensionand primary open angle glaucoma.” The summary two-year results were presentedat the April 2003 meeting of the American Society of Cataract and Refractive Surgeryin San Francisco, California.

 

All 27patients were receiving one or more glaucoma medications prior to entering intothe study and at the time the pre-surgery IOP was measured.  All patients completed a three-week wash-outperiod of glaucoma medication to establish an unmedicated baseline IOP for thestudy.  The SSP was then performed on 27dominant eyes.  At six monthspost-operative, 16 subjects elected to have the SSP performed on their non-dominanteye as permitted by the protocol.  Afterthe SSP, if the IOP was greater than 25 mmHg, or there appeared to be a changein the optic nerve, the eye was treated with glaucoma medication.

 

At the18-month follow-up exam, the study data indicated a mean IOP decrease of 6.8mmHg. overall in the dominant eyes, which was 0.4 mmHg. lower than thepre-surgery IOP values.  The number ofglaucoma medications decreased from a mean of 1.7 to 0.7 medications pereye.  In the two-year follow-up exam,data was available for 23 dominant eyes, which had a mean IOP decrease of 7.1mmHg overall, which was 0.7 mmHg lower than the pre-surgery mean IOPvalue.  At the two-year point, 56% ofthe study patients were receiving no glaucoma medication.  Of the 44% of the patients receivingmedication, either for the non-operated eye or both eyes, a large majority werereceiving substantially less medication than prior to the study.  Near vision was also evaluated in thosepatients and it was found that there was an overall improvement in thepatients’ near visual acuity at 20 centimeters. There were no significantsurgical complications.

 

In November2002, CIBA and we submitted to Health Canada an application for approval tocommercialize the PSI in surgery for the treatment of ocular hypertension,primary open angle glaucoma and presbyopia applications.  On June13, 2003, Health Canada informed us that it had determined that thesample size submitted in our Class III submittal for the surgical treatment ofglaucoma and other ocular disorders was insufficient for approval, and deniedthe application.  Based on furtherdiscussions with Health Canada in October 2003, we will need to perform furtherclinical trials at more sites and with significantly more patients in order toreceive approval for commercial sales. We are uncertain, at this time, as towhen we may receive Health Canada’s approval, but we believe it will not beuntil at least 2005 before results of these additional clinical trials can beresubmitted.  Our immediate focus,however, is currently on the FDA clinical trials and not those in Canada.

 

***Research andDevelopment***

 

Research and development expenditures were approximately $109,000,$167,000 and $339,000 during the years ended December 31, 2003, 2002 and 2001,respectively.  The expenditures for allthree years were related primarily to the development of the PresVIEW IncisionSystem.  These expenditures for thePresVIEW Incision System will decrease in the future as development of thesystem has been completed, subject to modifications or improvements that mightbe made based on feedback from the use of the system in the FDA clinicaltrials.

 

Additionalexpenditures for research on a treatment for ARMD will be conducted by usprimarily on a consulting basis, and expenditures for this research are notexpected to be significant in the near term. We will also need to expend additional amounts for research to developthe SEVFL.  We believe that theseresearch and development costs will be very limited until we have adequate cashflow or other significant funding is obtained. Therefore, we believe that our research and development activities willnot result in a new revenue source in the near future.

 

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***Other Material Agreements***

 

**Dr. Schachar’sSeparation and Consulting Agreement**

 

On February25, 2003, Dr. Ronald A. Schachar, our founder and former Chief Scientist, andwe entered into a Severance, Release and Consulting Agreement (the “ConsultingAgreement”).  In accordance with theConsulting Agreement, Dr. Schachar resigned as an officer, director andemployee of us at the Merger Closing Date. We agreed to retain Dr. Schachar as a consultant for a period of up tofive years, and he agreed not to compete with us during that time.  Dr. Schachar will assist us in conductingresearch and development on our products for the treatment of ARMD for theinitial two years of the Consulting Agreement and will assist in themaintenance of our patent portfolio and other matters for the entire term ofthe Consulting Agreement.

 

Subject tocertain conditions, Dr. Schachar will be paid $1,750,000 over the consultingperiod, of which $950,000 will be paid in the first two years.  The timing of the remaining $800,000 due inyears three through five is partially dependent on our profitability in thoseyears;  however, Dr. Schachar isguaranteed to receive a minimum of $250,000, but not more than $400,000, foreach of the third and fourth years, with the remainder, if any, to be paid inthe fifth year.

 

As securityfor the payment of his consulting fees, we granted Dr. Schachar a non-exclusivesecurity interest in our patent rights relating to the ARMD device and theSEVFL.  Dr. Schachar also received anassignment of our patents for the ARMD device outside the United States, whichis revocable under certain conditions.

 

**VerusSupport Services Inc.**

 

On March 3,2003, we entered into an agreement with Verus Support Services Inc. (“Verus”),which was an advisor of ours involved in the March 6, 2003 privateplacement.  Pursuant to this agreement,Verus was to provide strategic advisory services to us for a period of one yearfor a monthly fee of $15,000.  Inconjunction with Merger Agreement, Verus agreed that in the event that we didnot successfully raise at least $1.0 million of additional capital within sixmonths of March 6, 2003, upon terms that were at least as favorable as theMarch 2003 private placement, that they would subscribe for and purchase, orcause to be subscribed for and purchased, that number of units at a price of$2.00 per unit in order to satisfy the deficiency between the amount ofadditional capital we successfully raised and $1.0 million.  Each unit purchased by Verus upon theoccurrence of this event would consist of a share of common stock and adetachable warrant to purchase one-half of a share of our common stock at anexercise price of $2.50 per share that expires three years from the date ofissuance.  In light of events sinceMarch 2003, we reached agreements with Verus to allow the deferral of the $1.0million contingent investment until January 6, 2004, in return for theirforgiveness of $60,000 in advisory fees for the same period.

 

In January2004, a dispute arose as to the continuing obligation of Verus under this agreement.  As a means of deferring and ultimatelyresolving this dispute, we entered into an amendment to our agreement tofurther extend to June 30, 2004, Verus’ obligation to raise up to $1.0 million.  Verus has advised us that its ability toprovide the original subscription amount at a stock price well above currentmarket is limited, and it indicated that current market conditions should beconsidered.  Therefore, we have agreedto amend the funding obligation to permit Verus to reduce its funding obligationby:

 

•                  the surrenderand cancellation of shares of our common stock and warrants to purchase sharesof our common that were issued to Verus or its affiliates, assigns ordesignees, or investors in the March 2003 private placement, based on the currentmarket price of our common stock,

•                  the waiver ofthe remaining $20,000 in advisory fees due to it under its existing agreement,

•                  the waiver of upto $60,000 in advisory fees that might become due to it during the extensionperiod, and

•                  an amount of $25,000that was received from an investor in a December 2003 private placement, sincethat investor was introduced to us by Verus.

 

Further, after the credit ofthese amounts to the funding obligation, Verus has agreed to subscribe for andpurchase, or cause to be subscribed for and purchased, an amount that willraise, at prevailing market prices, an amount equal

 

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to 1.25 times the remainingfunding obligation.  We believe thatthis agreement is in our best interest and may result in funding during thisextension period; however, we cannot be assured that Verus will not continue todispute this obligation.

 

**Kingsdale CapitalCorp.**

 

On March 4,2003, we entered into an agreement with Kingsdale Capital Corp (“Kingsdale”)which was an advisor of ours involved in both a March 2003 and a December 2003private placement.  Pursuant to thisagreement, Kingsdale was to provide strategic advisory services to us in Canadafor a period of one year for a monthly fee of $15,000.  Kingsdale has agreed to allow us to deferthe payment of its fees for services rendered since August 2003.

 

***Employees***

 

We currentlyhave four employees, including one person who oversees our FDA clinical trialsand three persons who perform executive and administrative functions.  We are not a party to any collectivebargaining agreement with a labor union, and we consider relations with ouremployees to be good.

 

***Cautionary Statements***

 

If any of thefollowing material risks occur, our business, financial condition and/orresults of operations would likely suffer.

 

**Risks Related to Our Business and Industry**

 

**As a result of theCIBA Transfer Agreement, we must reestablish our own marketing and other operationalfunctions, which will substantially increase our costs and potentially causedelays.**  InMarch 2002, CIBA and we entered into the CIBA Agreement pursuant to which wegranted CIBA, among other things, the right to use our patent rights and otherintellectual property rights in connection with the manufacture, marketing andsale of ophthalmic medical devices used in the treatment of presbyopia, ocularhypertension and primary open angle glaucoma. In January 2004, CIBA and we terminated the CIBA Agreement and CIBAtransferred all of its rights under that agreement back to us.  Prior to the termination of the CIBAAgreement, we were dependent on CIBA for the commercialization of our products,part of our future capital needs and other license obligations.  As a result of the Transfer Agreement, wenow need to reestablish our own manufacturing, marketing, distribution,regulatory, and other operational activities. We may determine that we prefer to establish strategic agreements withvarious third parties for some operations and perform other of these operationsinternally.  We can provide noassurances, however, that we will be able to establish agreements with thirdparties or successfully perform the transition of such operations within areasonable time.  Nor can we be sure ofour ability to finance such operations. Consequently, our business, financial condition and results ofoperations may be adversely affected.

 

**As a result of theTransfer Agreement, we will assume full management responsibility for the FDAclinical trials, and we have less experience and resources in those mattersthan CIBA, which could result in delays or problems. **Prior to the CIBA Agreement executed inMarch 2002, we managed the feasibility phase of the FDA clinical trials in theUnited States.  That phase of theclinical trials required a much longer period of time than we hadanticipated.  Under the CIBA Agreement,a joint technical committee of CIBA and our personnel would have managed theFDA clinical trials going forward.  CIBAretained a qualified consultant to assist in those matters.  As a result of the Transfer Agreement, wehave again assumed full responsibility for the FDA clinical trials and have alreadyretained the same consultant that was retained by CIBA.  However, our management personnel havesignificantly less experience in the management of FDA matters than CIBA.  We can provide no assurances that we cansuccessfully assume the management of the FDA clinical trials without incurringsignificant delays or substantial additional expense.

 

**The Transfer Agreementprovides that CIBA will continue its efforts to obtain CE Mark certification onthe PSI inventory, but if that certification is not issued, European Unionsales will be delayed. **CIBAhas been seeking CE Mark certification of the PSI for its planned marketingefforts in the European Union in early 2004. The

 

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CE Mark certification of the PSI is still pending.  The Transfer Agreement requires CIBA tocontinue its efforts to obtain CE Mark certification of the PSI.  If the CE Mark certification for the PSI isobtained, CIBA and we will enter into a technical agreement, which will allowus to directly sell our products in CIBA packaging during 2004 in the EuropeanUnion.  We cannot assure you, however, thatall regulatory requirements will be finalized and that CIBA can finalize theissuance of the CE Mark certification for our current PSI inventory.  The certification process requires extensivedocumentation of the manufacturing, packaging, and other processes.  If we are unable to provide all of thedocumentation required in order to meet the regulatory requirements, if suchdocumentation requires substantial expenditures by us, or if such documentationresults in significant delays, CIBA may be unable to obtain the CE Markcertification in order for us to market the PSI during 2004 in the EuropeanUnion.

 

**As a result of theTransfer Agreement, we will need to reestablish our own internationalregulatory processes, which will require management time and significantexpense.  **Priorto the CIBA Agreement executed in March 2002, we obtained CE Mark certificationof the PSI, which permits sales of the device in the European Union and certainother international locations.  Underthe CIBA Agreement, CIBA was responsible for regulatory matters outside theUnited States.  In accordance with theCIBA Agreement, we ceased all direct manufacturing and marketing of the PSI andrelated products.  As a result of thetransition of those manufacturing responsibilities to CIBA, the modificationsin the packaging of the PSI and the resultant changes to those processes, theCE Mark certification we had obtained in 2000 on the PSI is no longerapplicable.  As a result of the TransferAgreement, we will need to reestablish our own CE Mark certification on thePSI.  In addition, we will be requiredto manage the process of obtaining regulatory approval for our products inother international markets.  We haveretained consultants to assist us in that effort; however, this process is timeconsuming, requires considerable management effort and will be expensive.  Our failure to reestablish our own CE Markcertification for the PSI would prevent us from marketing our products in theEuropean Union after December 31, 2004. Further, failure to establish regulatory approvals in other internationalmarkets on a timely basis will have a material adverse effect on our financialcondition as well.

 

**As a result of theTransfer Agreement, we will need to reestablish manufacturing arrangements forthe production of the PSI to support future sales, or we will be unable tosupply the PSI after our current inventory is exhausted. **Prior to the CIBAAgreement, we manufactured a significant quantity of the PSI for futureuse.  We no longer have thosemanufacturing arrangements in place because CIBA assumed responsibility formanufacturing under the CIBA Agreement. Due to the sufficiency of the available PSI inventory, CIBA did notestablish an injection molding manufacturing arrangement during the term of theCIBA Agreement.  We believe that we haveadequate inventory of the PSI for our expected requirements over the next 12 to24 months.  Consequently, we mustreestablish an injection molding manufacturing source for production of the PSIbefore our current inventory is exhausted. The PSI is a precisely designed micro-engineered part that requiresspecial manufacturing expertise, especially to meet the regulatory requirementsfor use as a medical implant.  Theprocess of establishing manufacturing sources will be time consuming, requireconsiderable management effort and will be expensive.  In addition, the costs of producing the associated injectionmolds may be high.  There can be noassurances, however, that we will be able to reestablish these arrangements ina timely and cost-effective manner prior to our need for additional PSI inventory.  An inability to establish these arrangementscould have a material adverse effect on our future sales.

 

**As a result****of theTransfer Agreement, we will need to reestablish our own marketing anddistribution arrangements, which will take time and increase our costs. **Prior to the CIBA Agreement, wemarketed our products through distribution agreements in various countriesoutside the United States.  Those distributionagreements provided the distributor with a commission based upon a percentageof the sales price.  Under the CIBAAgreement, CIBA was responsible for worldwide marketing and distribution of ourproducts and, thus, all of our previous distribution arrangements wereterminated.  As a result of the TransferAgreement, we will be required to reestablish distribution agreements for theinternational marketing and distribution of our products.  We may, however, seek to market our productsdirectly, especially in the European Union, during 2004.  We may also establish other distribution,license or strategic arrangements on a global or regional basis.  We can provide no assurances, however, thatwe will be able to reestablish new distribution and marketing arrangements in atimely and cost effective manner, and our failure to do so would have amaterial adverse effect on our business.

 

**As a result****of theTransfer Agreement, we may need to reestablish our own product developmentefforts, which will take time and increase our costs. **During the term of the CIBA Agreement, CIBA devotedsubstantial internal resources and manpower, including hiring severalconsultants, to resolve problems with, and substantially finalize thedevelopment of, the PresVIEW Incision System. Although we believe development of the PresVIEW

 

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Incision System is complete, additional development or enhancements maybe identified as the PresVIEW Incision System is further used in the SSP.  We are in the process of retaining several ofthe consultants used by CIBA to finalize the development of the system, buthave not completed all of those arrangements. If significant development issues are later identified that requirematerial financial resources, or if the consultants are not available to us onterms acceptable to us, or at all, to resolve any issues, it would have amaterial adverse effect on our business.

 

**If we do not receive and maintain regulatoryapprovals for our products, we will not be able to market and sell our products**.  We cannot market and sell our products orsurgical procedure in the United States until the products receive approvalfrom the FDA, and there can be no assurance that we will receive the necessaryapprovals.  Before receiving FDAclearance to market and sell a product, we must demonstrate that the product issafe and effective in the patient population that will be treated for specificindications.  Negative or inconclusiveresults or adverse medical events during a clinical trial could cause aclinical trial to be repeated, a program to be terminated or delays in receivingapproval.  We have limited experience inconducting or managing the clinical trials necessary to obtain regulatoryapproval.  Instead, we rely onthird-party clinical investigators to conduct our clinical trials and otherthird-party organizations to perform certain other tasks.  As a result, we may face additional delayingfactors outside our control.  Inaddition, delays or rejections may be encountered based upon additionalgovernmental regulation from future legislation, administrative action orchanges in FDA policies or interpretations during the period of productdevelopment, clinical trials or FDA regulatory review.  Therefore, the actual time and expendituresrequired to pursue FDA approval are beyond our control and cannot be predicted.

 

We receivedapproval for, and have conducted, feasibility clinical trials in the UnitedStates on the PSI for the treatment of presbyopia.  We submitted the clinical trial data to the FDA and filed aninvestigational device exemption application with the FDA in March 2003 toobtain approval for initiating Phase II clinical trials.  We subsequently filed amendments to thatapplication and received approval to start our Phase II clinical trials inDecember 2003, subject to certain final documentation.  The FDA may decline to authorize additionalclinical trials after the Phase II trials or may substantially delay thosetrials for a variety of reasons.  Wealso plan to submit an application to the FDA to conduct clinical trials on thePSI for the treatment of ocular hypertension and primary open angle glaucoma.  The FDA may not approve the proposed studyor may significantly delay the study, if approved.

 

Sales ofmedical devices outside the United States are subject to regulatoryrequirements that vary by country.  Thetime required to obtain approval may be shorter or longer than the timerequired for FDA consideration and involve complexities of dealing with avariety of international governmental regulations.  We have limited experience in dealing with the specificregulations that must be met to sell our medical devices in certaininternational markets.  The failure toobtain the necessary regulatory approvals on a timely basis may have a materialadverse effect on our business, financial condition and results of operations.

 

**We will requireadditional financing to conduct our operations and fund our FDA clinicaltrials. **We donot currently have sufficient financial resources to fund our operations forthe next twelve months.  In addition, wewill require substantial additional capital to fund our future operations andconduct our FDA clinical trials over the next several years.  Therefore, we may be required to seek additionalfunding through collaborative arrangements with corporate partners and throughpublic or private debt or equity financings. Any additional equity financing may be dilutive to stockholders.  Any debt financing, if available, may involverestrictions on our ability to pay dividends on our capital stock, be dilutivedue to possible conversion features or attached warrants, or restrict themanner in which we conduct our business. We can give you no assurances, however, that additional funding will beavailable in sufficient amounts, on terms acceptable to us, or at all, whenneeded.  Our ability to obtainadditional financing depends on many factors, some of which are beyond ourcontrol, including the state of the capital markets, the market price of ourcommon stock and the prospects for our business.  The inability to obtain sufficient funds may require us to delay,scale back or eliminate some or all of our research and product developmentprograms, clinical studies and/or regulatory activities or may cause us tocease our operations.

 

**We rely on third-party sales, marketing,manufacturing, training and customer service, which may have a material adverseeffect on our business.**  We have a limited staffof four full-time persons and rely on a number of independent consultants.  We have no sales, manufacturing, training orcustomer service staff.  We havemarketed and sold only a relatively small number of PSIs.  As a result of the Transfer Agreement, wewill have to develop new arrangements with third parties or hire a significantnumber of new staff, either of which may result in substantially

 

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higher costs or lower revenues to us.  We may be unable to hire qualified staff ormay be unable to retain qualified consultants to perform these functions, whichcould result in a material adverse effect to our business.

 

**We have a limited operating history, a singleunproven product to date, a history of net losses, and our business may never becomeprofitable.**** **We have spent the past nine yearsconcentrating our efforts on the development of the PSI and the relatedsurgical procedure for the correction of presbyopia and, more recently, for thetreatment of ocular hypertension and primary open angle glaucoma.  Sales of the PSI are pending approval of theproduct by the FDA in the United States and by other regulatory authorities inother countries.

 

Our limitedhistory may not be adequate to enable you to fully assess our ability toachieve market acceptance of our products or our ability to respond tocompetition.  Accordingly, we aresubject to the same uncertainties and risks associated with any companydeveloping new products and beginning operations.  If we are unsuccessful in addressing the risks and uncertaintiesfrequently encountered by early stage companies in a new and evolving market,our business will be seriously harmed.

 

We haveincurred losses every year since we began operations.  As of December 31, 2003, our accumulated deficit was $22.6million, including a net loss of $5.7 million for the year ended December 31,2003.  These losses have resultedprimarily from expenses associated with research and development activities,pre-clinical and clinical trials, obtaining regulatory approvals ininternational markets and general and administrative expenses.  We anticipate our operating expenses willincrease substantially for the foreseeable future as we expand our FDA clinicaltrials in the United States and assume functions formerly performed by CIBA.

 

To becomeprofitable, we must be able to generate revenues from product sales.  We have not had any significant revenuessince 2000.  For the next several years,our revenues will be dependent on the SSP for the treatment of presbyopia, ocularhypertension and primary open angle glaucoma utilizing our patented PSI and thePresVIEW Incision System.  There can beno assurance that the PresVIEW technology will be proven safe and effective orthat, if proven safe and effective, the technology will be successfullycommercialized.  To improve the surgicaloutcomes of the SSP, we developed the PresVIEW Incision System, which webelieve consistently produces incisions of accurate length and depth for theplacement of the PSI.  We believe thatthe development of this device has been completed, subject to continuedenhancements as surgeons use the PresVIEW Incision System in the SSP.  Any unexpected problems with the PresVIEWIncision System would cause additional delays in our ability to market our primaryproduct, the PSI.

 

If substantialgrowth in our revenues does not occur, we may not be able to achieve ormaintain profitability in the future. The amount of losses we will incur before achieving profitability, andthe time required to reach profitability, are each highly uncertain.  No assurances can be given that we will everachieve profitability.

 

**The components of the PresVIEW IncisionSystem and the related disposable blade are available only from single sources,and other sources may not be available or they may not properly provideproducts.**  Under the CIBA Agreement, these items wereprovided through suppliers established by CIBA.  Although CIBA will provide transition services under the TransferAgreement, we have not yet entered into supply contracts with thesesources.  If one or more of thesevendors are lost, delivery of our products could be delayed or prevented andour business would suffer.  If we areunable to produce our products in a cost-effective or timely manner, or if themanufacturing of our products is interrupted, our business, financial conditionand results of operations could be materially adversely affected.

 

Many of themanufacturing processes require a significant degree of technicalexpertise.  If these third-party vendorsand manufacturers fail to produce to our specifications or inadvertently usedefective materials in the manufacturing process, the reliability andperformance of our products will be compromised.

 

**We are dependent on our management, keypersonnel and consultants, and may be dependent on the recruitment ofadditional personnel to succeed; and the loss of personnel or consultants maydamage our business.** Our principal executive officers, consultants and key personnel haveextensive knowledge of our PresVIEW technology, the PresVIEW Incision Systemand the research and development efforts needed to bring the products tomarket.  The loss of the services of anyof our executive officers or other key personnel or consultants could have amaterial adverse effect on our business and financial condition.

 

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In light ofthe transition of certain operations from CIBA to us, our success and businessstrategy will likely depend in large part on our ability to attract and retainkey management, scientific and operating personnel.  We may need to develop expertise, add skilled personnel and/orretain consultants in the areas of research and development, clinical trials,government regulatory approvals, sales, marketing and manufacturing.  These persons are in high demand and areoften subject to competing employment offers. There can be no assurances that we will be able to attract and retainqualified personnel or develop the expertise needed for our business.  We currently have a small management groupwith limited operating experience.  Theinability to hire additional personnel and develop expertise as needed couldhave a material adverse effect on us.

 

**We face various international risks that maycause an increase in costs.  We facerisks due to our expected reliance on sales in international markets**.  Ourfuture success will depend in part upon our ability to recommence ourinternational marketing operations and our ability to expand internationalsales of the PSI.  International salesmay be our only source of revenue for the next several years while we seek FDAapproval of our products in the United States. International operations expose us to risks, including:

 

•                  need for exportlicenses;

•                  unexpectedregulatory requirements;

•                  tariffs andother potential trade barriers and restrictions;

•                  political, legaland economic instability in foreign markets;

•                  longer accountreceivable cycles;

•                  difficulties inmanaging operations across disparate geographic areas;

•                  foreign currencyfluctuations;

•                  reduced orlimited protection of our intellectual property rights in some countries;

•                  dependence onlocal distributors; and

•                  potentialdisruptions in sales or manufacturing due to military or terrorist acts.

 

If one or more of these risksmaterialize, our sales to international customers may be less than expected andcosts may be more than expected, which could negatively impact our financialcondition.

 

**Due to our dependence on the PSI, failure toachieve market acceptance in a timely manner could harm our business. **Even if regulatoryauthorities approve our products, the PSI and the PresVIEW Incision System maynot be commercially successful. Acceptance of, and demand for, the PSI and the PresVIEW Incision Systemwill depend largely on the following factors:

 

•                  safety andeffectiveness for all targeted indications (i.e., presbyopia, primary openangle glaucoma and ocular hypertension);

•                  awareness andacceptance by ophthalmologists and patients of our product as safe and effective;

•                  safety,effectiveness and pricing of alternative products;

•                  prevalence andseverity of side effects associated with our product;

•                  the possibilityof unknown side effects;

•                  pricing of ourproduct to both the ophthalmic community and the consumer;

•                  our ability todecrease the technical skill level of surgery required for outstanding outcomesvia the standardization and automation steps provided by the PresVIEW IncisionSystem;

•                  the amount oftraining required for the proper use of the PresVIEW Incision System andinsertion of the PSI;

•                  the generalresistance to implanting a foreign object in the eye;

•                  the lack oflong-term follow-up data;

•                  the degree ofusage by the ophthalmic community as a treatment alternative;

•                  how quicklycompetitors can develop and obtain FDA approval for competitive treatmentmethods;

•                  successfulseeding efforts with noted physicians and commercialization in Europe and otherinternational markets preceding FDA approval; and

•                  resolutionand/or clarification of the various scientific theories of what causespresbyopia and the specific mechanism of action involved in the SSP.

 

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Because all ofour revenues over the next several years are projected to come from the sale ofthe PSI and related products, our financial performance will depend uponophthalmologists’ adoption and patient awareness of the SSP.  If we are unable to convinceophthalmologists to use the PSI, we may not be able to generate revenuesbecause our other product candidates are not ready, and may never be ready, forcommercialization.

 

In order forus to sell our products, ophthalmologists must recommend and endorse them.  We may not obtain the necessaryrecommendations or endorsements from ophthalmologists.  Acceptance of our product is dependent uponeducating the ophthalmic community as to the distinctive characteristics,perceived benefits, clinical efficacy and cost-effectiveness of our productcompared to competitive products and on training ophthalmologists in the properapplication of our product and the surgical techniques of the SSP.  No assurances can be given that the medicalcommunity or the patients will accept the SSP over current conventional treatments.

 

**If we fail to keep pace with advances in ourindustry or fail to persuade physicians to adopt new products that weintroduce, customers may not buy our products and our revenues and profits maydecline**.  The ophthalmic industry is characterized bythe following: rapid product development, with a significant competitive advantagegained by companies that introduce products that are first to market; constantinnovation in products and techniques; frequent new product introductions; andprice competition.

 

Our futuregrowth depends, in part, on our ability to develop products that are moreeffective in treating diseases and disorders of the eye or that incorporate thelatest technologies.  In addition, wemust be able to manufacture and effectively market those products and persuadea sufficient number of eye care professionals to use the new products that weintroduce.  Many doctors are reluctantto switch a patient to a new treatment. For example, ophthalmologists may be reluctant to cease a patient’scurrent treatment for glaucoma if the current treatment remains effective.  Also, sales of our existing products maydecline rapidly if a new product is introduced by one of our competitors or ifwe announce a new product that, in either case, represents a substantialimprovement over our existing products. Similarly, if we fail to make sufficient investments in research anddevelopment programs or if we focus on technologies that do not lead to moreeffective products, our current and planned products could be surpassed by moreeffective or advanced products.

 

**We are subject to extensive governmentalregulation that increases our costs and could prevent us from, or delay us in,selling our products**. Our products (including the PSIand the PresVIEW Incision System) are subject to extensive governmentalregulation.  Governmental regulationincludes inspection of, and controls over, testing, manufacturing, safety andenvironmental controls, efficacy, labeling, advertising, promotion, recordkeeping and the sale and distribution of medical device products andsamples.  We are also subject to similargovernmental regulation that affects the prices we will charge, the rebates wemay offer to customers and the methods of our marketing.  Governmental regulation substantiallyincreases the cost of developing, manufacturing and selling our products.

 

We arerequired to obtain the approval of regulatory agencies worldwide before we canmarket and sell the PSI or other products and to undergo rigorous inspectionsby these agencies.  In the UnitedStates, we must obtain FDA approval or clearance for each medical device beforethe devices can be marketed and sold. The FDA approval process is typically lengthy and expensive, andapproval is never certain.  In order toobtain these approvals, our products must be shown to be effective and safe foruse in humans.  In addition, productsdistributed outside of the United States are subject to governmentalregulation, which may be equally or more demanding.  Our products could take a significantly longer time than we expectto gain regulatory approval or may never gain approval.  If a regulatory authority delays approval ofa product, our market value and operating results may decline.  Even if the FDA or another regulatory agencyapproves a product, the approval may limit the indicated uses for a product ormay otherwise limit our ability to promote, sell and distribute a product.  A regulatory agency may requirepost-marketing studies.  If we areunable to obtain regulatory approval of our products, we will not be able tomarket these products, which would result in a significant shortfall in oursales.  Currently, we are pursuing CEMark certification of our products from regulatory authorities for sale of ourproducts in the European Union.  We arealso seeking FDA and Health Canada approval for the sale of our products in theUnited States and Canada.  Growth in oursales will depend on the timely and successful introduction and marketing ofsome or all of our products.

 

The clinicaltrials required to obtain regulatory approvals are complex and expensive, andtheir outcomes are uncertain.  We haveincurred, and will continue to incur, substantial expense for, and willcontinue to devote significant time to, clinical trials, but we cannot becertain that the trials will ever result in the commercial sale of a product.

 

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Positive results from pre-clinical studies and early clinical trials donot ensure positive results in later clinical trials that form the basis of anapplication for regulatory approval.  Wemay suffer significant setbacks in clinical trials, even after earlier clinicaltrials show promising results.  Any ofour products may produce undesirable side effects that could cause us orregulatory authorities to interrupt, delay or halt clinical trials. The FDA,another regulatory authority or we may suspend or terminate clinical trials atany time if they or we believe that the trial participants face unacceptablehealth risks.

 

We are alsorequired to demonstrate compliance with the FDA’s quality system regulationsbefore we can receive FDA approval for the PSI and the PresVIEW IncisionSystem.  The FDA enforces its qualitysystem regulations through pre-approval and periodic post-approvalinspections.  These regulations relateto product testing, vendor qualification, design control, product manufacturingand quality assurance, as well as the maintenance of records anddocumentation.  If we are unable toconform to these regulations, we will be required to locate alternativemanufacturers that do conform. Identifying and qualifying alternative manufacturers may be a long anddifficult process and the delays could seriously harm our business.

 

Medicaldevices are also subject to post-market reporting requirements.  If safety or efficacy problems occur afterthe product reaches the market, the FDA may take steps to prevent or limitfurther marketing and sales of the product. Additionally, the FDA actively enforces regulations prohibitingmarketing of devices for indications or uses that have not been cleared orapproved by the FDA.

 

Noncompliancewith applicable United States requirements can result in fines, injunctions,penalties, disgorgement of profits, mandatory recalls or seizures, suspensionsof production, denial or withdrawal of pre-marketing approvals, marketingrestrictions, recommendations by the FDA against governmental contracts,criminal prosecution or clinical trial delays. The FDA also has the authority to request repair, replacement or refundof the cost of any device that we manufacture or distribute.  Regulatory authorities outside of the UnitedStates may impose similar sanctions against us for noncompliance withapplicable regulatory requirements.  Noassurances can be given that restrictions, sanctions or findings by one of theworldwide regulatory agencies will not result in similar or stronger actions byother regulatory agencies, including the FDA.

 

**We currently lack long-term data regardingthe safety and efficacy of our product and may find that long-term data doesnot support our short-term clinical results**.  TheSSP is a new technology with only a relatively limited number of clinical casesto date.  The long-term effects, if any,of the procedure have not been determined. The human eye may or may not tolerate the presence of the PSI.  The PSI may ultimately result in undesirableside effects or medical complications. We are unaware of any patient who has suffered any significant damage totheir vision or experienced any serious complications in the investigationalsurgeries conducted to date.  Thecomplications experienced to date appear to be minor and related to theevolution of the surgical technique. Further clinical testing of the PSI could reveal other complications andside effects, which could bear on the long-term safety and efficacy of the PSI,any of which could have a material adverse effect on our business.  There can be no assurances, therefore, thatthe PSI and the related surgical procedure will not result in latent complicationsor that our belief that the SSP is fully reversible in all patients will beconfirmed by clinical experience.

 

**We face competition from alternativetherapies, and sales of our products may be less than our expectations**.  We compete with many domestic and foreigncompetitors, who conduct business in various rapidly evolving andtechnologically advanced fields, including medical device, pharmaceutical andbiopharmaceutical companies.  Forexample, in the worldwide presbyopia market, the PSI will compete with readingglasses, bifocals, multifocal glasses, and the bifocal and multifocal contactlens industry, as well as alternative surgical techniques, such as the implantof “accommodating” intraocular lenses. There are world leaders in these markets, such as: Varilux, Bausch &Lomb, Vistakon (a subsidiary of Johnson & Johnson), Alcon, Allergan andVISX.  For the treatment of ocularhypertension and primary open angle glaucoma, we will compete with majorpharmaceutical companies, including Alcon, Allergan, Bausch & Lomb, Merckand Pfizer.  These competitors maydevelop technologies and products that are more effective, easier to use orless costly than any of our current or future product candidates or that couldrender our technologies and product candidates obsolete or noncompetitive.  Many of these competitors have substantiallymore resources, as well as more product development, manufacturing andmarketing experience and capabilities, than we do.  In addition, many of our competitors have significantly greaterexperience than we do in conducting pre-clinical testing, clinical trials andin obtaining FDA and other regulatory approvals of products and therapies.

 

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The visioncorrection industry is intensely competitive. The significant competitive factors in the industry include price,convenience, acceptance of new technologies, patient satisfaction, andgovernment approval.  Our ability tocompete successfully depends, in part, on our ability to respond quickly tomedical and technological change and user preference through the developmentand introduction of new products that are of high quality and that addresspatient and surgeon requirements.  Wecompete with many larger companies that enjoy several competitive advantages,including established distribution networks; established relationships withhealth care providers and payors; additional lines of products; the ability tobundle products to offer higher discounts or other incentives to gain a competitiveadvantage; and greater resources for product development, sales and marketingand patent litigation.  If we are unableto compete effectively against existing or future competitors, sales of ourproducts may be significantly less than our expectations.

 

Othercompanies are developing products based on the same or similar scientifictheories used by us.  Those products maybe more effective than our products and may not infringe our intellectualproperty rights.  These companies may beable to develop a surgical technique that does not require the use of any implantdevice to achieve the same or similar surgical result.

 

**We may not successfully develop and launchreplacements for our products that lose patent protection, which couldsignificantly decrease our future sales and profits**.  Mostof our products are covered by patents that give us a degree of marketexclusivity during the term of the patent. Significant patents covering our products will expire within the next 8to 14 years.  Upon patent expiration,our competitors may introduce products using the same technology.  As a result of this possible increase incompetition, we may need to charge a lower price in order to maintain sales ofour products, which could result in these products becoming lessprofitable.  If we fail to develop andsuccessfully launch, and receive regulatory approval for, more advancedreplacement products prior to the expiration of patents for our existingproducts, our sales and profits with respect to those products could declinesignificantly.  We may not be able todevelop and successfully launch more advanced replacement products before theseand other patents expire.

 

**Resources devoted to research and developmentmay not yield new products that achieve commercial success, and we would bedependent only on the PSI for sales.**  Inthe past, we have devoted substantial resources to research anddevelopment.  In the foreseeable future,we plan to devote relatively less resources to research and development.  The research and development process isexpensive, prolonged and entails considerable uncertainty.  Development of a new product, from discoverythrough testing and registration to initial product launch, typically takesbetween four and ten years for a medical device.  These periods vary considerably from product to product andcountry to country.  Because of thecomplexities and uncertainties associated with ophthalmic research and development,products we are currently developing may not complete the development processor obtain the regulatory approvals required for us to market these productssuccessfully.  None of the productscurrently in our development pipeline may be commercially successful.  We are dependent on Dr. Ronald A. Schacharto conduct research and development on the ARMD product for us.  He may be unsuccessful in his efforts or maynot devote adequate time to that project resulting in our inability tocommercialize that product.

 

**Surgeon training and the ability of surgeonsto routinely achieve a good surgical result for virtually all patients isimportant to our success**.  Failure, for any reason,by surgeons to achieve good results will harm our business.  During the course of the development of thePSI, the PresVIEW Incision System and the related surgical procedure, thesurgical technique and surgical instruments have evolved and changed as weattempted to make the surgical procedure easier for the surgeon toperform.  The SSP, while using surgicalskills similar to other ophthalmic surgical procedures, is a relatively newsurgical technique that requires training and precise execution by thesurgeon.  Some surgeons were not able tosuccessfully use earlier prototypes of the PresVIEW Incision System.  Some surgeons have not been able tosuccessfully place the PSI in the sclera of the eye to achieve the necessary effect.  Certain of these surgeons have chosen topublish their unsuccessful clinical results.

 

It is criticalto our sales effort to train a sufficient number of physicians to properlyperform the SSP.  We will need toeducate ophthalmic surgeons through presentations at international conferencesand through surgical training courses. If physicians are not properly trained, they may misuse or ineffectivelyuse our products, resulting in unsatisfactory patient outcomes, patient injuryand related liability or negative publicity. If we are not successful in adequately

 

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training surgeons, or perhapsin further improving the technique and surgical instruments so that all surgeonswith the requisite skills can routinely obtain good surgical results, ourbusiness will be significantly harmed.

 

**We may be subject to future product liabilitylitigation that could be expensive and may result in the inability to obtaininsurance coverage**.  The manufacture, distribution andsale of medical devices is inherently subject to the risk of product liabilityclaims.  We use appropriate efforts totake reasonable precaution in the handling, testing, packaging and distributionof the product to minimize potential liability.  Nonetheless, it is possible that we may become subject tolitigation involving the PSI, both in domestic and international markets.  We have provided, and may continue toprovide, certain limited indemnities to academic or other institutions that areparticipating in the FDA clinical trials.

 

We haveobtained $5.0 million in product liability insurance coverage.  The coverage is on a claims made basis andhas a retroactive effective date to the date of incorporation of Ocular inAugust 1994.  Despite such coverage, wemay be subject to claims that exceed the insurance coverage, and these claimsmay have a material adverse effect on us. In addition, we may require additional product liability coverage ifsales of our products increase.  Productliability insurance is expensive and may not be available to us in the futureon acceptable terms, or at all.  We havenot been subject to any product liability litigation to date.

 

Although weare not currently subject to any product liability proceedings, we may incurmaterial liabilities relating to product liability claims in the future,including product liability claims arising out of procedures performed usingthe PSI or our surgical equipment.  Thecombination of our insurance coverage and cash flows may not be adequate tosatisfy product liabilities we may incur in the future.  Even claims without merit could subject usto adverse publicity, hinder us from securing insurance coverage in the future andrequire us to incur significant legal fees. Successful product liability claims could have a material adverse effecton our financial condition as well.

 

**We may be subject to future claims fromphysicians who disagree with our return policy, and we may incur unexpectedexpenses to resolve the complaints**.  Anumber of ophthalmologists with practices based in the United States purchasedsurgical kits, including the PSI, at international locations.  While certain of these physicians conductedinvestigational surgeries at international locations for the purpose ofresearch, many of these physicians purchased our products with a desire toparticipate in the anticipated clinical trials of the PSI, which are regulatedby the FDA.  All of these physicianswere aware that the PSI was not approved by the FDA for use in the UnitedStates at the time of their purchase. We did not sell the products with a right of refund.  Nevertheless, several of these ophthalmologistshave requested a refund or have informed us that if they are not selected toparticipate in the clinical trials, they plan to return the products with arequest for a refund.  We cannot ensurethat all these physicians will be selected to participate in the clinicaltrials.  We did not sell our productswith a right of refund and do not believe that we have any liability to refundthe cost of these products.

 

As a result ofour continued suspension of sales, we have been notified by two of our foreigndistributors that they are seeking refunds on unsold products remaining intheir inventory.  We did not sell ourproducts with a right of refund and do not believe that we have any liabilityto refund the cost of these products.

 

As a result ofthe Transfer Agreement, we will be responsible for all future marketing.  As part of future marketing programs in theUnited States and internationally, we may determine that it is in our bestinterest to provide some compensation in the form or product discounts or byother means to the surgeons who bought our kits, and did not get to participatein the FDA trials, or to foreign distributors of our products.  At this time, we are currently unable todetermine the amount of possible compensation, if any, that we may agree to payin the future.

 

We establisheda reserve of $50,000 at December 31, 2001, as an estimate of the cost ofproviding replacement PSIs to physicians that might have PSI inventory onhand.  We had encouraged thesephysicians not to perform any surgeries until the PresVIEW Incision System wasavailable.  The packaging of the PSIprovided guaranteed sterility only for a limited period of time, and thatsterility dating has expired.  We maydecide to replace the PSI inventory of these physicians with new PSIs when theyare again able to perform the SSP, or, rather than replace all the expiredinventory, we may instead grant special pricing on future purchases to thesephysicians.  Actual claims may exceed,and/or the cost of replacing the PSIs may be higher than, our estimate and additionalcharges may have to be taken.

 

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**Failure by users of our products to obtainadequate reimbursement from third-party payors could limit market acceptance ofour products, which could impact our sales and profits. **The initiatives of managed care organizationsand governments to contain healthcare costs in the United States and elsewhereare placing an increased emphasis on the delivery of more cost-effectivemedical therapies. This emphasis could adversely affect sales and prices of ourproducts.  For example:

 

•                                          majorthird-party payors for hospital services, including government insurance plans,Medicare, Medicaid and private healthcare insurers, have substantially revisedtheir payment methodologies during the last few years, resulting in stricterstandards for reimbursement of hospital and outpatient charges for some medicalprocedures, including cataract and intraocular lens procedures.  Because of increased transparency of pricesfollowing the adoption of the euro, member governments in some countries in theEuropean Union are requesting price reductions to match prices charged in othercountries in the European Union;

•                                          numerouslegislative proposals have been considered that, if enacted, would result inmajor reforms in the United States healthcare system;

•                                          ourcompetitors may reduce the prices of their products, which could result in ourcompetitors being reimbursed for a larger number of procedures by third-partypayors;

•                                          thereare proposed and existing laws and regulations governing product prices and theprofitability of companies in the health care industry; and

•                                          therehave been recent initiatives by third-party payors to challenge the pricescharged for medical products, which could affect our profitability.

 

Surgicalprocedures to improve vision that are currently available, such as laserrefractive surgery, are generally not reimbursable by third-party payors.  We believe that third-party payors will notprovide reimbursement to patients for the SSP if the procedure is undergone forthe treatment of presbyopia. Third-party payors or government insurance programs may provide somelevel of reimbursement to patients that undergo the SSP for the treatment ofocular hypertension or primary open angle glaucoma.  In the United States, this reimbursement may not be availableimmediately at FDA approval or, if available, any reimbursement may be limited,thereby adversely affecting our ability to sell our medical devices on aprofitable basis for the treatment of ocular hypertension or primary open angleglaucoma.  Further, an adverse coveragedecision by the Centers for Medicare and Medicaid Services, the United Statesgovernment agency that oversees the Medicare and Medicaid programs, couldadversely influence private insurers, as well as other public payors.

 

Reductions inthe prices for our products in response to the trends noted above could reduceour profits.  Moreover, the SSP for thetreatment of ocular hypertension and primary open angle glaucoma may not be coveredin the future by third-party payors. Consequently, ophthalmologists, out-patient surgical facilities,hospitals and other health care providers may be reluctant to purchase ourproducts if they do not receive substantial reimbursement for the cost of ourproducts and for procedures performed using our surgical medical deviceproducts from third-party payors, including Medicare and Medicaid in the UnitedStates and health insurance programs, both governmental and private.  Therefore, the failure of our products to beso covered could cause our profits to decline.

 

Since the SSPtreats presbyopia, as well as ocular hypertension and primary open angleglaucoma, a decline in the price of the PSI due to price pressures bythird-party payors could result in a price decline for the PSI used in thetreatment of the other indication.

 

**Economic conditions and price competition maycause sales of our products used in elective surgical procedures to decline andreduce our profitability.**  Sales of our productsused in elective surgical procedures may be adversely impacted by economicconditions.  Generally, the costs ofelective surgical procedures are borne by individuals without reimbursementfrom their medical insurance providers or government programs.  Accordingly, individuals may be less willingto incur the costs of these procedures in weak or uncertain economic conditionsand, therefore, there may be a decline in the number of these procedures.  Sales of the PSI worldwide may come underpressure if weak economic conditions exist and, therefore, our revenues wouldlikely be negatively impacted.

 

**We may be required to bring litigation toenforce our intellectual property rights, which may result in substantialexpense**.  Werely on patents to protect our intellectual property rights.  We have 18 issued United States patents and20 issued or published international patents. We have 14 pending United States patent applications and

 

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56 pending international patent applications.  Related only to the PresVIEW technology, we have 11 issued UnitedStates patents, 15 issued or published international patents, 9 pending UnitedStates patent applications and 51 pending international patentapplications.  The patents associatedwith the PresVIEW technology have expiration dates ranging from 2012 to2020.  The patents and patentapplications related to our early stage products generally do not expire untilafter 2015.  The strength of our patentportfolio, however, could be challenged. In particular, our competitors and others may allege that:

 

•                                          ourpatents and pending patent applications use technology that we did not inventfirst, or

•                                          wewere not the first to file patent applications for these inventions.

 

Further, becauseof the uncertain nature of patent protection, we cannot be certain that:

 

•                                          otherswill not independently develop similar or alternative technologies or duplicateour technologies;

•                                          otherswill not develop enhancements to our technology that are beneficial to us,which we may not be able to utilize unless we license or pay compensation forthose enhancements;

•                                          anyof our pending patent applications will result in further issued patents; or

•                                          anypatents issued to us will provide a basis for commercially viable products,will provide us with any competitive advantages or will not face third-partychallenges or be subjected to further proceedings limiting their scope.

 

We may becomeinvolved in interference proceedings in the U.S. Patent and Trademark Office todetermine the priority of our inventions. We could also become involved in opposition proceedings in foreigncountries challenging the validity of our patents.  In addition, costly litigation could be necessary to protect ourpatent position.  In some jurisdictions,patent laws relating to the scope of claims in the technology fields in whichwe operate is still evolving and, consequently, patent positions in ourindustry are somewhat uncertain.  We maynot prevail in any lawsuit or, if we do prevail, we may not be awardedcommercially valuable remedies. Further, it is possible that we will not have the resources required topursue necessary litigation or to otherwise protect our patent rights.  Failure to protect our patent rights couldharm us.

 

We have beeninvolved as plaintiffs in three lawsuits in the United States related to ourpatented technology for the SSP.  Formore information on these lawsuits, see “*Item 3. Legal Proceedings*”.

 

Patent rightsin jurisdictions outside of the United States are even more uncertain anddifficult to protect.  There may bepatents in certain international jurisdictions that are not enforceable or, ifenforceable, we may determine not to attempt to enforce these rights due to theexpense, the likelihood of prevailing or for other reasons.  Furthermore, the laws of foreign countriesmay not protect our intellectual property rights to the same extent as the lawsof the United States.

 

We rely ontrade secrets, unpatented proprietary know-how and continuing technologicalinnovation, which we seek to protect with confidentiality agreements withemployees, consultants and others with whom we discuss our business.  We may not be able to prevent theunauthorized disclosure or use of our technical knowledge or other tradesecrets by consultants, vendors, former employees and current employees,despite the existence of nondisclosure and confidentiality agreements and othercontractual restrictions.  Theseindividuals may breach these confidentiality agreements and our remedies maynot be adequate to enforce these agreements. Disputes may arise concerning the ownership of intellectual property orthe applicability or enforceability of these agreements, and these disputes maynot be resolved in our favor. Furthermore, our competitors may independently develop trade secrets andproprietary technology similar to ours. If we do not receive patents for products arising from our research, wemay not be able to maintain the confidentiality of information relating tothose products.

 

If ourintellectual property rights are not adequately protected, we may be unable tokeep other companies from competing directly with us, which could result in adecrease in our market share. Enforcement of our intellectual property rights to prevent or inhibitappropriation of our technology by competitors can be expensive andtime-consuming to litigate, or otherwise dispose of, and can divertmanagement’s attention from carrying on with our core business.

 

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**Our products could infringe upon theintellectual property rights of others, which may cause us to engage in costlylitigation and, if we are not successful, could cause us to pay substantialdamages and prohibit us from selling our products.**  Thirdparties may assert infringement or other intellectual property claims againstus based on their patents or other intellectual property claims.  We may be required to pay substantialdamages, including treble damages, for past infringement if it is ultimatelydetermined that our products infringe a third-party’s patents.  Even if infringement claims against us arewithout merit, defending a lawsuit takes significant time, may be expensive andmay divert management’s attention from other business concerns.  Further, we may be prohibited from sellingour products before we obtain a license from the owner of the relevanttechnology.  If such a license is available,it may require us to pay substantial royalties.

 

**We may implement a product recall or voluntarymarket withdrawal due to product defects or product enhancements andmodifications, which would significantly increase our costs.**  Themanufacturing and marketing of medical devices and surgical equipment andinstruments involves an inherent risk that our products may prove to bedefective or cause a health risk.  Inthat event, we may voluntarily implement a recall or market withdrawal or maybe required to do so by a regulatory authority.  We have recalled products in the past as explained later in thissection and, based on this experience, believe that the occurrence of a recallcould result in significant costs to us, potential disruptions in the supply ofour products to our customers and potential adverse publicity, all of whichcould harm our ability to market our products. A recall of one of our products, or a similar product manufactured byanother manufacturer, could impair sales of the products we market as a resultof confusion concerning the scope of the recall.

 

We havedevoted substantial financial and management resources to research anddevelopment and the enhancement and improvement of both the patented PSI andthe SSP.  In order to improve theresults of the SSP, we have on several occasions replaced the inventory of thephysician customers with a new release of the PSI.  We have also provided to our paid customers, free of charge, allupgrades or modifications to the hand-held surgical instruments previously usedto perform the SSP.  We have written offthe cost of the previous injection molding equipment, the discontinued PSI andinstrument inventory and other costs associated with the upgrade of the PSI andinstruments.

 

In 1999 andearly 2000, Ocular conducted a voluntary recall of the PSI as a result of aredesign in the shape of the segments of the PSI.  One or more of the segments of the PSI prototype sold in 1998 andearly 1999 had a tendency to turn on its side in a small percentage ofpatients, presumably as a result of the patients rubbing their eyes.  Although not posing any known safety risk tothe patient, the patient would generally notice that their improvement in nearvision as a result of the surgery would decrease after the segmentrotated.  Ocular redesigned the shape ofthe PSI segments by making the segment wider than it was tall with the intentof eliminating this rotation problem. Ocular replaced, at no cost to the physicians, the PSI inventory ofphysician customers worldwide with the newly designed PSI.  We are not aware of any report of therotation of the current PSI design. During the period of the recall, Ocular did not recognize sales pendingshipment of the new release of the PSI. In addition, in early 2001, Ocular suspended sales of the PSI while itwas developing the PresVIEW Incision System. There can be no assurances that expenses associated with productupgrades and the loss of revenues from the suspension of sales during similar futureperiods, if any, will not have a material impact on our results of operationsand financial condition.

 

Futuremodifications to our products may require new clinical trials, FDA 510(k)clearances or pre-market approvals or may require us to recall the modifieddevices until clearances are obtained. Any modification to an FDA-cleared device that significantly affects itssafety or effectiveness, or that would constitute a major change in its intendeduse, requires a new FDA 510(k) clearance or possibly pre-market approval.  The FDA requires every manufacturer to makethis determination in the first instance, but the FDA can review anydecision.  We may make additionalmodifications to our products and future products after they have receivedclearance or approval and, in appropriate circumstances, determine that a newsubmission is unnecessary.  The FDA maynot agree with our decision not to seek new clearance or approval.  Also, in those circumstances, we could besubject to significant regulatory fines or penalties.

 

**Acquisitions that we consummate could disruptour business and harm our financial condition**.  In the future, we may evaluate potentialstrategic acquisitions of complementary businesses, products or technologies.  We may not be able to identify appropriateacquisition candidates or successfully negotiate, finance or integrate any

 

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businesses, products or technologies that we acquire.  Furthermore, the integration of anyacquisition may divert management’s time and resources from our corebusiness.  While we, from time to time,evaluate potential acquisitions of businesses, products and technologies, andanticipate continuing to make these evaluations, we have no presentunderstandings, commitments or agreements with respect to any acquisitions.

 

**We are subject to critical accountingpolicies and actual results may vary from our estimates**.  We follow accounting principles generallyaccepted in the United States of America in preparing our financialstatements.  In preparing the financialstatements, we must make many estimates and judgments about future events.  These affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities, and thereported amounts revenues and expenses. We believe that these estimates and judgments are reasonable, and wemake them in accordance with our accounting policies based on information availableto us at the time.  Actual results,however, could differ from our estimates, and this could require us to recordadjustments to the reported amounts of assets and liabilities, change thedisclosures related to contingent assets and liabilities, and/or adjust therecorded amounts of revenues and expenses. These changes could be material to our financial condition and resultsof operations.

 

**RisksRelated to Our Common Stock**

 

**The liquidity of our common stock is affectedby its limited trading market**.  Shares of our common stock are traded on theOTC Bulletin Board under the symbol “RFCG.OB.” We expect them to continue to trade in that market.  There is currently no broadly followed,established trading market for our common stock.  An established trading market may never develop or bemaintained.  Active trading marketsgenerally result in lower price volatility and more efficient execution of buyand sell orders.  The absence of anactive trading market reduces the liquidity of our shares.  The trading volume of our common stock,historically, has been limited and sporadic. As a result of this trading activity, the quoted price for our commonstock on the OTC Bulletin Board is not necessarily a reliable indicator of itsfair market value.  Further, if we ceaseto be quoted, holders would find it more difficult to dispose of, or to obtainaccurate quotations as to the market value of, our common stock, and the marketvalue of our common stock would likely decline.

 

**Our common stock may be subject toregulations prescribed by the Securities and Exchange Commission relating to“penny stock.”** The Securities and ExchangeCommission has adopted regulations that generally define a penny stock to beany equity security that has a market price (as defined in these regulations)of less than $5.00 per share, subject to certain exceptions.  If our common stock meets the definition ofa penny stock, it will be subject to these regulations, which impose additionalsales practice requirements on broker-dealers who sell these securities topersons other than established customers and accredited investors, generallyinstitutions with assets in excess of $5.0 million and individuals with a networth in excess of $1.0 million or annual income exceeding $0.2 million (individually)or $0.3 million (jointly with their spouse).

 

**We are required to file and maintain theeffectiveness of registration statements for shares issued in our privateplacements.** Pursuant to registration rights agreements with stockholders whopurchased shares of our common stock in the March 2003 private placement, weagreed to use our reasonable best efforts to register the shares for resale andto maintain the effectiveness of the registration through March 6, 2004.  While we filed a registration statement on atimely basis, it was not declared effective prior to March 6, 2004.

 

In addition,pursuant to registration rights agreements with stockholders who purchasedshares of our common stock in the December 2003 private placement, we agreed touse our reasonable best efforts to register for resale that stock and tomaintain the effectiveness of that registration statement through December 23,2004.  We have filed a registrationstatement that included the shares that these stockholders purchased in thatprivate placement, but it has not yet been declared effective.  Once the registration statement has beendeclared effective, we are required to maintain the effectiveness of theregistration statement until December 23, 2004, except as permitted.

 

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**Our common stock will likely be subject to substantialprice and volume fluctuations.**  The market price of our commonstock has been volatile and could fluctuate widely in response to severalfactors, some of which are beyond our control, including:

 

•                                          our quarterly operating results;

•                                          additions or departures of key personnel;

•                                          changes in the business, earnings estimatesor market perceptions of our competitors;

•                                          the introduction of new products by us or ourcompetitors;

•                                          future sales of our common stock by us orother selling stockholders;

•                                          changes in general market or economicconditions; and

•                                          announcements of legislative or regulatorychanges.

 

Thestock market has experienced extreme price and volume fluctuations in recentyears that have significantly affected the quoted prices of the securities ofmany companies, including companies in our industry.  The changes often appear to occur without regard to specificoperating performance.  In addition,there has been a limited public market for our common stock.  We cannot predict the extent to whichinvestor interest in us will be maintained. Interest in our common stock is necessary for an active, liquid tradingmarket for our common stock.  Activetrading markets generally result in lower price volatility and more efficientexecution of buy and sell orders for investors.  The price and trading volumes of our common stock may fluctuatewidely due to the limited public market for our stock.

 

Salesof a significant number of shares of our common stock in the public marketcould harm the market price of our common stock.  At December 31, 2003, approximately 18% of our outstandingcommon stock was unrestricted and could be sold in the public market withoutregistration under the Securities Act or compliance with Rule 144.

 

Approximately9% of our outstanding common stock that was issued to former Ocularstockholders and in the March 2003 private placement became eligible forsale under Rule 144 beginning on March 6, 2004.  In general, a person who has held restricted shares for a periodof one year may, upon filing with the Securities and Exchange Commission anotification on Form 144, sell into the market shares of stock up to an amountequal to the greater of 1% of the outstanding shares or the average weeklynumber of shares sold in the last four weeks prior to that sale.  These sales may be repeated once each threemonths, and any of the restricted shares may be sold by a non-affiliate withoutcompliance with Rule 144 after such shares have been held two years.  Another 8% of our common stock is alsoeligible for sale under Rule 144 starting March 6, 2004, but these sharesare subject to  lock-up agreements thatgenerally limit the number of shares that can be sold each month to 9% of astockholder’s holdings from the March 2003 private placement.  Under the lock-up arrangement, a maximum ofapproximately 163,000 shares of our outstanding common stock could be sold bythese stockholders in the first month following March 6, 2004.

 

Inaddition, 19% of our outstanding common stock will become eligible for sale theearlier of the effective date of a registration statement we have filedcovering these shares or December 23, 2004.  Another 46% of our outstanding common stock will also be eligiblefor sale the earlier of the effective date of that registration statement orMarch 6, 2005, but these shares are subject to various  lock-up agreements that subject stockholdersto limitations on the number of shares that can be sold each month.   A maximum of approximately 158,000 sharesof our outstanding common stock that are subject to lock-up agreements could besold in the first month following the effective date of a registrationstatement under the terms of those lock-up agreements.  In subsequent months, additional shares willalso be released from lock-up arrangements according to various agreements.

 

Allof the lock-up agreements expire March 6, 2005, thus releasing anyremaining unsold shares from these limitations.  The release of shares from lock-up arrangements may have anegative impact on our stock price if such released shares are sold by theholders.

 

**After giving effect to the merger, certain of ourprincipal stockholders continue to have significant voting power and may takeactions that may not be in the best interest of other stockholders. **Certain of our directors and principal stockholders continue to controla significant percentage of our outstanding common stock.  If these stockholders act together, they maybe able to exert significant control over our management and affairs requiringstockholder approval, including approval of significant corporatetransactions.  This concentration ofownership may

 

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havethe effect of delaying or preventing a change in control and might adverselyaffect the market price of our common stock. This concentration of ownership may not be in the best interests of allour stockholders.

 

**We do not anticipate paying dividends in theforeseeable future, and the lack of dividends may have a negative effect on thestock price. **While there are no restrictions on thepayment of dividends, we have not declared or paid any cash dividends ordistributions on our common stock in the last two fiscal years.  We currently intend to retain our futureearnings to support operations and to finance expansion and, therefore, do notanticipate paying any cash dividends on our common stock in the foreseeablefuture.

 

**Our certificate of incorporation and Delaware lawcontain certain anti-takeover provisions that may inhibit a takeover, and wemay adopt other measures to discourage a takeover. **Delawarelaw and provisions in our certificate of incorporation, including those relatedto a classified board of directors, may have the effect of not onlydiscouraging attempts by others to buy us, but also of making it more difficultor impossible for existing stockholders to make management changes.  Our board of directors is divided into threeclasses.  Directors in each class areelected for terms of three years.  As aresult, the ability of stockholders to effect a change in control of us throughthe election of new directors is limited by the inability of stockholders toelect a majority of our board of directors at any particular annual meeting.  Our board may consider and adopt additionalmeasures that would prevent us from being subject to a takeover.

 

## **ITEM 2**.  DESCRIPTION OF PROPERTIES

## ** **

Ourcorporate headquarters are located at 10300 North Central Expressway, Suite104, Dallas, Texas, in approximately 1,274 square feet of space occupied undera lease with a monthly rental rate of $1,433.25 that expires inJune 2004.  Prior toSeptember 2003, we occupied additional space in a freestanding 4,000square foot building on 4.5 acres in Denison, Texas under a month-to-monthlease.  The Denison facility housed ourclean room and is owned by Dr. Ronald A. Schachar, the former chairman andChief Scientist of Ocular.  The rent forthe Denison facility was $4,000 per month. We terminated the lease for the Denison facility effectiveAugust 31, 2003.  Mr. Walts, adirector and our Chief Executive Officer and President, is based in Atlanta,Georgia.

 

**ITEM 3.****  LEGAL PROCEEDINGS**

 

Fromtime to time we may become subject to proceedings, lawsuits and other claims inthe ordinary course of business, including proceedings related to our productsand other matters.  Such matters aresubject to many uncertainties, and outcomes are not predictable with assurance.

 

InMarch 2000, we filed suit against Surgilight for patent infringement inthe United States District Court for the Middle District of Florida, OrlandoDivision.  We own multiple domestic andinternational patents.  Certain of thesepatents are directed to methods, devices and systems for the treatment of presbyopiaand other eye disorders.  One of thesepatented methodologies is directed to the use of lasers to weaken the sclera(the white of the eye), and thereby manipulate the ciliary muscle to treatpresbyopia.  Our international patentportfolio is directed to, and includes within its scope, various means andmethodologies that increase the effective working distance of the ciliarymuscle in a presbyopic eye.  By usinglasers to ablate the sclera, we asserted that Surgilight infringed upon one ormore of our patents.

 

InDecember 2001, we accepted a cash settlement from Surgilight.  In conjunction with that settlement,Surgilight acknowledged the validity and enforceability of our patents.  The settlement did not include a license ofany of our technology to Surgilight.

 

InMay 2000, we filed a patent infringement suit against Howard N. Straub, D.O.,the Colorado Eye Institute, Restorvision, Inc. and LensTec, in the UnitedStates District Court for the District of Colorado.  We alleged that Straub had performed, or arranged for theperformance of, surgical procedures on United States citizens and in foreigncountries in which unauthorized copies of our patented PSI were used.  We and our patent counsel believe that the copiesof the PSI created by the defendants are covered under existing patents issuedto us.  In June 2002, the Courtgranted a motion jointly proposed by both parties that stayed the litigationfor a period of twelve months.  The

 

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Courtgranted an additional twelve month stay in 2003.  During this period, the United States Patent and Trademark Officewill continue its investigation into the validity of Restorvision’s patentapplications.

 

Ifthe Patent Office issues a patent on Restorvision’s modification, our patentcounsel and we believe that Restorvision would still be required to obtain alicense to our underlying patents prior to marketing the Restorvisionmodification in the United States and in many countries around the world.

 

Toencourage medical and scientific research that might otherwise constitutepatent infringement in the United States, Congress has provided a limitedpatent infringement exemption.  Thisexemption, found at 35 U.S.C. § 271(e)(1), provides that a person does notcommit an act of infringement by using patented technology “solely for usesreasonably related to the development and submission of information” to theFDA.  This exemption applies equally topatented drugs and medical devices.  Inthe Surgilight and Straub suits, the defendants attempted to rely upon thisexemption as part of their defense.  Wedisputed that the defendants’ activities are protected by the exemption.  We contend, among other things, that inorder for activities to be undertaken solely for the purposes of submittinginformation to the FDA, the activities must comply with the regulations of theFDA.  We believe that the defendantshave violated FDA regulations and are not protected by the exemption.  We further believe that any activities notpermitted under this exemption, such as commercial activities in the UnitedStates, are violations of our patents.

 

InMay 2001, we also filed suit against Douglas Steel, M.D.  We alleged in the suit that Dr. Steelcopied, manufactured and sold in the United States a scleral prosthesisdeveloped and patented by us.  Wefurther alleged that Dr. Steel performed numerous commercial surgeries in theUnited States to treat presbyopia in accordance with procedures developed andpatented by us.  The United States DistrictCourt for the Central District of California issued a preliminary injunction inlate May 2001 against Dr. Steel, as requested by us.  In October 2001, we accepted a cash settlement from Dr.Steel.  The settlement did not include alicense of any of our technology to Dr. Steel.

 

Wehave notified certain other potential infringers of potential litigation, butare not currently engaged in other litigation.

 

**ITEM 4****.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

**PART II**

 

**ITEM 5****.  MARKET FOR CORPORATION’S COMMON EQUITY AND RELATED STOCKHOLDERMATTERS**

 

OnApril 16, 2002, shares of common stock of VeryBestoftheInternet.com becameeligible for quotation on the NASD Electronic Bulletin Board under the symbol“VYIB.OB”.  On February 25, 2003,the symbol was changed to “RFCG.OB”.  Notrades, however, were ever made with respect to shares of Refocus common stockprior to the merger, which was effective March 6, 2003.  As a result, the range of high and low bidinformation for shares of Refocus common stock for each full quarterly periodwithin the two most recent fiscal years is not available. The range of high andlow bids for shares of Refocus common stock by quarter since the closing of themerger through December 31, 2003 are as follows, based on bids thatrepresent prices quoted by broker-dealers on the OTC Bulletin Board System(these quotations reflect inter-dealer prices, without retail mark-up,mark-down or commissions, and may not represent actual transactions):

 

| **Year 2003:**                         |   | **High** |   | **Low** |   | **Dividends  Paid** |   |
|----------------------------------------|--------|----------|--------|---------|--------|---------------------|--------|
| First Quarter since March 6, 2003 |   | $        | 5.50   |    | $      | 3.50                |   | $ | 0.00 |   |
| Second Quarter                         |   | 3.70     |   | 1.50    |   | 0.00                |   |
| Third Quarter                          |   | 2.25     |   | 1.05    |   | 0.00                |   |
| Fourth Quarter                         |   | 1.80     |   | 0.36    |   | 0.00                |   |
|                                        |        |          |        |         |        |                     |        |  |  |  |

 

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Ocularstock, prior to the merger, was not traded on a public trading market, andOcular had no registered securities outstanding.

 

Asof March 26, 2004, there were 23,382,182 shares of Refocus common stockoutstanding with approximately 377 stockholders of record.

 

# ***Dividend Policy***

# ** **

Whilethere are no restrictions on the payment of dividends, we have not declared orpaid any cash or other dividends on shares of Refocus common stock in the lasttwo fiscal years and presently have no intention of paying any cash dividendsin the foreseeable future.

 

*Equity Compensation Plan Information*

 

Informationrelating to Refocus’ equity compensation plans will be set forth in our 2004Proxy Statement for the Annual Meeting of Stockholders.

 

*Transactions and Sales of Unregistered Securities:*

 

Weconsummated a private placement on December 23, 2003 resulting in theissuance of 4,425,000 units at $.50 per unit. Each unit consisted of a share of our common stock with a detachablewarrant to purchase one-half share of our common stock at an exercise price of$2.00 per share.  We issued a total of4,425,000 shares of our common stock and warrants to purchase an aggregate of2,212,500 shares of our common stock. We received gross proceeds of $2,212,500.  We paid $185,000 in agent fees and $81,348 for legal, audit, andother private placement costs.  Asconsideration for services provided to us, we issued warrants to purchase anaggregate of 170,000 shares of our common stock at an exercise price of $2.00 pershare to the agent.  All the $2.00 warrantsissued in connection with the private placement expire inDecember 2006.  In addition, awarrant that had been issued to that agent in March 2003 to purchase200,000 shares of our common stock at an exercise price of $2.50 per share wascancelled and reissued at the same exercise price but with an expiration dateof December 23, 2006.

 

Theshares of our common stock and warrants to purchase shares of our common stockthat were issued in the private placement were not registered under theSecurities Act of 1933 and, as a result, are “restricted securities” and maynot be offered or sold in the United States absent registration or anapplicable exemption from registration requirements.  Certificates and agreements representing these shares andwarrants, respectively, contain a legend stating the same.  These securities were issued by us inreliance upon an exemption from registration set forth in Section 4(2) ofthe Securities Act of 1933 and Rule 506 promulgated under that act.   The issuance of the shares of our commonstock to the investors in the private placement was undertaken without generalsolicitation or advertising.  Theinvestors represented to us that, among other items, they were acquiring thesesecurities for investment purposes only and not with a view toward publicdistribution and that they were accredited investors within the meaning of Rule506.  Moreover, we filed with theSecurities and Exchange Commission a Form D pursuant to Rule 506 with respectto this transaction.

 

Theparticipants in this private placement who invested in our March 6, 2003private placement,  which was previouslydisclosed in our Annual Report on Form 10-KSB for the year endedDecember 31, 2002, and who invested an amount equal to their secondtranche commitment under the terms of the March 2003 private placement,were relieved of that second tranche commitment.  In addition, the shares issued to these investors in the firsttranche of the private placement were released from any trading restrictionsimposed by a lock-up agreement agreed to by those participants.

 

Pursuantto the terms of the private placement, we agreed to register for resale underthe Securities Act of 1933 the shares of our common stock and shares of ourcommon stock acquirable upon exercise of the warrants issued in the privateplacement.  Such shares were included ina registration statement filed with the Securities and Exchange Commission, butthat registration statement has not yet been declared effective as discussedbelow.

 

Asa result of the Transfer Agreement with CIBA entered into in January 2004,one of the conditions precedent to the closing of the second tranche of theMarch 2003 private placement, previously disclosed in Item 5 of our

 

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AnnualReport on Form 10-KSB for the year ended December 31, 2002, cannot befulfilled.  Therefore, we can no longercompel the investors in the first tranche of the private placement to fund thesecond tranche and the closing of the second tranche will not occur.

 

Weoriginally filed with the Securities and Exchange Commission a RegistrationStatement on Form SB-2 (File Number 333-108440) in September 2003.  We filed an amendment in February 2004.  The registration statement has not yet beendeclared effective.  The registrationstatement seeks to register the resale of shares of our common stock and sharesof our common stock underlying warrants already held by certain stockholders.  We will not receive any proceeds from thesale of those securities, except to the extent amounts are received for theexercise of warrants into our common stock.

 

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**ITEM 6****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS**

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OFOPERATIONS**

**DECEMBER 31, 2003**

 

Thefollowing discussion and analysis of the financial condition and results ofoperations of Refocus Group, Inc. and its subsidiaries should be read inconjunction with the financial statements and related footnotes included inItem 7.  All dollar amounts presented inthis section have been rounded to the nearest thousand, except per shareamounts.

 

Thefollowing discussion and analysis contains “forward-looking statements” that arebased on the assumptions, beliefs and opinions of management.  Such statements reflect our current viewswith respect to future events and involve known and unknown risks,uncertainties and other factors that may cause our actual results, levels ofactivity, performance or achievements to be materially different from whatmanagement currently believes.  See amore detailed discussion about such statements prior to “*Item 1. Description of Business*”.  Also see those risks described in “*Cautionary Statements*” above.

 

***Overview***

 

OnMarch 6, 2003, Refocus Group, Inc. (“Refocus”) and Refocus Ocular, Inc.(“Ocular”), formerly known as Presby Corp (“Presby”), entered into a mergeragreement (the “Merger Agreement”).  OnMarch 6, 2003 (the “Merger Closing Date”), a newly created, wholly-ownedsubsidiary of Refocus was merged with and into Ocular, with Ocular surviving asa wholly-owned subsidiary of Refocus. In addition, on the Merger Closing Date, Refocus completed the firsttranche of a private placement of its shares of common stock.

 

Afterthe merger, Refocus discontinued its previous business as an internet websiteranking service, the founders of Refocus resigned their positions, and Refocussucceeded to the business of Ocular. For accounting purposes, the merger was accounted for as a reversemerger, whereby Ocular was deemed to be the accounting acquirer of Refocussince the former stockholders of Ocular owned a majority of the issued andoutstanding shares of common stock of Refocus on the Merger Closing Date,including those shares issued in the first tranche of the private placementthat closed on that date.  Therefore,all financial information included in this report prior to the Merger ClosingDate is that of Ocular as if Ocular had been the reporting entity.  The audited financial information in thisreport is also that of Ocular, as it provides the most relevant information forRefocus on a continuing basis.

 

Allreferences to “Refocus”, “Presby”, “Ocular”, “we”, “us”, “our”, or the“Company” mean Refocus or Ocular, as the former Presby, separately prior to theMerger Closing Date and Refocus, as successor to the business of Ocular, aftergiving effect to the merger.

 

Weare a medical device company based in Dallas, Texas, engaged in the researchand development of surgical treatments for human vision disorders.  We may also use our research andunderstanding of the human eye to develop and patent technology for use withcommercial optical lens applications.

 

Ourprincipal products are the patented PresVIEW Scleral Implant (the “PSI”) andthe PresVIEW Incision System, which consists of the surgical instruments usedto implant the PSI in the human eye. The PSI and the PresVIEW Incision System are utilized in our surgicaltechnique, the Scleral Spacing Procedure (the “SSP”), for the treatment ofpresbyopia, ocular hypertension and primary open angle glaucoma in the humaneye.  Presbyopia, the Greek word for“old eye”, is the primary reason that a substantial portion of the populationbeginning in their early 40s uses bifocals, reading glasses or removes theirdistance glasses in order to read at a comfortable distance.  We believe that the SSP treats presbyopia byreducing the crowding of the underlying tissues surrounding the crystallinelens, which allows the muscles to once again reshape the lens to restore theeye’s ability to accommodate or focus. In the case of  ocularhypertension and primary open angle glaucoma, we believe that the SSP restoresthe natural base-line tension of the muscle inside the eye, which permits theeye to drain naturally and, thus, lower the intraocular pressure.

 

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Wehave additional products in early-stage research, including a medical devicefor the treatment of dry age-related macular degeneration (“ARMD”) and a singleelement variable focus lens (“SEVFL”) for use in commercial opticalapplications.

 

Inaddition, you should be aware that we may not be able to continue as a goingconcern over the next twelve months if additional funding is not obtained.  See the discussion in “*Liquidity and Capital Resources*” below.

 

*The Merger and March 2003 Private Placement*

 

Asa result of the March 2003 private placement discussed below andimmediately prior to the merger, the holders of Ocular’s Series B preferredstock and Series C preferred stock converted their shares into common stock ofOcular.  At the same time, Ocularcompleted a 2.14-to-1 reverse split, resulting in 11,940,144 shares of Ocularcommon stock outstanding, including the shares of common stock issued uponconversion of the preferred stock.

 

Eachshare of Ocular common stock outstanding on the Merger Closing Date wasconverted into common stock of Refocus on a one-for-one basis.  Therefore, Refocus issued 11,940,144 shares ofcommon stock to the stockholders of Ocular, representing approximately 63% ofRefocus’ outstanding common stock following the merger and the funding of theinitial tranche of the March 2003 private placement, in exchange for 100%of the outstanding capital stock of Ocular. Following the merger, all of Refocus’ business operations are conductedthrough its wholly-owned subsidiary, Ocular. Because Refocus did not have any significant business prior to themerger and its former operations were discontinued after the merger, there wasno goodwill or other intangibles that arose from the merger.

 

Aspart of the Merger Agreement, Refocus assumed the Amended and Restated PresbyCorp 1997 Stock Option Plan and all outstanding options (after they wereadjusted for the 2.14-to-1 reverse split) to purchase Ocular common stock wereconverted into options to purchase 719,486 shares of Refocus common stock.

 

Inconnection with the merger, we completed a private placement of shares of ourcommon stock that was to be consummated in two tranches, with 50% of the totalsubscribed paid with each tranche.  Thefirst tranche closed on the Merger Closing Date and consisted of 2,875,000units at $2 per unit.  Each unit wascomprised of a share of our common stock and a detachable three-year warrant topurchase one-half of a share of our common stock at an exercise price of $2.50per share.  As a result, the investorsin the first tranche of the private placement were issued 2,875,000 shares ofour common stock and warrants to purchase 1,437,500 shares of our commonstock.  In addition, 12,500 shares ofour common stock, three-year warrants to purchase 1,250,000 shares of ourcommon stock at an exercise price of $2.50 per share and five-year warrants topurchase 50,000 shares of our common stock at an exercise price of $2.00 pershare were issued to agents and others involved in the private placement.

 

Wepaid certain agent and advisory fees and legal, audit and other privateplacement costs from the proceeds received from the offering as follows:

 
| Proceeds from the offering: 2,875,000 units  at $2.00 per unit |   | $        | 5,750,000 |   |
|----------------------------------------------------------------|--------|----------|-----------|--------|
| Amounts paid to placement agent and  advisors                  |   | (577,000 | )         |
| Legal and audit fees incurred                                  |   | (620,000 | )         |
| Expenses incurred by advisors                                  |   | (147,000 | )         |
| Expenses incurred by us                                        |   | (90,000  | )         |
| Payment to founders of Refocus for their  stock                |   | (25,000  | )         |
| Cash received from the offering                                |   | $        | 4,291,000 |   |

 

Investorswho participated in the first tranche of the March 2003 private placementwere required to irrevocably commit to the second tranche, with the remaining50% of the funds from the private placement to be paid at the closing of thesecond tranche. The closing of the second tranche was contingent on certainconditions precedent.  One of theconditions, an additional investment by CIBA Vision AG (“CIBA”) will not be metas a result of an agreement reached between CIBA and us in January 2004(see “*CIBA Agreements*” below)and, therefore, the second tranche will never be funded.

 

Theshares issued in the first tranche are subject to lock-up agreements.  Only 9% of the shares held by a firsttranche investor can be sold each month starting on the earlier of theeffective date of a registration statement covering

 

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thoseshares or March 6, 2004.  Theselock-up agreements expire March 6, 2005. Those first tranche investors who participated in the December 2003private placement (see discussion below) had their lock-up agreementswaived.  Therefore, of the 2,875,000shares issued in the first tranche, 1,806,250 are still subject to lock-upagreements.

 

InApril 2003, we engaged an agent to conduct a post-closing privateplacement.  The post-closing privateplacement offering expired September 6, 2003, without being funded.  We wrote off $192,000 of deferred offeringexpenses in connection with the offering. These expenses are included in “Selling, general and administrative”expenses for the year ended December 31, 2003.  In the event that at least $1,000,000 was not raised in a post-closingprivate placement within six months of March 6, 2003, on terms no lessfavorable than the private placement consummated in March 2003, anotherparty, Verus Support Services, Inc. (“Verus”), subscribed to purchase thatnumber of units at $2.00 per unit in order to satisfy the deficiency betweenthe amount of additional capital successfully raised and $1,000,000.  Each unit would have consisted of a share ofour common stock and a detachable warrant to purchase one-half of a share ofour common stock at an exercise price of $2.50 per share.  Since no funds were received from apost-closing private placement, Verus is required to fund the entire$1,000,000.  We previously gave Verus an120-day extension to their funding requirement in exchange for their forgivenessof $60,000 in consulting fees we owned them.

 

InJanuary 2004, a dispute arose as to the continuing obligation of Verusunder this agreement.  As a means ofdeferring and ultimately resolving this dispute, we entered into an amendmentto our agreement to further extend to June 30, 2004, Verus’ obligation topurchase up to $1,000,000 of units and to make certain other amendments.  Verus has advised us that its ability toprovide the original subscription amount at a stock price well above currentmarket is limited, and it indicated that current market conditions should beconsidered.  Therefore, we have agreedto amend the funding obligation to permit Verus to reduce its fundingobligation by:

 

•                  the surrender and cancellation of shares ofour common stock and warrants to purchase shares of our common that were issuedto Verus or its affiliates, assigns or designees, or investors in theMarch 2003 private placement, based on the current market price of ourcommon stock,

•                  the waiver of the remaining $20,000 inadvisory fees due to it under an existing consulting agreement,

•                  the waiver of up to $60,000 in advisory feesthat might become due to it during the extension period, and

•                  an amount of $25,000 that was received froman investor in a December 2003 private placement since that investor wasintroduced to us by Verus.

 

Further,after the credit of these amounts to the funding obligation, Verus has agreedto subscribe for and purchase, or cause to be subscribed for and purchased, anamount of our common stock at prevailing market prices equal to 1.25 times theremaining funding obligation.  Webelieve that this agreement is in our best interest and may result in fundingduring this extension period; however, we cannot be assured that Verus will notcontinue to dispute this obligation.

 

*CIBA Agreements*

 

InMarch 2002, we entered into a license agreement with CIBA (the “CIBAAgreement”) pursuant to which CIBA obtained an exclusive license to our patentsrelated to the treatment of presbyopia, ocular hypertension and primary openangle glaucoma in international markets. CIBA also had the right in the CIBA Agreement to acquire a license forour products in the United States.  Wewere entitled to receive a percentage royalty on CIBA’s worldwide sales of thePSI and related products under the CIBA Agreement.  Upon entering into the CIBA Agreement, CIBA paid us $2,000,000 inadvance royalties and was committed to purchase equity interests in us if weobtained certain other investments from third-parties.  Simultaneously with our receipt ofthird-party investments in the first tranche of the March 2003 privateplacement, CIBA purchased 625,000 shares of our common stock and a warrant topurchase 312,500 shares of our common stock at an exercise price of $2.50 pershare for an aggregate purchase price of $1,250,000.  In addition, CIBA was committed to make an additional $1,250,000investment at the closing of the second tranche of the March 2003 privateplacement.

 

Underthe CIBA Agreement, CIBA was responsible for manufacturing, marketing anddistributing our products worldwide at its expense.  CIBA was also responsible for regulatory matters outside theUnited States and was committed to jointly manage the United States Food andDrug Administration (“FDA”) clinical trials with us.  In accordance with the CIBA Agreement, we ceased all

 

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directmanufacturing and marketing of the PSI and related products.  As a result of the transition of thosemanufacturing responsibilities to CIBA, the modifications in the packaging ofthe PSI and the resultant changes to those processes, the CE Mark certificationwe had obtained in 2000 on the PSI is no longer applicable.  CIBA has been seeking CE Mark certificationof the PSI for its planned marketing efforts in the European Union in early2004.  That CE Mark certification of thePSI is still pending.  Late in 2003, aCE Mark certification of the components of the PresVIEW Incision System wasobtained by the suppliers of those components.

 

InAugust 2003, CIBA announced that it was seeking strategic alternatives forits surgical business unit, including the sale of that unit.  CIBA’s surgical business unit marketed avariety of ophthalmic products and was primarily responsible for performing theCIBA Agreement.  On December 29,2003, CIBA informed us that it was exiting the surgical business and expectedto complete the sale of the surgical business unit’s various product lines to avariety of parties by early 2004.  Inconjunction with that sale, CIBA received an offer from a third-party topurchase CIBA’s rights under the CIBA Agreement.  Pursuant to the CIBA Agreement, the transfer of the licenserequired our consent.  As a condition tothe assumption of CIBA’s duties associated with that proposed licenseassignment, the third-party requested the renegotiation of certain key terms ofthe license agreement.  Afterdeliberation, we declined to renegotiate the license and did not permit the assignmentof the license to the third-party.  As aresult, we began negotiations with CIBA for the transfer of CIBA’s rights underthe CIBA Agreement back to us and the termination of the license.

 

InJanuary 2004, we entered into an agreement with CIBA, the License Transferand Transition Services Agreement (the “Transfer Agreement”).  Pursuant to the Transfer Agreement, wereacquired all worldwide license rights to our patents that were granted toCIBA under the CIBA Agreement, and CIBA was released from all future financialcommitments, including its commitment to fund $1,250,000 at the closing of thesecond tranche of the March 2003 private placement and its obligationsassociated with manufacturing, marketing, distribution and regulatorymatters.  Under the Transfer Agreement,CIBA has agreed to provide us with certain transition services during 2004,including efforts to finalize the CE Mark certification of the PSI.  These transition services will help ustransfer the manufacturing, distribution and marketing functions back to usfrom CIBA.  If CIBA obtains CE Markcertification of the PSI, CIBA and we will enter into a technical agreement,which will permit us to directly sell our products in CIBA packaging during2004 in the European Union while we seek our own CE Mark certification.  As consideration for the acquisition ofCIBA’s license rights, the forgiveness of the $2,000,000 in prepaid royaltieswe received under the CIBA Agreement and the transition services to beperformed by CIBA under the Transfer Agreement, we agreed to pay CIBA anaggregate of $3,000,000 in twelve quarterly installments commencing in thefirst calendar quarter of 2006.  We,however, are entitled to prepay and extinguish our payment obligations bypaying an aggregate amount of $2,000,000 to CIBA prior to January 1, 2006.

 

Underthe Transfer Agreement, CIBA has also agreed to return the warrant to purchase312,500 shares of our common stock that it acquired in the March 2003private placement.  While it will retainthe 625,000 shares of common stock acquired at the same time, these shares willbe subject to certain restrictions on their transfer.

 

Weexpect that the transition from CIBA will result in a significant increase incosts for us related to performing functions that CIBA had assumed under theCIBA Agreement.  Conversely, however, wewill be entitled to all gross proceeds from the sale of our products instead ofa royalty based on a percentage of sales as previously specified in the CIBAAgreement.  Even assuming that CIBAobtains the CE Mark certification of the PSI, our ability to directly marketour products in the European Union is currently limited.  The anticipated date of the initial sale ofour products in the European Union is likely to be delayed, and the number ofPresVIEW Incision System and PSI units sold is likely to be reduced, in theshort term and especially in 2004, relative to the number of unit sales thatcould have been achieved by CIBA.  Wemay seek to market the PSI and PresVIEW Incision System in the European Unionand elsewhere directly or through other distribution, license or strategicarrangements.  Therefore, as a result ofthe increased expenses and potential for delayed revenues, we believe that theTransfer Agreement may have a material adverse impact on our financialcondition in the short term.  We believethat the reacquisition of our license will be in the best long-term interest ofour stockholders.

 

*Dr. Schachar’s Separation and Consulting Agreement*

 

OnFebruary 25, 2003, Dr. Ronald A. Schachar, our founder and former ChiefScientist, and we entered into a Severance, Release and Consulting Agreement(the “Consulting Agreement”).  Inaccordance with the Consulting

 

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Agreement,Dr. Schachar resigned as an officer, director and employee of us at the MergerClosing Date.  We agreed to retain Dr.Schachar as a consultant for a period of up to five years, and he agreed not tocompete with us during that time.  Dr.Schachar will assist us in conducting research and development on our productsfor the treatment of ARMD for the initial two years of the Consulting Agreementand will assist in the maintenance of our patent portfolio and other mattersfor the entire term of the Consulting Agreement.

 

Subjectto certain conditions, Dr. Schachar will be paid $1,750,000 over the consultingperiod, of which $950,000 will be paid in the first two years.  The timing of the remaining $800,000 due inyears three through five is partially dependent on our profitability in thoseyears;  however, Dr. Schachar isguaranteed to receive a minimum of $250,000, but not more than $400,000, foreach of the third and fourth years, with the remainder, if any, to be paid inthe fifth year.

 

Assecurity for the payment of his consulting fees, we granted Dr. Schachar anon-exclusive security interest in our patent rights relating to the ARMDdevice and the SEVFL.  Dr. Schachar alsoreceived an assignment of our patents for the ARMD device outside the UnitedStates, which is revocable under certain conditions.

 

Werecorded the present value of the future payments under the ConsultingAgreement as a liability on the balance sheet at March 31, 2003.  We allocated the liability and the value ofthe ARMD patents assigned to Dr. Schachar to prepaid consulting and research anddevelopment expenses, to a non-compete agreement and to severance expense.

 

*December 2003 Private Placement*

 

OnDecember 23, 2003, we successfully completed a private placement of4,425,000 units at a purchase price of $0.50 per unit.  Each unit consisted of a share of our commonstock and a three-year warrant to purchase one-half of a share of our commonstock at an exercise price of $2.00 per share. An agent involved in the private placement received a three-year warrantto purchase 170,000 shares of our common stock at an exercise price of $2.00per share.  In addition, a warrant thathad been issued to that agent in March 2003 to purchase 200,000 shares ofour common stock at an exercise price of $2.50 per share was cancelled andreissued at the same exercise price but with an expiration date ofDecember 23, 2006.

 

Wepaid certain agent fees and legal, audit and other private placement costs fromthe proceeds received from the offering as follows:

 
| Proceeds from the offering: 4,425,000 units  at $.50 per unit |   | $        | 2,212,000 |   |
|---------------------------------------------------------------|--------|----------|-----------|--------|
| Amount paid to agent                                          |   | (185,000 | )         |
| Legal and audit fees incurred                                 |   | (69,000  | )         |
| Expenses incurred by agent                                    |   | (7,000   | )         |
| Expenses incurred by us                                       |   | (5,000   | )         |
| Cash received from the offering                               |   | $        | 1,946,000 |   |

 

Thefunds received will be primarily used to fund our Phase II clinical trials forthe surgical treatment of presbyopia (see below).  For an investor who participated in this private placement in anamount equal to or greater than that investor’s investment in the initialtranche of the March 2003 private placement, we waived that investor’slock-up arrangement on their common stock and warrants acquired in theMarch 2003 private placement.

 

*Other*

 

InNovember 2002, we, along with CIBA, submitted to Health Canada anapplication for approval to commercialize the PSI in surgery for the treatmentof ocular hypertension, primary open angle glaucoma and presbyopia.  On June 13, 2003, Health Canadainformed us that it had determined that the sample size submitted in ourapplication was insufficient for approval, and denied the application.  Based on further discussions with HealthCanada in October 2003, we will need to perform further clinical trials atmore sites and with significantly more patients in order to receive approvalfor commercial sales.  We are uncertain,at this time, as to when we may receive Health Canada’s approval, but webelieve it will not be until at least 2005 before the results of theseadditional clinical trials can be resubmitted. Our immediate focus, however, is currently on the FDA clinical trialsand not those in Canada.

 

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InMarch 2003, an investigational device exemption application was submittedto the FDA to obtain approval for initiating our Phase II clinical trials forthe surgical treatment of presbyopia utilizing the PSI and SSP.  This application was followed by lateramendments.  In December 2003, wereceived approval to begin our Phase II clinical trials of the PSI and SSP forthe treatment of presbyopia.  The FDAapproval was conditioned on our submittal of certain final documentationconcurrent with the initiation of the clinical study.  We started these clinical trials in the first quarter of 2004.

 

*See* “*Liquidity and Capital Resources*”below for a discussion of our expected cash inflows, cash requirements andoperating plan.

 

***Application of Critical Accounting Policies***

 

Theprocess of preparing financial statements in conformity with accountingprinciples generally accepted in the United States of America requires the useof estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses. These estimates and assumptions are based upon the best informationavailable at the time.  These estimatesand assumptions could change materially as conditions within and beyond ourcontrol change.  Accordingly, actualresults could differ materially from these estimates.  The following are the most significant accounts affected by theseestimates.

 

*Revenue recognition* – Sales will be recognized when product has been shipped.  We do not sell our products with a right ofreturn.  Any amounts received fortraining or seminars will be recognized at the time the training or seminartakes place.

 

Asa result of the suspension of sales of our products in 2001, while we weredeveloping the PresVIEW Incision System, and the continued suspension of salesas a result of CIBA Agreement, pursuant to which CIBA was supposed toexclusively handle our future sales and marketing, we have encouraged customersnot to perform the SSP using the PSI until the PresVIEW Incision System isavailable, and we and/or CIBA were ready to begin sales of the PSI again.  The packaging of the PSI provided guaranteedsterility only for a limited time, and the sterility date on the PSIs stillheld by our customers has expired.  Anestimated liability of $50,000 was recorded for the possible replacement ofthese PSIs at our historical manufacturing cost.  The estimate was based on the total number of PSIs that had been soldby us less an estimate of the number already used.  Rather than replace all the expired inventory, we may insteadgrant special pricing on future purchases to these surgeons.  Actual claims by customers may exceed,and/or the cost of replacing the PSIs may be higher than, our estimates andadditional charges may have to be taken.

 

Inaddition, certain physicians may have purchased surgical kits in anticipationof taking part in the FDA clinical trials. The physicians were aware that the product was not yet approved for usein the United States, and we did not sell the surgical kit with a right ofreturn.  Several of these physicianshave requested a refund or have informed us that if they are not selected toparticipate in the clinical trials, they will be seeking a refund.  Since we did not sell our products with aright of return, we do not believe we have any liability to repurchase theseproducts.

 

Asa result of our continued suspension of sales, we have been informed by two ofour former foreign distributors that they are seeking refunds on unsoldproducts remaining in their inventory. We did not sell our products with a right of return and do not believewe have any liability to repurchase these products.

 

Asa result of the Transfer Agreement, we will be responsible for all futuremarketing.  As part of future marketingprograms in the United States or internationally, we may determine that it isin our best interest to provide some compensation in the form of productdiscounts or by other means to the surgeons who bought our kits, and did notget to participate in the FDA trials, or to foreign distributors of ourproducts.  At this time, we arecurrently unable to determine the amount of possible compensation, if any, thatwe may agree to pay in the future.

 

*Income taxes* – Deferred income taxes are provided for temporary differences betweenthe basis of assets and liabilities for tax and financial reportingpurposes.  A valuation allowance isestablished for any portion of the deferred tax assets for which realization isnot likely.  We maintain a 100%valuation allowance against our deferred tax assets.  The valuation allowance is subject to periodic review, and we maydetermine that a portion of our deferred tax assets may be realizable in the future.

 

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*Patent costs, trademarks, non-compete agreement andproperty and equipment*– These assets are subject to periodic review to determine our ability torecover their cost.  We must makeestimates about their recovery based on future cash flows and other subjectivedata.  We, in the future, may determinethat some of these costs may not be recoverable, which may require us to adjusttheir capitalized value by writing off all or a portion of the value of theseassets.  The patents for the SEVFL havea carrying value of $173,000 and the patents for ARMD have a carrying value of$27,000 at December 31, 2003. Since these patents involve new technologies that have not been proven,we cannot yet determine whether these costs are recoverable.  We believe that these technologies can bedeveloped and will continue to carry these patents at their amortizedvalue.  At some future point, if webelieve that we cannot develop these technologies or these technologies cannotbe profitability developed, we will reduce the carrying value of these assetsat that time to their estimated fair value.

 

# **Resultsof Operations**

# ** **

*The Year Ended December 31, 2003 Compared to theYear Ended December 31, 2002*

 

**Revenues. **There were no revenues for the years endedDecember 31, 2003 or December 31, 2002.  The lack of sales resulted from (i) our suspension of sales in2001 while we developed the PresVIEW Incision System and (ii) the CIBA Agreementin March 2002, pursuant to which CIBA assumed responsibility for allmarketing and sales of the PSI and related surgical instruments.  We had previously anticipated that futurerevenues would be generated from royalties on product sales and from milestone paymentsmade under the CIBA Agreement.  As aresult of the Transfer Agreement that was effective in January 2004,future revenues are instead expected to be generated by sales of the product byus directly or through other distributors. No distribution contracts are in place at this time.  Our immediate focus is on our FDA clinicaltrials and, because of the lack of funds, most of our available capital will beexpended on these clinical trials. Therefore, we do not expect to be able to devote much management time orfunds to international markets where we may receive approval to sell ourproducts during the next year.

 

Wehad expected CIBA to start sales in European Union in the first quarter of2004; however, as  a result of thetransition of marketing responsibilities under the Transfer Agreement, we willnot begin sales as expected.  CIBA is inthe process of obtaining their CE Mark on the PSI.  Assuming they are successful, CIBA and we will enter into atechnical agreement, which will permit us to directly sell our products in CIBApackaging during 2004 in the European Union. Depending on the timing of their obtaining the CE Mark certification forthe PSI and on our ability to supply products and training, sales in Europe maybe delayed for several months, or possibly longer.  In addition, we will have to obtain our own CE Mark by the end of2004 in order to continue sales in the European Union after 2004.

 

**Cost of Sales. **There were nocost of sales for the years ended December 31, 2003 or 2002, as there wereno revenues, as discussed above.  Untilwe fully assume manufacturing operations from CIBA under the TransferAgreement, and determine how we are going to distribute our products ininternational markets where we may receive approval to sell, we cannotaccurately estimate what profit margins are to be expected from future sales.

 

**Selling, General and Administrative Expenses.**  Forthe year ended December 31, 2003, selling, general and administrative(“SG&A”) expenses were $1,172,000 compared to $889,000 for the year endedDecember 31, 2002, an increase of $283,000.  The increase was due to increased costs for public relations of$266,000, director fees of $132,000 and other public company expenses of$68,000.  In addition, insurance costsincreased $158,000 as compared to the prior year.  These increases were partially offset by decreased costs forleases of $156,000, for the write off of excess property and equipment of$61,000 and for other SG&A expenses of $124,000 compared to the prior year.

 

Publicrelations, director fees and other costs associated with being a public companyincreased as a result of our merger with Refocus in March 2003.  Insurance costs increased primarily as aresult of higher premiums for coverage for directors and officers as a resultof our becoming a public company with the merger with Refocus.  Lease costs decreased as a result of ourmoving to a smaller office in connection with the downsizing of our operationsand the termination of our lease on our facility in Denison, Texas in thecurrent year.  The decrease in the writeoff of our property and equipment was also related to our downsizing, as wasthe decrease in other SG&A expenses. Both the

 

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downsizingand closing of our Denison facility were the result of the CIBA Agreement,whereby CIBA had assumed manufacturing, distribution, marketing and otheroperations from us starting in March 2002.

 

Weexpect additional costs related to being a public company to continue tonegatively impact the comparison to the prior year through the first quarter ofthe next fiscal year.  However, as aresult of our liquidity concerns discussed below, we have temporarilyeliminated most of our public relation costs since September 2003.  We are currently unable to estimate the impactof the Transfer Agreement on our SG&A expenses going forward.  It is likely that our SG&A expenses willincrease as a result of the Transfer Agreement.  However, due to our lack of funds and our immediate focus on ourFDA clinical trials, we will try to minimize the impact the Transfer Agreementwill have on our SG&A expenses.

 

**Salary and Related Expenses. **For theyear ended December 31, 2003, these expenses were $1,224,000 compared to$1,170,000 for the year ended December 31, 2002.  The increase of $54,000 was principally due to (i) a severancecharge of $595,000 related to employee terminations, including Dr. Schachar’sConsulting Agreement, as described above and (ii) bonus payments of$103,000.  The increases were offset bya $644,000 decrease in salaries and related employee expenses.

 

Thedecrease in salaries and related expenses was due to the reduction in thenumber of employees reflecting the downsizing that took place as a result ofthe CIBA Agreement that was entered into in March 2002.  The bonus payments were primarily requiredto maintain our key staff during the downsizing.  We were able to significantly reduce staff because CIBA assumedresponsibility for the manufacturing, distribution, and marketing of ourPresVIEW products.  The decrease alsoreflected an allocation to research and development of $89,000 for the yearended December 31, 2003 of salaries of certain personnel in 2003 involvedfull-time in research and development work.

 

Oursalary and related expenses may increase in the future as we may hireadditional personnel in connection with reestablishing our manufacturing,distribution, marketing and regulatory operations as a result of the TransferAgreement.  We cannot, at this time,determine to what extent our salary and benefits costs will increase.

 

**Stock-based Compensation: **Stock-basedcompensation was $792,000 for the year ended December 31, 2003 compared to$8,000 for the year ended December 31, 2002.  The increase was primarily due to options issued to officers anddirectors in connection with our merger with Refocus and the completion of theprivate placement in March 2003.

 

**Professional Services. **Professionalservice fees were $1,337,000 for the year ended December 31, 2003 comparedto $534,000 for the year ended December 31, 2002.  The $803,000 increase in professionalservices was the result of an increase of $38,000 in auditing fees, $539,000 inconsulting fees and $226,000 in legal fees.

 

Higherauditing fees are associated with being a public company. We expect that auditfees will probably not change significantly over the next year.  The higher consulting fees are almostentirely related to investment advisors and bankers that provided servicesrelated to long-range financial planning and investor relations.  We currently expect costs related to theseconsulting agreements with investment advisors and bankers will be the same orlower in the next twelve months as a result of the expiration of certain ofthese contracts.  While legal feesincreased between the two periods, the prior year costs related primarily tolitigation expense associated with defending our patents, while the currentyear costs related primarily to the negotiation and drafting of the ConsultingAgreement and to our being a public company.

 

Futurecosts related to defending our patents, hiring consultants for regulatorymatters in various countries and hiring consultants to assist in the transitionand management of operations assumed from CIBA under the Transfer Agreementwill cause an increase in our consulting costs.  The amount of that increase cannot be determined at thistime.  Legal costs related to our beinga public company will continue to be significant.

 

**Clinical Trials: **The costincurred for our FDA and other clinical trials increased $295,000 to $358,000for the year ended December 31, 2003 compared to $63,000 for the yearended December 31, 2002.  Theincrease in clinical trial costs consisted of an increase of $109,000 inconsulting fees, $75,000 in salary expense associated with clinical trials,$77,000 in equipment purchased for doctors participating in the clinicaltrials, $20,000 in travel expenses and $14,000 in other expenses .  The increase in consulting fees primarilyrelates to our contract with

 

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PromedicaInternational (“Promedica”) who will be managing our Phase II FDA clinicaltrials and had already started preliminary work for those trials in 2003.  The increase in salaries and travel expensesreflects our hiring of a full time director of clinical affairs to oversee thetrials and work with Promedica and the physicians performing the clinicalsurgeries.  Equipment purchasesincreased as we bought equipment for doctors participating in our Phase IIclinical trials.  Expenses haveincreased in the current year because we did not incur any material clinicaltrial expenses in the prior year while we continued development of the PresVIEWIncision System.

 

Asa result of the funds obtained through the initial tranche of the privateplacement in March 2003 and the private placement in December 2003,we will be able to fund the start our Phase II FDA clinical trials now that wehave obtained FDA approval.  We expectthat costs in the coming months will be materially higher than comparableperiods of the prior year as we ramp up these clinical trials.  Contingent on the availability of funding,we had projected spending approximately $2,406,000 related to these clinicaltrials during 2004.  However, the actualcost is subject to many variables, some of which are beyond our control.  Therefore, the actual amount that will bespent and when such funds will be needed may be materially different than thisprojection.  We currently do not haveadequate resources to complete the FDA clinical trials in the UnitedStates.  Additional funding will beneeded to complete these trials.

 

**Research and Development Expense.** Research and development expense decreased $58,000 to $109,000 forthe year ended December 31, 2003 compared to $167,000 for the year endedDecember 31, 2002.  The decreasewas the result of incurring $162,000 less in expenses, which was partiallyoffset by (i) a charge of $89,000 for salaries in 2003 for certain personneldevoting full time to research and development and (ii) a charge of $15,000 forthe settlement of a dispute with a manufacturer of prototypes of the PresVIEWIncision System in 2003.  Of the$162,000 decrease, $161,000 related to a decrease in costs incurred for theproduction and testing of the prototypes of the PresVIEW Incision device.  Other research and development expensesdecreased $1,000.  The increase insalaries was the result of the allocation of salaries for employees who wereworking full-time in this area in 2003. These employees were terminated during the quarter ended June 30,2003.  Most of our expenditures relatedto the development of the PresVIEW Incision System were incurred prior to 2003.

 

Researchand development expenses are not expected to increase materially in the nearterm.  Most of our future research anddevelopment on the ARMD device will be done by Dr. Schachar as part of hisConsulting Agreement.  We do not expectto spend any additional funds on research for the SEVFL during the next year.  However, as a result of the Transition Agreement,we may spend additional funds on the further enhancement of the PresVIEWIncision device over the next year.

 

**Depreciation and Amortization Expense. **Depreciation and amortization expense was $604,000 for the year endedDecember 31, 2003 compared to $123,000 for the year endedDecember 31, 2002.  Of the $481,000increase, amortization of patents and trademarks increased approximately$345,000, amortization of the non-compete agreement was $163,000, and depreciationdecreased approximately $27,000.

 

Theincrease in patent and trademark amortization primarily reflects (i) the$253,000 write-off of certain of our PSI and SEVFL patents and (ii) thewrite-off of Presby and related device trademarks of $95,000, partially offsetby a $3,000 decrease in amortization of patents.  The write-off of the patents was related to a cost-benefitanalysis performed by us and our patent attorney, whereby we decided not tomaintain or pursue patents in countries where the cost of obtaining ordefending those patents appeared to outweigh the potential return from sales ofour products.  We have continued tomaintain or pursue patents in all major economic areas.  The write-off of the trademarks related tothe change in the Presby name to Refocus Ocular.  Amortization decreased primarily as a result of the write-offsduring the year.  The amortization ofthe non-compete agreement began in March 2003 as a result of thecapitalization of the non-compete component of the Consulting Agreement.  Depreciation decreased primarily due to thewrite-off of surplus furniture and equipment in 2002, due to the reduction intheir value in connection with the downsizing of our operations after the CIBAAgreement.

 

**Other Income (Expense), Net. **Otherexpense of $98,000 for the year ended December 31, 2003 consistedprimarily of interest expense of $122,000 which was partially offset by $24,000in interest income on our cash balances. Interest expense consisted of $1,000 paid on a bridge loan received inFebruary 2003 to fund operations until the completion of the merger andprivate placement and $121,000 that represented the accretion of discount onthe

 

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liabilityfor the Consulting Agreement.  Otherincome of $20,000 for the year ended December 31, 2002 was primarilyinterest income earned on cash balances held by us.

 

**Income Taxes.** Werecorded no income tax benefit for either period.  Any benefit related to the current or prior year’s loss wasoffset by a corresponding increase in the deferred tax asset valuationallowance.

 

**Preferred Dividends.** Preferred dividends and the accretion of discount on the preferredstock were $4,000 for the year ended December 31, 2003.  Preferred dividends and accretion ofdiscount were $2,801,000 for the year ended December 31, 2002.  The decrease from 2002 to 2003 was due tothe July 2002 agreement with the Series B preferred stockholders, wherebythe Series B preferred stockholders received approximately 1,199,837 additionalshares of Series B preferred stock in 2002 in lieu of any future dividends ontheir shares, and the subsequent conversion of the Series B preferred stock tocommon stock in conjunction with the merger, which was consummated inMarch 2003.

 

*The Year Ended December 31, 2002 Compared to theYear Ended December 31, 2001*

 

**Revenues. **There were no revenues for the year endedDecember 31, 2002.  Revenues forthe year ended December 31, 2001 of $230,000 consisted of seminar revenuesof $67,000 and $163,000 in sales of PSIs and surgical kits.

 

Thedecrease in product sales resulted from our decision to suspend sales of PSIsand surgical kits in early 2001 in order to develop an automated incisionmaking tool, the PresVIEW Incision System, for use in the SSP.  Since seminars were used by us to promotethe sale of the PresVIEW technology, these were also suspended in 2001.  In addition, as a result of the CIBAAgreement in March 2002, CIBA was to be responsible for all PSI andsurgical kit sales and seminars in the future. As a result, we had anticipated generating future revenues fromroyalties from CIBA on product sales and from milestone payments CIBA wouldmake under the CIBA Agreement and not from either seminars or from directproduct sales for the PSI and related products.  See the above discussion of the Transfer Agreement and itsexpected impact on revenues.

 

**Cost of Sales. **There were nocost of sales for the year ended December 31, 2002, as there were norevenues.  Cost of sales were $223,000for the year ended December 31, 2001 of which $182,000 related to seminarfees and $41,000 to sales of PSIs and surgical kits.

 

**Selling, General and Administrative Expenses.**  Forthe year ended December 31, 2002, SG&A expenses were $889,000 comparedto $1,036,000 for the same period in 2001. SG&A expenses decreased as a result of the CIBA Agreement, whichallowed us to reduce the size of our operations as we would no longer beresponsible for distribution, marketing and manufacturing.

 

FutureSG&A expenses will reflect a full year of our decreased size.  In addition, costs related to publicrelations, board of director fees, insurance and other public company costswill increase substantially after the merger discussed in the *“Overview”* above.

 

**Salary and Related Expenses. **For theyear ended December 31, 2002, these expenses were $1,170,000 compared to$1,286,000 for the year ended December 31, 2001.  Salaries in 2001 reflected the additional staff hired inassociation with the FDA feasibility clinical trials and the development of thePresVIEW Incision System in 2001.  As aresult of the CIBA Agreement, staffing was reduced during the year formarketing, administration, FDA clinical trials and engineering functions.  The full impact of these reductions will notbe recognized until future periods.

 

**Stock-based Compensation: **Stock-basedcompensation was $8,000 for the year ended December 31, 2002 compared to$160,000 for the year ended December 31, 2001.  These amounts represent the value of options issued to a formerpresident of ours under his employment contract.

 

**Instrument Upgrade Costs. **Instrumentupgrade costs were $365,000 for the year ended December 31, 2001.  The expenses primarily related to additionsand modifications made to the associated hand-held instruments provided in asurgical kit.  Instrument modificationsor additions made to the surgical kit were generally provided at no

 

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chargeto physicians that had previously purchased the surgical kit.  We wanted to ensure that physicians were usingthe latest instrumentation in performing the SSP.

 

**Inventory Adjustment Costs. **Inventoryadjustment costs were $128,000 for the year ended December 31, 2002.  The costs primarily represented inventorywrite-downs related to the transfer of distribution and marketing to CIBA underthe CIBA Agreement.  Since the PSIs wereto be manufactured by CIBA and packaged under the PresVIEW brand name, andsince the surgical instruments in our inventory were to be replaced by thePresVIEW Incision System or by instruments branded by CIBA, we wrote off ourremaining inventory less any expected recoveries.

 

**Professional Services. **Professionalservice fees were $534,000 in 2002 and $1,231,000 in 2001.  The decrease in professional service feesrelated primarily to decreased costs of litigation initiated by us againstcompanies and individuals allegedly infringing upon our patent rights partiallyoffset by higher accounting and consulting fees.  In the future, we expect public company costs related toconsulting fees, legal fees and audit fees will increase substantially afterthe merger.

 

**Clinical Trials. **Clinical trialcosts were $63,000 for the year ended December 31, 2002 compared to$194,000 for the year ended December 31, 2001.  The prior year expense reflected primarily the costs related tothe completion of FDA Phase I clinical trials, while the expense for 2002primarily reflected certain costs related to obtaining FDA Phase II clinicaltrial approval.  The low level ofexpenditures during 2002 reflected the delay in trying to start our Phase IIclinical trials until the PresVIEW Incision System was ready.  We expect a significant increase inexpenditures related to the FDA clinical trials in the next fiscal year after thePresVIEW Incision System is ready.

 

**Research and Development Expense.** Research and development expense decreased to $167,000 for theyear ended December 31, 2002 compared to $339,000 for the year endedDecember 31, 2001.  The decrease wasprimarily related to the design, development and production of prototypes ofthe PresVIEW Incision System that started in 2001.  The level of spending in 2002 decreased as most of theengineering had been done in 2001.  Inthe future, research and development expenses are expected to decrease evenfurther as testing and engineering on the PresVIEW Incision System is nearingcompletion.

 

**Depreciation and Amortization Expense. **Depreciation and amortization expense was $123,000 for the year endedDecember 31, 2002 compared to $119,000 for the year ended December 31,2001.  Of the $4,000 increase for theyear ended December 31, 2002, amortization of patents and trademarksincreased approximately $18,000 due to patent and trademark additions during2002, while depreciation decreased approximately $14,000 primarily due to thewrite-off of surplus furniture and equipment.

 

**Other Income (Expense), Net. **Otherincome decreased to $20,000 for the year ended December 31, 2002, comparedto $273,000 for the year ended December 31, 2001.  Interest income decreased to $21,000 from$171,000 due to the decrease in interest rates and in cash available forinvestment.  We have had to use our cashreserves for operations due to the lack of revenue after we suspended productsales.  Other income includes a legalsettlement of  $115,000 in 2001, whichalso contributed to the decrease.

 

**Income Taxes.** Werecorded no income tax benefit for either period.  Any benefit related to the current or prior year’s loss wasoffset by a corresponding increase in the deferred tax asset valuation allowance.

 

**Preferred Dividends.** Preferred dividends and the accretion of discount on the preferredstock were $2,801,000 for the year ended December 31, 2002 compared to$618,000 for the year ended December 31, 2001.  The increase was due to the July 2002 agreement with theSeries B preferred stockholders whereby the Series B preferred stockholdersreceived approximately 1,199,837 shares of Series B preferred stock, valued at$2,455,000, in 2002 in lieu of any future dividends on their shares.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cashand cash equivalents were $3,000,000 at December 31, 2003.  This represents an increase of $2,733,000since December 31, 2002.  Theincrease was primarily funded from the $6,431,000 in funds received fromprivate placements of common stock during the year, which was partially offsetby $3,468,000 in funds used for operations,

 

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additionsto patents and trademarks of $225,000, and additions to property and equipmentof $13,000.  In order to fund operatingexpenses until the Merger Closing Date, we borrowed $250,000 in lateFebruary 2003, of which a majority was converted into our common stock atthe closing of the March 2003 private placement.  We paid interest of approximately $1,000 on this loan at theclosing of that private placement.

 

Withthe funds received from the private placements in March 2003 andDecember 2003, we began our Phase II FDA clinical trials in the UnitedStates during the first quarter of 2004. We retained Promedica to assist in the management of these FDA clinicaltrials.  We have five sitesparticipating in this early phase of the clinical trials.  We have incurred significant costs inpreparation for the start of the clinical trials, which costs will continue toincrease as the trials progress.  Weexpect to spend an additional $1,228,000 by August 2004 related to the FDAclinical trials, subject to the availability of funds.  The actual costs to be incurred are subjectto many variables, some of which are beyond our control.  Therefore, the actual amount that will bespent and when such funds will be needed may be materially different than ourcurrent projection.  We currently do nothave adequate resources to complete the FDA trials, which may continue for severalyears.  Additional funding will beneeded to complete these FDA clinical trials.

 

Wecannot sell our products in the United States until they receive approval fromthe FDA, and there can be no assurance, even if we have adequate funding, thatwe will receive the necessary approvals. Clinical trials required to obtain regulatory approvals are complex andexpensive, and their outcomes are uncertain. Negative or adverse results during a clinical trial could causesubstantial delays in receiving approval. Delays may also arise from additional government regulations from futurelegislation, administrative actions or changes in FDA policies.  Therefore, the actual time and expendituresrequired to pursue FDA approval cannot be predicted with certainty, and theamounts of additional funding needed for these clinical trials may not beavailable when needed.

 

Wewill not generate any significant revenue in 2004, as the expectedre-introduction of the procedure in the European Union during 2004 will bedelayed due to the Transfer Agreement with CIBA, remaining issues associatedwith the CE Mark certification of the PSI, and the lack of adequatefunding.  Even if the SSP is marketed inthe European market during 2004, our marketing efforts may involve only a fewphysicians.  These initial physicianswould later train other physicians as well as generate surgical data that canbe published to encourage other physicians to adopt our procedure.  We do not presently have any plans to startthe procedure in any other international markets during 2004.

 

Asa result of the Transfer Agreement, we need to reestablish our ownmanufacturing, marketing, distribution, regulatory and other operationalfunctions.  If we decide to performthese functions directly, our expenses will increase substantially before anyrevenues from international sales could be achieved.  We cannot be sure of our ability to finance these tasks due totheir cost and our limited amount of funding. We may also determine that we prefer to establish strategic, license ordistribution agreements with various regional partners for someoperations.  We can provide noassurance, however, that we will be able to establish agreements with thirdparties within a reasonable time frame. Therefore, as a result of increased expenses and the potential fordelayed revenues, we believe that the Transfer Agreement will have a materialadverse impact on our financial condition in the short term.

 

Wehave taken steps to preserve our cash to give us time to complete the firstgroup of surgeries under the Phase II clinical trials, which results weanticipate will indicate the success of the SSP in treating presbyopia.  In order to preserve our funds, we operatewith only four full-time employees, have taken steps to significantly reduceour public relation costs and have deferred payments of consulting fees tofinancial advisors, with their concurrence. In addition, several of our directors have agreed to accept a portion oftheir director fees in stock rather than cash. However, in addition to our planned FDA clinical trial expendituresnoted above, we also will pay approximately $433,000 to Dr. Schachar in 2004 inconnection with his Consulting Agreement, will pay a former employeeapproximately $32,000 in 2004 under his severance agreement, and will continueto incur significant expenditures for costs related to being a public company,especially audit, legal, insurance and director fees.  As noted above, the cost of assuming the operating functionspreviously performed by CIBA under the CIBA Agreement may be very significantrelative to our available funds.  Atthis time, we cannot estimate the amount of, and when, funds will be requiredto reestablish the functions formerly performed by CIBA.  We will concentrate our immediate efforts onour FDA clinical trials, and any operations or matters not directly connectedwith those clinical trials will probably be managed on a minimum funding basis.

 

47

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Webelieve that the funds currently on hand will fund operations untilapproximately the first month of the 3rd quarter of 2004.  Therefore, we do not have sufficientfinancial resources to fund our operations for the next twelve months.  In addition, we will require substantial additionalcapital to fund our future operations and conduct our FDA clinical trials overthe next several years.  We may berequired to seek additional funding through collaborative arrangements withcorporate partners and through public or private debt or equityfinancings.  Any equity financing may bedilutive to stockholders.  Any debtfinancing may involve restrictions on our ability to pay dividends on ourcapital stock, may also be dilutive to stockholders if it involves conversionfeatures or warrants, or may affect the manner in which we can conduct ourbusiness.  We cannot give any assurancesthat additional equity or debt funding will be available in sufficient amounts,on terms acceptable to us, or at all, when needed.  Our ability to raise additional capital depends on many factors,some of which are beyond our control, including the state of capital markets,the market price of our common stock and the prospects for our business.  The inability to obtain sufficient funds mayrequire us to delay, scale back or eliminate some or all of our research,clinical studies and/or regulatory activities or may cause us to ceaseoperations.  We may seek a mergerpartner or the sale of our assets if additional financing is notavailable.  Our inability to obtainadditional financing could have a material adverse effect on us.

 

Wewill be seeking additional equity funds as soon as possible, most probablyafter the initial results of our Phase II FDA trials are known.  We anticipate that those results willindicate to prospective investors or corporate partners that the SSP is asuccessful treatment for presbyopia.  Wecannot assure you that the results will be available before funds are needed orthat they will enable us to attract new funding.

 

**OTHER**

 

THISANNUAL REPORT ON FORM 10-KSB DOES NOT CONSTITUTE AN OFFER TO SELL ORSOLICITATION OF AN OFFER TO PURCHASE SECURITIES OF THE COMPANY.  ANY OFFER OF SECURITIES MADE BY THE COMPANYOR OTHER PERSON ON BEHALF OF THE COMPANY MAY BE MADE ONLY PURSUANT TO MATERIALSAND OTHER OFFERING DOCUMENTS PREPARED BY THE COMPANY AND DELIVERED TO QUALIFIEDPURCHASERS EXPRESSLY FOR USE IN CONNECTION WITH, OR PURSUANT TO AN EXEMPTIONFROM, SECTION 5 OF THE SECURITIES ACT OF 1933.  THE SECURITIES OFFERED WILL NOT BE REGISTERED UNDER THESECURITIES ACT OF 1933 AND MAY NOT BE OFFERED OR SOLD IN THE UNITED STATESABSENT REGISTRATION OR AN APPLICABLE EXEMPTION FROM REGISTRATION REQUIREMENTS.

 

**Recently Issued Accounting Pronouncements:**  InApril 2002, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 145 “Rescission ofFASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, andTechnical Corrections”.   SFAS No. 13 isamended to eliminate any inconsistency between the required accounting for saleleaseback transactions and the required accounting for certain leasemodifications that have economic effects that are similar to leasebacktransactions.  This statement alsoamends other existing authoritative pronouncements to make various technicalcorrections, clarify meanings, or describe their applicability under changedconditions.  We adopted this standard inour fiscal year beginning January 1, 2003.  There was no impact on our results of operations or financialcondition as a result of the adoption of the standard.

 

InJune 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associatedwith Exit or Disposal Activities”.  Thisstatement requires recording costs associated with exit or disposal activitiesat their fair value when a liability has been incurred.  Under previous guidance, certain exit costswere accrued upon management’s commitment to an exit plan, which is generallybefore an actual liability has been incurred. The provisions of this statement are effective for exit or disposalactivities that are initiated after December 31, 2002.  This standard did not have any impact on ourresults of operations or financial condition.

 

InNovember 2002, the FASB issued Interpretation No. 45 (“FIN 45”)“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others”.  This interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at theinception of a guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee. The disclosure

 

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requirementsand initial measurement requirements of FIN 45 are effective prospectively forguarantees issued or modified after December 31, 2002.  We are not a party to any agreement in whichwe are a guarantor of indebtedness of others. Accordingly, the pronouncement is currently not applicable to us.

 

InApril 2003, the FASB issued SFAS No. 149 “Amendment of Statement 133 onDerivative Instruments and Hedging Activities”.  This statement amends SFAS No. 133 “Accounting for DerivativeInstruments and Hedging Activities” for certain decisions made by theFASB.  This statement is effective formost contracts entered into or modified, and for most hedging relationshipsdesignated, after June 30, 2003. Because we do not currently have any derivative instruments or hedgingrelationships, the adoption of this standard did not have any impact on ourresults of operations or financial condition.

 

InMay 2003, the FASB issued SFAS No. 150 “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity”.  This statement establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  It requires that many instruments formerly classified as equitywill be classified as liabilities.  Thestatement does not apply to features that are embedded in a financialinstrument that is not a derivative in its entirety.  It also does not affect the classification or measurement ofconvertible bonds or other outstanding shares that are conditionallyredeemable.  Generally, theseliabilities should initially be measured at fair value.  The statement is effective for financialinstruments entered into or modified after May 31, 2003 and, otherwise, shallbe effective at the first interim period beginning after June 15,2003.  Restatement of financialstatements issued for earlier periods is not permitted.  Our former Series B redeemable preferredstock, which was exchanged for common stock in March 2003, was redeemableat the option of the holder.  Therefore,this statement does not change the prior accounting for that preferredstock.  We do not currently have anyinstruments affected by this statement and, therefore, the standard will nothave any impact on our results of operations or financial condition.

 

InDecember 2003, the FASB issued SFAS No. 132 (revised 2003) “Employers’Disclosures about Pensions and Other Postretirement Benefits”.  This statement retains the disclosuresprovided in the original SFAS No. 132 but adds disclosures describing the typeof plan assets, investment strategy, measurement dates, plan obligations, cashflows and components of net periodic benefit cost recognized during interimperiods.  The revised statement isgenerally effective for fiscal years ending after December 15, 2003.  We do not currently have any contributoryplans that would require the additional disclosures.

 

**ITEM 7****.  FINANCIAL STATEMENTS**

 

Theaudited financial statements and related footnotes of Refocus Group, Inc. andSubsidiaries can be found beginning with the Index to Consolidated FinancialStatements following Part III of this Annual Report on page F-1.

 

**ITEM 8****.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND  FINANCIAL DISCLOSURE**

 

Theinformation required by this item has been previously disclosed by theregistrant.

 

**ITEM 8A****.  CONTROLS AND PROCEDURES.**

 

Atthe end of the period covered by this report, an evaluation was performed underthe supervision and with the participation of Company’s management, includingthe principal executive officer and principal financial officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based on that evaluation, our principalexecutive officer and principal financial officer concluded that the Company’sdisclosure controls and procedures were effective in timely accumulating, processing,recording and communicating to them material information related to the Companyand its consolidated subsidiaries that are required to be disclosed by theCompany in reports that it files or submits under the Exchange Act.  There have not been any changes in theCompany’s internal controls over financial reporting (as

 

49

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definedin Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter endedDecember 31, 2003 that have materially affected, or are reasonably likelyto materially affect, the Company’s internal control over financial reporting.

 

**PART III**

 

Theinformation called for by Part III Items 9, 10, 11, 12 and 14 is incorporatedherein by reference to our definitive Proxy Statement for our Annual Meeting ofStockholders which is expected to be filed with the Securities and ExchangeCommission within 120 days of December 31, 2003.

 

50

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**ITEM 13****.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                                                                                                             |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                        |
| 2.1             |   | Agreement  of Merger and Plan of Reorganization, dated as of March 6, 2003, by and  among the Registrant, Refocus Acquisition Corp. and Presby Corp  (Filed as Exhibit 2.1 to the registrant’s  Current Report on Form 8-K filed March 12, 2003 and incorporated herein  by reference.) |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 3.1             |   | Certificate  of Incorporation of the Registrant, dated as of January 10, 2003.  (Filed as Exhibit 3.1 to the registrant’s  Current Report on Form 8-K filed March 12, 2003 and incorporated herein  by reference.)                                                                      |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 3.1.1           |   | Certificate  of Amendment of Incorporation of the Registrant, dated as of July 3,  2003.  (Filed as Exhibit 3.1.1 to the  registrant’s Form SB-2 filed September 2, 2003 and incorporated herein  by reference.)                                                                        |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 3.2             |   | Bylaws  of the Registrant.  (Filed as Exhibit  3.2 to the registrant’s Current Report on Form 8-K filed March 12, 2003  and incorporated herein by reference.)                                                                                                                               |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 3.2.1           |   | First  Amendment to Bylaws of the Registrant.   (Filed as Exhibit 3.2.1 to the registrant’s  Form SB-2 filed September 2, 2003 and incorporated herein  by reference.)                                                                                                                  |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.1             |   | Form  of common stock certificate.  (Filed  as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                                       |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.2             |   | Form  of Warrant to Purchase Common Stock, issued to certain investors, at $2.50  per share, expiring March 6, 2006.   (Filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K  filed March 12, 2003 and incorporated herein by reference.)                                |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.3             |   | Form  of Warrant to Purchase Common Stock, issued to certain advisors, at $2.50 per  share, expiring March 6, 2006.   (Filed as Exhibit 4.3 to the registrant’s Annual Report on Form 10-KSB  for the year ended December 31, 2002 and incorporated herein by reference.)               |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.4             |   | Form  of Warrant to Purchase Common Stock, issued to certain advisors, at $2.50 per  share, expiring March 6, 2006. (Files as Exhibit 4.4 to the registrant’s  Annual Report on Form 10-KSB for the year ended December 31, 2002 and  incorporated herein by reference.)                     |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.5             |   | Form  of Warrant to Purchase Common Stock, issued to an advisor, at $2.00 per  share, expiring March 6, 2008.   (Filed as Exhibit 4.5 to the registrant’s Annual Report on Form 10-KSB  for the year ended December 31, 2002 and incorporated herein by  reference.)                    |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.6             |   | Form  of Warrant to Purchase Common Stock, issued to certain investors, at $2.00  per share, expiring December 23, 2006.   (Filed as Exhibit 4.6 to the registrant’s Form SB-2 Amendment No. 1  filed February 2, 2004 and incorporated herein by reference.)                           |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 4.7             |   | Form  of Warrant to Purchase Common Stock, issued to an agent, at $2.00 per share,  expiring December 23, 2006.   (Filed as Exhibit 4.7 to the registrant’s Form SB-2 Amendment No. 1  filed February 2, 2004 and incorporated herein by reference.)                                    |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 10.1            |   | Amended  and Restated Presby Corp 1997 Stock Option Plan.  (Filed as Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed March 12, 2003 and incorporated herein by reference.)                                                                                                |
|            |   |                                                                                                                                                                                                                                                                                                        |
| 10.2            |   | Presby  Corp Employees Savings Plan.  (Filed  as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                                    |

 

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| 10.3   |   | Confidentiality  Letter Agreement, dated as of May 5, 1999, by and between RAS Holding Corp.  and CIBA Vision Corporation.  (Filed  as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.4   |   | Secrecy  Agreement, dated as of August 21, 2001, by and among CIBA Vision  Corporation, RAS Holding Corp. and Presby Corp  (Filed as Exhibit 10.4 to the registrant’s Current Report on  Form 8-K filed March 12, 2003 and incorporated herein by reference.)                        |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.5.1 |   | License  Agreement, dated as of March 6, 2002, by and between Presby Corp and  CIBA Vision AG.  (Filed as Exhibit  10.5.1 to the registrant’s Current Report on Form 8-K filed March 12,  2003 and incorporated herein by reference.)                                                |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.5.2 |   | First  Amendment to License Agreement, dated as of March 11, 2003, by and  between Presby Corp and CIBA Vision AG.   (Filed as Exhibit 10.5.2 to the registrant’s Current Report on Form  8-K filed March 12, 2003 and incorporated herein by reference.)                            |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.6   |   | Employment  Agreement, dated as of April 24, 1998, by and between RAS Holding Corp.  and Mark A. Cox, and as amended December 1, 2002.  (Filed as Exhibit 10.6 to the registrant’s  Current Report on Form 8-K filed March 12, 2003 and incorporated herein  by reference.)     |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.7   |   | Employee  Confidentiality and IP Rights Agreement, dated July 1997, by and between  Presby Corp. and Mark A. Cox.  (Filed  as Exhibit 10.7 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                               |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.8   |   | Employment  Agreement, dated as of September 5, 2002, by and between Presby Corp and  Terence A. Walts.  (Filed as Exhibit  10.8 to the registrant’s Current Report on Form 8-K filed March 12, 2003  and incorporated herein by reference.)                                         |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.8.1 |   | First  Amendment to Employment Agreement, dated as of May 29, 2003, by and between Presby  Corp and Terence A. Walts.  (Filed as  Exhibit 10.8.1 to the registrant’s Form SB-2 filed September 2, 2003 and  incorporated herein by reference.)                                            |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.9   |   | Non-Qualified  Stock Option Agreement with Terence A. Walts, dated as of September 1,  2002.  (Filed as Exhibit 10.9 to the  registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.)                                                    |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.10  |   | Severance,  Release and Consulting Agreement, dated as of February 25, 2003, by and  between Presby Corp and Ronald A. Schachar, M.D., Ph.D.  (Filed as Exhibit 10.10 to the  registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.)   |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.11  |   | Amended  and Restated Registration Rights Agreement, dated as of June 22, 2000,  by and among RAS Holding Corp. and the parties named therein.  (Filed as Exhibit 10.11 to the  registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.) |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.12  |   | Form  of Promissory Note, dated as of February 26, 2003, made by Presby Corp  in favor of six lenders for $250,000 aggregate principal amount.  (Filed as Exhibit 10.12 to the  registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.) |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.13  |   | Advisory  Agreement, dated as of March 3, 2003, by and between the Registrant and  Verus Support Services Inc.  (Filed as  Exhibit 10.13 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                 |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.14  |   | Advisory  Agreement, dated as of March 4, 2003, by and among the Registrant and  Kingsdale Capital Corporation and its affiliates.  (Filed as Exhibit 10.14 to the registrant’s Current Report on  Form 8-K filed March 12, 2003 and incorporated herein by reference.)              |

 

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| 10.15   |   | Indemnification  Agreement, dated as of March 6, 2003, by and among the Registrant,  Daniel Gunter and Adrienne Beam.   (Filed as Exhibit 10.15 to the registrant’s Current Report on Form 8-K  filed March 12, 2003 and incorporated herein by reference.)                                                                                  |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.16   |   | Form  of Lock-Up Letter by and between the Registrant and holders of Presby Corp  common stock.  (Filed as Exhibit 10.16  to the registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.)                                                                                                             |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.17   |   | Form  of Lock-Up Letter by and between the Registrant and holders of Presby Corp  Series B preferred stock.  (Filed as  Exhibit 10.17 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                 |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.18   |   | Form  of Lock-Up Letter by and between the Registrant and holders of Presby Corp  Series C preferred stock.  (Filed as  Exhibit 10.18 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                 |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.19   |   | Form  of Subscription Agreement.  (Filed as  Exhibit 10.19 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.20   |   | Letter  Agreement, dated as of March 6, 2003, by Verus Support Services Inc. and  acknowledged by the Registrant relating to Verus’s contingent  subscription.  (Filed as Exhibit 10.20  to the registrant’s Current Report on Form 8-K filed March 12, 2003 and  incorporated herein by reference.)                                    |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.20.1 |   | Letter  Agreement, dated as of August 28, 2003, between the Registrant and Verus  Support Services Inc. relating to the deferral of Verus’s contingent  subscription. (Filed as Exhibit 10.1 to the registrant’s Quarterly Report on  Form 10-QSB for the quarter ended September 30, 2003 and incorporated  herein by reference.)           |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.20.2 |   | Letter  Agreement dated as of December 4, 2003 between the Registrant and  Verus Support Services Inc. relating to  the deferral of Verus’s contingent subscription.  (Filed as Exhibit 10.20.2 to the registrant’s Form SB-2  Amendment No. 1 filed February 2, 2004 and incorporated herein by  reference.)                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.20.3 |   | Letter  Agreement dated as of January 6, 2004 between the Registrant and  Verus Support Services Inc. relating to  the deferral of Verus’s contingent subscription and other items.  (Filed as Exhibit 10.20.3 to the  registrant’s  Form SB-2 Amendment No.  1 filed February 2, 2004 and incorporated herein by reference.) |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.21   |   | Letter  Agreement, dated as of March 4, 2003, by and between Registrant and  Insite Productions, LLC.  (Filed as  Exhibit 10.21 to the registrant’s Current Report on Form 8-K filed  March 12, 2003 and incorporated herein by reference.)                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.22   |   | Agreement  between the registrant and Promedica International.  (Filed as Exhibit 10.2 to the registrant’s Quarterly Report on  Form 10-QSB for the quarter ended September 30, 2003 and incorporated  herein by reference.)                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.23   |   | Form  of Amended and Restated Subscription Agreement.  (Filed as Exhibit 10.23 to the registrant’s Form SB-2 Amendment  No. 1 filed on February 2, 2004 and incorporated herein by reference.)                                                                                                                                                    |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.24   |   | License  Transfer and Transition Services Agreement, dated as of January 30,  2004, by and among the registrant, Refocus Ocular, Inc., CIBA Vision AG and  CIBA Vision Corporation.  (Filed as  Exhibit 10.24 to the registrant’s Current Report on Form 8-K filed on  February 2, 2004 and incorporated herein by reference.)               |
|    |   |                                                                                                                                                                                                                                                                                                                                                             |
| 14.1    |   | Refocus  Group, Inc. Code of Conduct and Ethics. *                                                                                                                                                                                                                                                                                                               |

 

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| 21.1   |   | Subsidiaries  of the Registrant. *                                                                                                    |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                  |
| 31.1   |   | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act. *                               |
|   |   |                                                                                                                                  |
| 31.2   |   | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange  Act. *                               |
|   |   |                                                                                                                                  |
| 32.1   |   | Certification  Required by 18 U.S.C. Section 1350 (as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002).* |
|   |   |                                                                                                                                  |
|        |
|   |   | *  Filed herewith.                                                                                                                    |

 

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(b)                                 Reports on Form8-K

 

During the three months ended December 31,2003, we did not file any Current Reports on Form 8-K.

 

The following Current Report on Form 8-K was filedafter December 31, 2003:

 

Current Report on Form 8-K dated January 30,2004, filed February 2, 2004, which disclosed the License Transfer andTransition Services Agreement between the registrant, its wholly-ownedsubsidiary, Refocus Ocular, Inc., CIBA Vision AG and CIBA Vision Corporation,that was entered into on January 30, 2004.

 

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**SIGNATURES**

 

Inaccordance with Section 13 or 15(d) of the Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                 |   | Refocus  Group, Inc.                                                                                |
|----------------------|--------|-----------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                |
|                 |   |                                                                                                |
|                 | By     | /s/  Mark A. Cox                                                                                    |
|                 |   | Mark  A. Cox                                                                                        |
| March 30,  2004 |   | Vice  President, Secretary and Chief Financial Officer(Principal Financial and  Accounting Officer) |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 
| **Principal Executive Officers:** |   |                                                                                                |   |                 |
|-----------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|----------------------|
|                              |   |                                                                                                |   |                 |
|                              |   |                                                                                                |   |                 |
|   /s/ Terence A. Walts       |   |                                                                                                |   |                 |
|   Terence A. Walts           |   | Director, Chief Executive Officer and President  (Principal Executive Officer)                      |   | March 30,  2004 |
|   /s/ Mark  A. Cox           |   |                                                                                                |   |                 |
|   Mark A. Cox                |   | Vice President, Secretary and Chief Financial  Officer (Principal Financial and Accounting Officer) |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
| **Additional Directors:**         |   |                                                                                                |   |                 |
|                              |   |                                                                                                |   |                 |
|   /s/ C. Glenn Bradley       |   |                                                                                                |   |                 |
|   C. Glenn Bradley, Ph.D.    |   | Director                                                                                            |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
|   /s/Abbey J. Butler         |   |                                                                                                |   |                 |
|   Abbey J. Butler            |   | Director                                                                                            |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
|   /s/ Melvyn J. Estrin       |   |                                                                                                |   |                 |
|   Melvyn J. Estrin           |   | Director                                                                                            |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
|   /s/ Peter C. Hobbins       |   |                                                                                                |   |                 |
|   Peter C. Hobbins, Ph.D.    |   | Director                                                                                            |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
|   /s/ Grady E. Schleier      |   |                                                                                                |   |                 |
|   Grady E. Schleier          |   | Director                                                                                            |   | March 30,  2004 |
|                              |   |                                                                                                |   |                 |
|   /s/ David A. Williams      |   |                                                                                                |   |                 |
|   David A. Williams          |   | Director                                                                                            |   | March 30,  2004 |

 

56

----

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| Independent Auditors’ Report                                                                                           |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                        |   |
| Consolidated Statements of Operations - For  the Three Years Ended December 31, 2003                                   |   |
|                                                                                                                        |   |
| Consolidated Balance Sheets - December 31, 2003 and 2002                                                               |   |
|                                                                                                                        |   |
| Consolidated Statements of Shareholders’  Equity (Deficiency) - For the Three Years Ended Ended December 31, 2003 |   |
|                                                                                                                        |   |
| Consolidated Statements of Cash Flows - For  the Three Years Ended December 31, 2003                                   |   |
|                                                                                                                        |   |
| Notes to Consolidated Financial Statements  - For the Three Years Ended December 31, 2003                              |   |

 

F-1

----

 

INDEPENDENTAUDITORS’ REPORT

 

Board of DirectorsRefocus Group, Inc.

 

We have audited the accompanying consolidated balance sheets of RefocusGroup, Inc. (“Refocus”) and subsidiaries as of December 31, 2003 andRefocus Ocular, Inc. (“Ocular”), formerly known as Presby Corp, andsubsidiaries (collectively, the “Company”), as of December 31, 2002 andthe related consolidated statements of operations, shareholders’ equity (deficiency),and cash flows for each of the three years in the period endedDecember 31, 2003.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the consolidated financial position of the Company asof December 31, 2003 and 2002 and the results of its operations and itscash flows for each of the three years in the period ended December 31,2003, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

The accompanying 2003 consolidated financial statements have beenprepared assuming that the Company will continue as a going concern.  As described in Notes 1 and 4 to theconsolidated financial statements, the Company believes that it will be unableto continue as a going concern through December 31, 2004 without obtainingadditional debt or equity financing. The Company’s uncertainty of obtaining sufficient additional debt orequity financing raises substantial doubt about its ability to continue as agoing concern.  Management’s plansconcerning these matters are also described in Note 4.  The financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

As discussed in Note 1 to the financial statements, on March 6,2003, a newly created wholly-owned subsidiary of Refocus was merged with andinto Ocular, with Ocular surviving as a wholly-owned subsidiary of Refocus.

 

 

Deloitte & Touche LLP

Ft. Worth, Texas

March 29, 2004

 

F-2

----

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
|                                                                |   | **Years  ended December 31,** |       |
|---------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                |   | **2003**                           |       | **2002** |   | **2001** |   |
| REVENUES                                                            |   | $                                  | —     |   | $ | — |   | $ | 230,250 |   |
|                                                                |   |                               |       |   |   |   |   |
| COST OF SALES                                                       |   | —                             |       | — |   | 223,575 |   |
|                                                                |   |                               |       |   |   |   |   |
| GROSS PROFIT                                                        |   | —                             |       | — |   | 6,675 |   |
|                                                                |   |                               |       |   |   |   |   |
| OPERATING EXPENSES:                                                 |   |                               |       |   |   |   |   |
| Selling, general and administrative                                 |   | 1,172,124                          |       | 889,147 |   | 1,036,404 |   |
| Salary and related expenses                                         |   | 1,224,248                          |       | 1,170,438 |   | 1,285,907 |   |
| Stock-based employee compensation                                   |   | 791,697                            |       | 7,650 |   | 160,250 |   |
| Instrument upgrade costs                                            |   | —                             |       | — |   | 364,695 |   |
| Inventory adjustment costs                                          |   | —                             |       | 128,059 |   | — |   |
| Professional services                                               |   | 1,337,445                          |       | 534,432 |   | 1,231,176 |   |
| Clinical trials                                                     |   | 357,739                            |       | 63,275 |   | 194,137 |   |
| Research and development                                            |   | 108,918                            |       | 166,949 |   | 339,289 |   |
| Depreciation and amortization                                       |   | 604,028                            |       | 123,403 |   | 118,789 |   |
|                                                                |   |                               |       |   |   |   |   |
| LOSS FROM OPERATIONS                                                |   | (5,596,199                         | )          | (3,083,353 | ) | (4,723,972 | ) |
|                                                                |   |                               |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                             |   |                               |       |   |   |   |   |
| Interest income                                                     |   | 23,805                             |       | 20,577 |   | 171,367 |   |
| Interest expense                                                    |   | (121,947                           | )          | — |   | — |   |
| Other income (expense)                                              |   | 15                                 |       | (325 | ) | 101,494 |   |
| Total                                                               |   | (98,127                            | )          | 20,252 |   | 272,861 |   |
| NET LOSS                                                            |   | (5,694,326                         | )          | (3,063,101 | ) | (4,451,111 | ) |
|                                                                |   |                               |       |   |   |   |   |
| Accretion of discount on preferred stock                            |   | (4,306                             | )          | (23,482 | ) | (23,501 | ) |
| Accrued dividends on preferred stock                                |   | —                             |       | (2,777,062 | ) | (594,106 | ) |
|                                                                |   |                               |       |   |   |   |   |
| NET LOSS APPLICABLE TO COMMON SHARES                                |   | $                                  | (5,698,632 | ) | $ | (5,863,645 | ) | $ | (5,068,718 | ) |
|                                                                |   |                               |       |   |   |   |   |
| NET LOSS PER SHARE APPLICABLE TO COMMON  SHARES - BASIC AND DILUTED |   | $                                  | (0.34      | ) | $ | (0.91 | ) | $ | (0.79 | ) |
|                                                                |   |                               |       |   |   |   |   |
| AVERAGE NUMBER OF COMMON SHARES OUTSTANDING  - BASIC AND DILUTED    |   | 16,862,075                         |       | 6,450,878 |   | 6,447,164 |   |

 

See notes to consolidated financial statements.

 

F-3

----

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                    |   | **December 31,** |      |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|-----------|
|                                                                                                                                                                    |   | **2003**              |      | **2002** |   |
| **ASSETS**                                                                                                                                                              |   |                  |      |   |   |
|                                                                                                                                                                    |   |                  |      |   |   |
| Current Assets                                                                                                                                                          |   |                  |      |   |   |
| Cash and cash equivalents                                                                                                                                               |   | $                     | 2,999,784 |   | $ | 267,180 |   |
| Accounts receivable                                                                                                                                                     |   | 10,000                |      | 27,068 |   |
| Prepaid expenses (Note 9)                                                                                                                                               |   | 230,464               |      | 83,733 |   |
| Total current assets                                                                                                                                                    |   | 3,240,248             |      | 377,981 |   |
| Property and Equipment - net                                                                                                                                            |   | 12,252                |      | 22,595 |   |
| Patent Costs and Trademarks - net (Note 1)                                                                                                                              |   | 957,227               |      | 1,277,198 |   |
| Non-Compete Agreement - net (Notes 1 and 6)                                                                                                                             |   | 618,397               |      | — |   |
| Other Long-Term Assets (Note 9)                                                                                                                                         |   | 138,412               |      | 194,447 |   |
| Total Assets                                                                                                                                                            |   | $                     | 4,966,536 |   | $ | 1,872,221 |   |
|                                                                                                                                                                    |   |                  |      |   |   |
| **LIABILITIES &  SHAREHOLDERS’ EQUITY (DEFICIENCY)**                                                                                                           |   |                  |      |   |   |
|                                                                                                                                                                    |   |                  |      |   |   |
| Current Liabilities                                                                                                                                                     |   |                  |      |   |   |
| Accounts payable                                                                                                                                                        |   | $                     | 419,968   |   | $ | 104,194 |   |
| Accrued expenses (Note 9)                                                                                                                                               |   | 277,312               |      | 190,983 |   |
| Current portion of separation and  consulting agreement (Note 6)                                                                                                        |   | 407,384               |      | — |   |
| Current portion of CIBA obligation (Note 5)                                                                                                                             |   | 375,000               |      | — |   |
| Customer deposits                                                                                                                                                       |   | 23,000                |      | 23,000 |   |
| Total current liabilities                                                                                                                                               |   | 1,502,664             |      | 318,177 |   |
| Long-Term Liabilities                                                                                                                                                   |   |                  |      |   |   |
| Separation and consulting agreement (Note  6)                                                                                                                           |   | 688,421               |      | — |   |
| CIBA obligation (Note 5)                                                                                                                                                |   | 1,625,000             |      | 2,000,000 |   |
| Total long-term liabilities                                                                                                                                             |   | 2,313,421             |      | 2,000,000 |   |
| Commitments and Contingencies (Note 10)                                                                                                                                 |   | —                |      | — |   |
| Redeemable Series B Preferred Stock -  4,500,000 shares of $.001 par value authorized, 4,481,396 shares issued and  outstanding in 2002 - Refocus Ocular, Inc. (Note 7) |   | —                |      | 9,114,144 |   |
| Shareholders’ Equity (Deficiency) (Note 7)                                                                                                                         |   |                  |      |   |   |
| Preferred stock: 10,000,000 shares of  $.0001 par value authorized, no shares issued and outstanding in 2003                                                            |   | —                |      |   |   |
| Series C preferred stock: 65,000 shares of  $.001 par value authorized, 21,614 shares issued and outstanding in 2002 -  Refocus Ocular, Inc.                            |   | —                |      | 1,049,104 |   |
| Warrants for the purchase of Refocus Group,  Inc. common stock                                                                                                          |   | 2,047,350             |      |   |   |
| Common stock: 60,000,000 shares of $.0001  par value authorized, 23,368,887 shares issued and outstanding in 2003                                                       |   | 2,337                 |      |   |   |
| Common stock: 30,000,000 shares of $.001  par value authorized, 6,450,878 shares issued and outstanding in 2002 -  Refocus Ocular, Inc.                                 |   | —                |      | 6,451 |   |
| Paid-in capital                                                                                                                                                         |   | 21,660,056            |      | 6,245,005 |   |
| Accumulated deficit                                                                                                                                                     |   | (22,559,292           | )         | (16,860,660 | ) |
| Total shareholders’ equity (deficiency)                                                                                                                            |   | 1,150,451             |      | (9,560,100 | ) |
| Total Liabilities and Shareholders’ Equity  (Deficiency)                                                                                                           |   | $                     | 4,966,536 |   | $ | 1,872,221 |   |

 

See notes to the consolidated financial statements.

 

F-4

----

 

**REFOCUS GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)FOR THE THREE YEARS ENDED DECEMBER 31, 2003**

 
|                                                                                                             |   | **Shares**  |   | **Amount** |      |
|------------------------------------------------------------------------------------------------------------------|--------|-------------|--------|------------|-----------|
| **Series C Preferred  Stock of Refocus Ocular, Inc.:**                                                           |   |        |   |       |      |
| Balance at December 31, 2000                                                                                |   | 21,400      |   | $          | 1,025,747 |   |
| Exercise of Series C preferred stock  warrants (net of $2,609 in expenses)                                       |   | 214         |   | 23,357     |      |
| Balance at December 31, 2001 and 2002                                                                       |   | 21,614      |   | 1,049,104  |      |
| Conversion of Series C preferred stock to  common                                                                |   | (21,614     | )      | (1,049,104 | )         |
| Balance at December 31, 2003                                                                                |   | —      |   | $          | —    |   |
|                                                                                                             |   |        |   |       |      |
| **Series C Preferred  Stock Warrants of Refocus Ocular, Inc.:**                                                  |   |        |   |       |      |
| Balance at December 31, 2000                                                                                |   |        |   | $          | 913,386   |   |
| Exercise of Series C preferred stock  warrants                                                                   |   |        |   | (4,566     | )         |
| Expiration of Series C preferred stock  warrants                                                                 |   |        |   | (904,254   | )         |
| Balance at December 31, 2001                                                                                |   |        |   | 4,566      |      |
| Expiration of Series C preferred stock  warrants                                                                 |   |        |   | (4,566     | )         |
| Balance at December 31, 2002 and 2003                                                                       |   |        |   | $          | —    |   |
|                                                                                                             |   |        |   |       |      |
| **Warrants of Refocus  Group, Inc.:**                                                                            |   |        |   |       |      |
| Balance at December 31, 2000, 2001 and  2002                                                                |   |        |   | $          | —    |   |
| Warrants issued in private placement  March 6, 2003                                                         |   |        |   | 1,430,500  |      |
| Warrant issued to agent                                                                                          |   |        |   | 130,000    |      |
| Warrant issued to consultant                                                                                     |   |        |   | 130,000    |      |
| Warrants issued in private placement  December 23, 2003                                                     |   |        |   | 460,850    |      |
| Warrant issued March 6, 2003 cancelled                                                                      |   |        |   | (104,000   | )         |
| Balance at December 31, 2003                                                                                |   |        |   | $          | 2,047,350 |   |
|                                                                                                             |   |        |   |       |      |
| **PC Lens Corp Common  Stock:**                                                                                  |   |        |   |       |      |
| Balance at December 31, 2000 and 2001                                                                       |   | 8,830,546   |   | $          | 1,286     |   |
| Acquisition of common stock of PC Lens Corp                                                                      |   | (8,830,546  | )      | (1,286     | )         |
| Balance at December 31, 2002 and 2003                                                                       |   | —      |   | $          | —    |   |
|                                                                                                             |   |        |   |       |      |
| **Refocus Ocular,  Inc. Common Stock:**                                                                          |   |        |   |       |      |
| Balance at December 31, 2000                                                                                |   | 13,787,949  |   | $          | 13,788    |   |
| Effect of 2.14-to-1 reverse split (see Note  2)                                                                  |   | (7,344,898  | )      | (7,345     | )         |
|                                                                                                             |   | 6,443,051   |   | 6,443      |      |
| Sale of common stock                                                                                             |   | 5,374       |   | 5          |      |
| Exercise of stock options                                                                                        |   | 2,453       |   | 3          |      |
| Balance at December 31, 2001 and 2002                                                                       |   | 6,450,878   |   | 6,451      |      |
| Conversion of Refocus Ocular, Inc. Series B  preferred stock to common                                           |   | 5,277,164   |   | 5,277      |      |
| Conversion of Refocus Ocular, Inc. Series C  preferred stock to common                                           |   | 212,102     |   | 212        |      |
| Exchange of Refocus Ocular, Inc. common  stock for Refocus Group, Inc., common stock                             |   | (11,940,144 | )      | (11,940    | )         |
| Balance at December 31, 2003                                                                                |   | —      |   | $          | —    |   |
|                                                                                                             |   |        |   |       |      |
| **Refocus Group, Inc.  Common Stock:**                                                                           |   |        |   |       |      |
| Balance at December 31, 2000, 2001 and  2002                                                                |   | —      |   | $          | —    |   |
| Common stock outstanding when Refocus  Ocular, Inc. was merged into a subsidiary of Refocus Group, Inc. (Note 1) |   | 4,097,107   |   | 410        |      |
| Common stock issued to former stockholders  of Refocus Ocular, Inc.                                              |   | 11,940,144  |   | 1,194      |      |
| Common stock issued in private placement on  March 6, 2003                                                  |   | 2,887,500   |   | 288        |      |
| Common stock issued in private placement on  December 23, 2003                                              |   | 4,425,000   |   | 443        |      |
| Stock options exercised                                                                                          |   | 19,136      |   | 2          |      |
| Balance at December 31, 2003                                                                                |   | 23,368,887  |   | $          | 2,337     |   |

 

See notes to the consolidated financialstatements.

 

F-5

----

 

**REFOCUS GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY (DEFICIENCY)FOR THE THREE YEARS ENDED DECEMBER 31, 2003**

**(Continued)**

 
|                                                                                                                   |   | **Amount**  |        |
|------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|
| **Paid-in Capital:**                                                                                                   |   |        |        |
| Balance at December 31, 2000                                                                                      |   | $           | 5,036,522   |   |
| Effect of 2.14-to-1 reverse split (see Note  2)                                                                        |   | 7,345       |        |
|                                                                                                                   |   | 5,043,867   |        |
| Expiration of Refocus Ocular, Inc. Series C  preferred stock warrants                                                  |   | 904,254     |        |
| Sale of Refocus Ocular, Inc. common stock  (net of $11,595 in expenses)                                                |   | 63,150      |        |
| Exercise of Refocus Ocular, Inc. stock  options                                                                        |   | 222         |        |
| Stock-based employee compensation                                                                                      |   | 160,250     |        |
| Balance at December 31, 2001                                                                                      |   | 6,171,743   |        |
| Refocus Ocular, Inc. Series B preferred  stock issued in lieu of service fee due to RAS Service LP                     |   | 60,642      |        |
| Expiration of Refocus Ocular, Inc. Series C  preferred stock warrants                                                  |   | 4,566       |        |
| Acquisition of common stock of PC Lens Corp                                                                            |   | 404         |        |
| Stock-based employee compensation                                                                                      |   | 7,650       |        |
| Balance at December 31, 2002                                                                                      |   | 6,245,005   |        |
| Conversion of Refocus Ocular, Inc. Series B  preferred stock to common                                                 |   | 9,113,173   |        |
| Conversion of Refocus Ocular, Inc. Series C  preferred stock to common                                                 |   | 1,048,892   |        |
| Exchange of Refocus Ocular, Inc. common  stock for Refocus Group, Inc. common stock                                    |   | 10,746      |        |
| Effect of Refocus Group, Inc. acquisition  by Refocus Ocular, Inc. for accounting purposes                             |   | (42         | )           |
| Refocus Group, Inc. common stock issued in  private placement on March 6, 2003 (net of $1,459,259 in expenses)    |   | 2,859,953   |        |
| Refocus Group, Inc. common stock issued in  private placement on December 23, 2003 (net of $266,348 in expenses)  |   | 1,484,859   |        |
| Refocus Group, Inc. warrant issued  March 6, 2003 cancelled                                                       |   | 104,000     |        |
| Refocus Group, Inc. stock options exercised                                                                            |   | 1,773       |        |
| Stock-based employee compensation                                                                                      |   | 791,697     |        |
| Balance at December 31, 2003                                                                                      |   | $           | 21,660,056  |   |
|                                                                                                                   |   |        |        |
| **Accumulated  Deficit:**                                                                                              |   |        |        |
| Balance at December 31, 2000                                                                                      |   | $           | (5,928,297  | ) |
| Accretion of discount on Refocus Ocular,  Inc. Series B preferred stock                                                |   | (23,501     | )           |
| Accrued dividends on Refocus Ocular, Inc.  Series B preferred stock                                                    |   | (594,106    | )           |
| Net loss                                                                                                               |   | (4,451,111  | )           |
| Balance at December 31, 2001                                                                                      |   | (10,997,015 | )           |
| Accretion of discount on Refocus Ocular,  Inc. Series B preferred stock                                                |   | (23,482     | )           |
| Accrued dividends on Refocus Ocular, Inc.  Series B preferred stock                                                    |   | (322,195    | )           |
| Refocus Ocular, Inc. Series B preferred  stock issued in lieu of accrued dividends and in lieu of payment of dividends |   | (2,454,867  | )           |
| Net loss                                                                                                               |   | (3,063,101  | )           |
| Balance at December 31, 2002                                                                                      |   | (16,860,660 | )           |
| Accretion of discount on Refocus Ocular,  Inc. Series B preferred stock                                                |   | (4,306      | )           |
| Net loss                                                                                                               |   | (5,694,326  | )           |
| Balance at December 31, 2003                                                                                      |   | $           | (22,559,292 | ) |

 

See notes to the consolidated financialstatements.

 

F-6

----

 

**REFOCUS GROUP, INC AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                    |   | **Years  ended December 31,** |       |
|-----------------------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                                    |   | **2003**                           |       | **2002** |   | **2001** |   |
| **Cash Flows from  Operating Activities:**                                              |   |                               |       |   |   |   |   |
| Net loss                                                                                |   | $                                  | (5,694,326 | ) | $ | (3,063,101 | ) | $ | (4,451,111 | ) |
| Adjustments to reconcile net loss to net  cash provided (used) by operating activities: |   |                               |       |   |   |   |   |
| Depreciation and amortization                                                           |   | 604,028                            |       | 123,403 |   | 118,789 |   |
| Loss on disposal of equipment                                                           |   | 6,091                              |       | 66,951 |   | 600 |   |
| Loss on write-down of inventory                                                         |   | —                             |       | 128,059 |   | — |   |
| Compensation cost due to stock options  granted                                         |   | 791,697                            |       | 7,650 |   | 160,250 |   |
| Warrants issued in lieu of cash payments                                                |   | 260,000                            |       | — |   | — |   |
| Interest accreted on discounted liability                                               |   | 121,280                            |       | — |   | — |   |
| Cash provided (used) by working capital  items:                                         |   |                               |       |   |   |   |   |
| Accounts receivable                                                                     |   | 17,068                             |       | 123,765 |   | (101,544 | ) |
| Inventories                                                                             |   | —                             |       | 4,532 |   | 307,878 |   |
| Other assets                                                                            |   | 19,088                             |       | 99,020 |   | (150,417 | ) |
| Accounts payable, accrued expenses and  other liabilities                               |   | 406,685                            |       | (96,522 | ) | 125,662 |   |
| CIBA obligation                                                                         |   | —                             |       | 2,000,000 |   | — |   |
| **Net Cash Used by  Operating Activities**                                              |   | (3,468,389                         | )          | (606,243 | ) | (3,989,893 | ) |
|                                                                                    |   |                               |       |   |   |   |   |
| **Cash Flows from  Investing Activities:**                                              |   |                               |       |   |   |   |   |
| Additions to property and equipment                                                     |   | (13,025                            | )          | (16,155 | ) | (99,802 | ) |
| Additions to patents and trademarks                                                     |   | (225,476                           | )          | (365,805 | ) | (269,558 | ) |
| Purchase of Refocus Group, Inc. by Refocus  Ocular, Inc.                                |   | 5,102                              |       | — |   | — |   |
| Other                                                                                   |   | 1,277                              |       | (882 | ) | — |   |
| **Net Cash Used by  Investing Activities**                                              |   | (232,122                           | )          | (382,842 | ) | (369,360 | ) |
|                                                                                    |   |                               |       |   |   |   |   |
| **Cash Flows from  Financing Activities:**                                              |   |                               |       |   |   |   |   |
| Borrowings                                                                              |   | 250,000                            |       | — |   | — |   |
| Borrowings repaid                                                                       |   | (250,000                           | )          | — |   | — |   |
| Exercise of Series C preferred stock  warrants                                          |   | —                             |       | — |   | 18,791 |   |
| Proceeds from private placements, net of  expenses                                      |   | 6,431,340                          |       | — |   | 63,155 |   |
| Exercise of common stock options                                                        |   | 1,775                              |       | — |   | 225 |   |
| Offering expenses                                                                       |   | —                             |       | (194,447 | ) | — |   |
| **Net Cash Provided  (Used) by Financing Activities**                                   |   | 6,433,115                          |       | (194,447 | ) | 82,171 |   |
|                                                                                    |   |                               |       |   |   |   |   |
| **Net Increase  (Decrease) in Cash and Cash Equivalents**                               |   | 2,732,604                          |       | (1,183,532 | ) | (4,277,082 | ) |
| Cash and Cash Equivalents, beginning of  year                                           |   | 267,180                            |       | 1,450,712 |   | 5,727,794 |   |
| **Cash and Cash  Equivalents, end of year**                                             |   | $                                  | 2,999,784  |   | $ | 267,180 |   | $ | 1,450,712 |   |

 

See notes to consolidated financialstatements.

 

F-7

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**REFOCUSGROUP, INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2003**

 

**NOTE 1 – SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Going Concern:** Thesefinancial statements have been prepared on a going concern basis, which contemplatesthe realization of the assets of Refocus Group, Inc. (“Refocus”) and thesatisfaction of its liabilities and commitments in the normal course ofbusiness.  However, Refocus believesthat it will be unable to continue as a going concern for the next twelvemonths without obtaining additional debt or equity financing.  See Note 4 for a discussion of the Company’sability to continue as a going concern and its plans for addressing thoseissues.  The inability to obtainadditional financing could have a material adverse effect on Refocus.

 

**Merger:**  OnMarch 6, 2003, Refocus and Refocus Ocular, Inc. (“Ocular”), formerly knownas Presby Corp (“Presby”), entered into a merger agreement (the “MergerAgreement”).  On March 6, 2003 (the“Merger Closing Date”), a newly created, wholly-owned subsidiary of Refocus wasmerged with and into Ocular, with Ocular surviving as a wholly-owned subsidiaryof Refocus.  In addition, on the MergerClosing Date, Refocus completed the first tranche of a private placement ofshares of its common stock and warrants to purchase shares of its common stock.

 

Sincethe former stockholders of Ocular owned a majority of the issued andoutstanding shares of common stock of Refocus on the Merger Closing Date afterthe merger and the funding of the first tranche of the March 2003 privateplacement, this transaction was accounted for as a reverse merger, wherebyOcular was deemed to be the accounting acquirer of Refocus.  Therefore, all financial informationincluded in this report on Form 10-KSB prior to the Merger Closing Date is thatof Ocular, as if Ocular had been the registrant.  The financial information since the Merger Closing Date is thatof Refocus and Ocular consolidated.

 

Allreferences to “Refocus”, “Presby”, “Ocular”, or the “Company” mean Refocus orOcular, as the former Presby, separately prior to the Merger Closing Date andRefocus, as successor to the business of Ocular, after giving effect to themerger.

 

**Basis of Presentation:** Theconsolidated financial statements include the accounts of all wholly-ownedsubsidiaries.  All significantintercompany accounts and transactions have been eliminated in the consolidatedfinancial statements.  All theoutstanding stock of one of the subsidiaries, PC Lens Corp (“PCL”), wasacquired in August 2002.  This acquisitionwas accounted for as if pooled since the acquisition was of an entity undercommon control.

 

**Description of Business:**  TheCompany’s primary business has been the development of a patented medicaldevice, the PresVIEW Scleral Implant (the “PSI”), and the related surgicaltechnique, the Scleral Spacing Procedure (the “SSP”), for the treatment ofpresbyopia, primary open angle glaucoma and ocular hypertension in the humaneye.  Sale of this medical device iscurrently restricted while the Company seeks approval for the device in theUnited States, from the Food and Drug Administration (the “FDA”), and in otherinternational markets.  The Company hasconducted research into, and has developed, a prototype device to treat dry agerelated macular degeneration (“ARMD”). Also, the Company conducted research into and may, at a later time,develop for commercial applications a single element variable focus lens(“SEVFL”).

 

By1998, the Company had obtained CE Mark approval for sales of its products inthe European Union and subsequently in certain other internationalmarkets.  In 2000, the Company receivedapproval from the FDA to conduct Phase I clinical trials of the PSI for thetreatment of presbyopia on humans.  TheCompany decided to suspend international sales in 2001, however, in order todevelop an automated surgical incision device to help simplify, standardize andautomate the surgical procedure and to make the outcomes of the surgicalprocedure less dependent on each physician’s surgical skill.  Since that time, the Company has developedthe PresVIEW Incision System, which consists of both automated and manualsurgical instruments used to implant the PSI in the human eye.  The Company believes the PresVIEW IncisionSystem will improve the consistency of the results of the SSP.

 

F-8

----

 

In March 2002, the Company entered into a license agreement withCIBA Vision AG (“CIBA”), pursuant to which CIBA obtained an exclusive licenseto the Company’s patents related to the treatment of presbyopia, ocularhypertension and primary open angle glaucoma in international markets.  CIBA also had the right in the licenseagreement (the “CIBA Agreement”) to acquire a license for the Company’sproducts in the United States.  Underthe CIBA Agreement, CIBA was responsible for manufacturing, distribution andmarketing of the Company’s products, as well as for regulatory matters outsidethe United States.  In accordance withthe CIBA Agreement, the Company ceased all direct manufacturing, distributionand marketing of the PSI and related products. The CE Mark the Company had obtained was allowed to lapse becausethe product would be sold in the European Union by CIBA.

 

However,in August 2003, CIBA announced that it was seeking strategic alternativesfor its surgical business unit, including the sale of that unit.  CIBA’s surgical unit marketed a variety ofophthalmic products and was primarily responsible for performing the CIBAAgreement.  In January 2004, theCompany entered into a License Transfer and Transition Services Agreement (the“Transfer Agreement”) with CIBA.  As aresult of the Transfer Agreement, the Company has reacquired all worldwidelicense rights to its patents and will have to assume responsibility formarketing, manufacturing, distribution and regulatory functions.  See Note 5 for a discussion of the CIBAAgreement and the Transfer Agreement.

 

TheCompany filed an investigational device exemption application with the FDA inMarch 2003 to obtain approval for initiating Phase II clinicaltrials.  The Company subsequently filedamendments to that application and, in December 2003, received approval tostart Phase II clinical trials, subject to certain final documentation.  The Company started these trials during thefirst quarter of 2004.

 

TheCompany had also received permission from Health Canada (the Canadianequivalent of the FDA) in 2000 to begin clinical trials of the PSI for thetreatment of ocular hypertension and primary open angle glaucoma.  In November 2002, the Company submittedan application for approval to commercialize the PSI in Canada.  On June 13, 2003, Canada denied theapplication due to the insufficient size of the clinical trial.  In October 2003, Health Canadaindicated the Company would have to increase the size of its clinical trialsusing more sites and significantly more patients before approval could bereconsidered.

 

PCLwas formed primarily to develop the patented SEVFL technology.  PCL has had no revenues for the three yearsended December 31, 2003.  InAugust 2002, a contract with a licensing agent to market the technologyexpired.  At that time, Oculardetermined that it should no longer continue to fund the operations of PCL on apromissory note basis and that it should repurchase the outstanding commonstock of PCL.  PCL had no source offunding other than Ocular.  The holdersof PCL common stock agreed to sell their common stock back to Ocular at a priceper share less than par value.  Ocularcompleted the purchase of all the outstanding common stock of PCL inAugust 2002 at a total cost of $882.

 

**Business Segments:**  TheCompany has determined that it currently operates in one segment, developmentof optical technologies.

 

**Management Estimates andSignificant Risks and Uncertainties:**  The preparation of theconsolidated financial statements, in conformity with accounting principlesgenerally accepted in the United States of America, requires management of theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities, and the disclosure of contingent assets and liabilities,at the dates of the financial statements and the reported amounts of revenuesand expenses during such reporting periods. Actual results could differ from these estimates.

 

TheCompany is subject to a number of risks and can be affected by a variety offactors.  For example, management of theCompany believes that these following factors, as well as others, could have asignificant negative effect on the Company’s future financial position, resultsof operations and/or cash flows: failure to develop and commercialize existingand new products or product enhancements; failure to obtain or maintainnecessary regulatory approvals; failure to maintain or obtain proprietaryintellectual property rights; failure to obtain or maintain customer andphysician acceptance or third party reimbursement; intense competition fromcompanies with greater financial, technical and marketing resources; risksassociated with the Company’s assumption from CIBA of the marketing,distribution, regulatory and manufacturing operations formerly performed byCIBA; risks associated with product liability and product defects; and risksassociated with general economic conditions.

 

F-9

----

 

**Cash and Cash Equivalents:**  Cashand cash equivalents consist principally of amounts held in demand depositaccounts and amounts invested in financial instruments with initial maturitiesof three months or less at the time of purchase.

 

**Inventories:** Inventories were valued at the lower of cost (determined using anaverage cost method) or market.  During2002, as a result of the CIBA Agreement, the Company wrote off its remaininginventory at a cost of $128,059.  Underthat agreement, CIBA would be providing PSIs and surgical instruments undertheir brand name and, for the most part, would not be using the Company’sinventory.

 

**Property and Equipment:** Property and equipment is stated at cost.  Depreciation is computed once an asset is placed in service usinga straight-line method at rates designed to distribute the cost of the assetover its estimated useful life of from 3 to 10 years for furniture andequipment.  Amortization of leaseholdimprovements is included in depreciation and amortization expense and is basedon the lesser of the asset’s useful life or the projected term of thelease.  The cost to maintain propertyand equipment is charged to expense as incurred.  During 2002, the Company wrote off a substantial portion of itsfixed assets as a result of the downsizing of its staff and office space inconjunction with CIBA assuming most of the responsibility for marketing,manufacturing and regulatory matters under the CIBA Agreement.  The loss from disposal of excess fixedassets in 2002 was $66,951.  Additionalwrite-offs of $6,091, net of proceeds, were taken in 2003 from the disposal ofadditional equipment.  Property andequipment consisted entirely of furniture and equipment at December 31,2003 and 2002, respectively.

 

**Intangible Assets:** Costs incurred for patents and trademarks are capitalized and amortizedover their actual or estimated life.  Ifit is determined that a patent or trademark will not be issued or that theCompany no longer wants to maintain or pursue a patent or trademark, therelated costs are charged to expense at the time such determination ismade.  The cost of maintaining patentsafter they are issued is charged to expense and shown in “Depreciation and amortization”.

 

Asa result of the merger with Refocus, discussed in Note 2, and the subsequentchange of the name of Presby to Refocus Ocular, Inc. in April 2003 as partof a rebranding of the Company’s products that was implemented in lateMarch 2003, the Company decided not to continue to defend or renew any ofthe Presby and related device trademarks. Therefore, these trademarks had no further value to the Company, and theremaining capitalized value of these trademarks was written off as ofMarch 31, 2003.  The charge of$94,592 was shown in “Depreciation and amortization” in the accompanyingconsolidated statement of operations for the year ended December 31, 2003.

 

Inaddition, under the separation and consulting agreement with the Company’sformer Chief Scientist (see Note 6), certain foreign patents related to adevice for the treatment of ARMD were assigned to him.  While the assignment is revocable undercertain conditions, the value of these patents, for accounting purposes, ofapproximately $120,355 was considered transferred to him as part of hiscompensation under the separation and consulting agreement and was removed fromthe capitalized value of the patent portfolio.

 

The Company conducted a review of its entire patent portfolio after theMerger Closing Date.  It is expensive tomaintain and obtain patents, and the Company determined that it would reduce thenumber of countries in which it will continue to maintain or pursue PSI orSEVFL patents.  The Company continues topursue or maintain PSI and SEVFL patent protection in all major economicmarkets.  The net book value of the patentswritten off for the year ended December 31, 2003 was $253,038.  This amount was shown in “Depreciation andamortization” in the accompanying consolidated statements of operations.

 

F-10

----

 

Thefollowing tables show the capitalized value of patents and trademarks as ofDecember 31, 2003 and December 31, 2002, respectively.

 
|                              |   | **Costs** |      | **Amortization** |   | **Net** |   |
|-----------------------------------|--------|-----------|-----------|------------------|--------|---------|--------|
| PSI and related product patents   |   | $         | 925,718   |             | $      | 168,708 |   | $ | 757,010 |   |
| Trademarks                        |   | —    |      | —           |   | —  |   |
| ARMD patents                      |   | 31,704    |      | 4,897            |   | 26,807  |   |
| SEVFL Patents                     |   | 222,756   |      | 49,346           |   | 173,410 |   |
| Balance at December 31, 2003 |   | $         | 1,180,178 |             | $      | 222,951 |   | $ | 957,227 |   |
|                              |   |      |      |             |   |    |   |
| PSI and related product patents   |   | $         | 1,018,262 |             | $      | 175,981 |   | $ | 842,281 |   |
| Trademarks                        |   | 123,415   |      | 29,036           |   | 94,379  |   |
| ARMD patents                      |   | 149,452   |      | 13,000           |   | 136,452 |   |
| SEVFL Patents                     |   | 250,892   |      | 46,806           |   | 204,086 |   |
| Balance at December 31, 2002 |   | $         | 1,542,021 |             | $      | 264,823 |   | $ | 1,277,198 |   |

 

Amortizationexpense for trademarks and patents was $425,092 (including the patents andPresby trademarks written off), $79,958 and $61,262 for the years endedDecember 31, 2003, 2002 and 2001, respectively.  The estimated aggregate amortization expense for each of thesucceeding five fiscal years will be approximately $31,350 each year based onthe capitalized costs of patents granted at December 31, 2003.

 

Aportion of the costs incurred in connection with the separation and consultingagreement with the Company’s former Chief Scientist was allocated to anon-compete agreement and is being amortized over its life of 4 years on astraight-line basis.  The $618,397 capitalizedvalue of the non-compete agreement at December 31, 2003 was net of$162,737 of accumulated amortization. Amortization of the non-compete agreement was $162,737 for the yearended December 31, 2003.  Theestimated amortization expense during each of the remaining fiscal years of thenon-compete agreement are as follows: for 2004 - $195,283; for 2005 - $195,283; for 2006 - $195,284; and for2007 - $32,547.

 

**Long-Lived Assets:**  TheCompany reviews long-lived assets and identifiable intangibles for impairmentwhenever events or circumstances indicate that the carrying value of an assetmay not be recoverable.  Recoverabilityof assets to be held and used is measured by a comparison of the carrying valueof an asset to the undiscounted expected future cash flows generated by thatasset.  If the carrying value of thatasset exceeds the expected future cash flows, an impairment exists and ismeasured by the amount the carrying value exceeds the estimated fair value ofthe asset.  The SEVFL patents atDecember 31, 2003 had a carrying value of $173,410 and the ARMD patentshad a carrying value of $26,807.  Sincethese patents involve new technologies, it is not presently possible toaccurately measure whether these costs are recoverable.  However, management believes that thesetechnologies can be developed at some future time and will continue to carrythese patents at their amortized value until it is determined that they cannotbe profitably developed.  Therefore,management believes no impairment of its long-term assets existed atDecember 31, 2003 based on their current carrying value.

 

**Fair Value of FinancialInstruments:**  The fair value of financial instruments isdetermined by reference to various market data and other valuation techniques,as appropriate.  Unless otherwisedisclosed, the fair value of financial instruments approximate their recordedvalue due primarily to their short-term nature.

 

**RevenueRecognition:** Since March 2002, the Company has had one main source of potentialrevenue: royalty and milestone revenues earned under the CIBA Agreement.  Prior to the CIBA Agreement, the Company’srevenues consisted of products sales and seminar revenues.  Revenue in each of these categories wasrecognized when the following four criteria were met:

 

•                  Persuasiveevidence of an arrangement existed;

•                  Deliveryhad occurred or services had been rendered;

•                  Theselling price was fixed or determinable; and

•                  Collectibilitywas reasonably assured.

 

F-11

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No royalty or milestone revenues were earned under the CIBA Agreementin either 2002 or 2003.  Prior to theCIBA Agreement, revenue was recognized when title passed to the buyer whengoods were shipped or upon performance of the service for seminars.  The Company’s products were sold withoutwarranty or the right to return. However, see Note 10 for claims being made by certain customersrequesting refunds on products previously sold to them.

 

Asa result of the Transfer Agreement executed in January 2004, the CIBAAgreement was terminated, and CIBA will not owe any royalty or milestonepayments.  Any future revenues will beprimarily from product sales directly by the Company or, possibly, throughother distributors (see Note 5).

 

The Company received $2,000,000 in advance royalties from CIBA inMarch 2002 that had been deferred and is shown in the consolidated balancesheets as the “CIBA obligation”.  Noneof the $2,000,000 advance royalty had been earned as of December 31,2003.  The advance royalty was forgivenin January 2004 as part of the Transfer Agreement.

 

**Researchand Development Costs:**  Research and development costs, including the costs of certainspecialized equipment and the salaries of certain personnel devoting full timeto research and development, are incurred to establish the feasibility of, andto develop, the Company’s products and are charged to operations.  As part of the separation and consultingagreement with the Company’s former Chief Scientist (see Note 6), a portion ofthat contract has been designated as prepaid consulting expenses for researchand development of the ARMD device.  Theoriginal balance of the prepaid research and development costs was $57,557,which is being amortized over two years. The remaining balance included in current and long-term assets was$33,576 at December 31, 2003.

 

**Stock-BasedCompensation:** In January 2002, the Company elected to adopt the fair value basedmethod of accounting for stock-based compensation as defined in Statement ofFinancial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-BasedCompensation”.  The Company elected toreport the change in accounting principle using the modified prospective methodas outlined in SFAS No. 148 “Accounting for Stock-Based Compensation –Transition and Disclosure”.  Under thismethod, the stock-based employee compensation expense recognized for the yearsended December 31, 2003 and 2002 is the same as would have been recognizedhad the fair value based recognition provisions of SFAS No. 123 been used toaccount for all employee awards granted, modified or settled afterDecember 31, 1994.

 

For options issued during the three years ended December 31, 2003,the fair value of each option grant was estimated on the date of grant by usingthe Black-Scholes option-pricing model. The fair value of options issued during the year ended December 31,2003 was approximately $1.14 per share, during the year ended December 31,2002 was approximately $0.51 per share and during the year endedDecember 31, 2001 was approximately $13.78 per share.  The following weighted average assumptionswere used in valuing the options granted during these periods:

 

|                    |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected dividend yield |   | 0.00     | %      | 0.00     | %      | 0.00     | %      |
| Expected volatility     |   | 60.50    | %      | 69.80    | %      | 49.90    | %      |
| Risk-free interest rate |   | 2.91     | %      | 4.88     | %      | 4.26     | %      |
| Expected option lives   |   | 6 years  |   | 10 years |   | 10 years |   |

 

SFASNo. 123 requires disclosure of the pro forma effect on net income if a companycontinues to account for stock options under the provisions of AccountingPrinciples Board No. 25 “Accounting for Stock Issued to Employees” rather thanthe alternative fair value accounting provided under SFAS 123.  As a result of adopting SFAS No. 123 in 2002using the modified prospective method under the provisions of SFAS No. 148, thenet loss for the years ended December 31, 2003 and 2002, which includes acharge of $791,697 and $7,650, respectively, related to stock-based compensation,is not different from the net loss that would have been recognized had SFAS No.123 been adopted at its inception.  Thefollowing table illustrates the effect on net loss and net loss per share forthe three years ended December 31, 2003 as if compensation cost for theCompany’s stock options had been determined based upon the fair value at thedate of grant for such awards consistent with using the provisions of SFAS No.123.

 

F-12

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|                                                                     |                                                                                        | **Year ended  December 31,** |       |
|--------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|-----------------------------------|------------|
|                                                                     |                                                                                        | **2003**                          |       | **2002** |   | **2001** |   |
| Net loss applicable to common shares as  reported                        |                                                                                        | $                                 | (5,698,632 | ) | $ | (5,863,645 | ) | $ | (5,068,718 | ) |
| Add:                                                                     | Stock-based employee compensation expense included in net loss  applicable to common shares |                              | 791,697    |   | 7,650 |   | 160,250 |   |
| Deduct:                                                                  | Stock-based employee compensation expense determined under a fair  value based method       |                              | (791,697   | ) | (7,650 | ) | (161,000 | ) |
| Pro forma net loss applicable to common  shares                          |                                                                                        | $                                 | (5,698,632 | ) | $ | (5,863,645 | ) | $ | (5,069,468 | ) |
|                                                                     |                                                                                        |                              |       |   |   |   |   |
| Net loss per share applicable to common  shares – basic and diluted |                                                                                        | $                                 | (0.34      | ) | $ | (0.91 | ) | $ | (0.79 | ) |

 

**Loss pershare:**  The netloss applicable to common shares was used in the calculation of earnings pershare for both basic and diluted loss per share.  There was no adjustment to the calculation of diluted loss pershare for dividends accrued on the shares of Series B convertible preferredstock outstanding, as they were anti-dilutive.

 

Theweighted average number of shares of our common stock outstanding forcalculation of both basic and diluted earnings per share was also thesame.  Options to purchase 1,111,051shares of common stock and warrants to purchase 5,520,000 shares of commonstock in 2003, options to purchase 161,851 shares of common stock in 2002, andoptions to purchase 189,922 shares of common stock in 2001 were not included inthe computation of diluted earnings per share as the effect of including theoptions and warrants in the calculation would be anti-dilutive.  Conversion of the Company’s preferred stockwas also not included in the calculation of diluted earnings per share as itwould also have been anti-dilutive.

 

**ComprehensiveLoss:**  For allperiods presented, comprehensive loss is equal to net loss.

 

**Reclassifications:**  Certain previously reported amounts havebeen reclassified to conform to current year presentations.

 

**DeferredOffering Expenses:** The Company has deferred certain costs associated with common stockofferings until the offers are completed and the deferred expenses are offsetagainst the proceeds received from the offerings.  The balance of deferred offering expenses outstanding atDecember 31, 2001 was written off during the year ended December 31,2002 as a result of the cancellation of the offering.  Deferred offering expenses at December 31, 2002, whichrelated to the March 2003 private placement discussed in Note 3, wereoffset against the proceeds of that offering. In addition, $192,123 of deferred offering expenses incurred during theyear ended December 31, 2003 were written off as a result of theexpiration of a post-closing private placement in September 2003 (see Note3).

 

**IncomeTaxes:** Deferredtax assets and liabilities are established for temporary differences betweenfinancial statement carrying amounts and the taxable basis of assets andliabilities at rates currently in effect. A valuation allowance is established for any portion of a deferred taxasset for which realization is not likely. The deferred tax asset is reviewed periodically to determine the amountconsidered realizable.

 

**RecentlyIssued Accounting Pronouncements:**  In April 2002, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 145 “Rescission of FASB Statements No.4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”.  SFAS No. 13 is amended to eliminate anyinconsistency between the required accounting for sale leaseback transactionsand the required accounting for certain lease modifications that have economiceffects that are similar to leaseback transactions.  This statement also amends other existing authoritative pronouncementsto make various technical corrections, clarify meanings, or describe theirapplicability under changed conditions. The Company adopted this standard in its fiscal year beginningJanuary 1, 2003.  There was noimpact on the Company’s results of operations or financial condition as aresult of the adoption of the standard.

 

In June 2002, the FASB issued SFAS No. 146 “Accounting for CostsAssociated with Exit or Disposal Activities”. This statement requires recording costs associated with exit or disposalactivities at their fair value when a

 

F-13

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liability has been incurred. Under previous guidance, certain exit costs were accrued uponmanagement’s commitment to an exit plan, which is generally before an actualliability has been incurred.  Theprovisions of this statement are effective for exit or disposal activities thatare initiated after December 31, 2002. This standard did not have any impact on the Company’s results ofoperations or financial condition.

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”)“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others”.  This interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at theinception of a guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee. The disclosure requirements and initial measurement requirements of FIN45 are effective prospectively for guarantees issued or modified afterDecember 31, 2002.  The Company isnot a party to any agreement in which it is a guarantor of indebtedness ofothers.  Accordingly, the pronouncementis currently not applicable to the Company.

 

In April 2003, the FASB issued SFAS No. 149 “Amendment ofStatement 133 on Derivative Instruments and Hedging Activities”.  This statement amends SFAS No. 133“Accounting for Derivative Instruments and Hedging Activities” for certain decisionsmade by the FASB.  This statement iseffective for most contracts entered into or modified, and for most hedgingrelationships designated, after June 30, 2003.  Because the Company does not currently have any derivativeinstruments or hedging relationships, the adoption of this standard did nothave any impact on the Company’s results of operations or financial condition.

 

In May 2003, the FASB issued SFAS No. 150 “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities andEquity”.  This statement establishesstandards for how an issuer classifies and measures certain financial instrumentswith characteristics of both liabilities and equity.  It requires that many instruments formerly classified as equitywill be classified as liabilities.  Thestatement does not apply to features that are embedded in a financialinstrument that is not a derivative in its entirety.  It also does not affect the classification or measurement ofconvertible bonds or other outstanding shares that are conditionallyredeemable.  Generally, theseliabilities should initially be measured at fair value.  The statement is effective for financialinstruments entered into or modified after May 31, 2003 and, otherwise, shallbe effective at the first interim period beginning after June 15,2003.  Restatement of financialstatements issued for earlier periods is not permitted.  The Company’s former Series B redeemable preferredstock, which was exchanged for common stock in March 2003, was redeemableat the option of the holder.  Therefore,this statement does not change the prior accounting for that preferred stock.  The Company does not currently have anyinstruments affected by this statement and, therefore, the standard will nothave any impact on the Company’s results of operations or financial condition.

 

In December 2003, the FASB issued SFAS No. 132 (revised 2003)“Employers’ Disclosures about Pensions and Other Postretirement Benefits”.  This statement retains the disclosuresprovided in the original SFAS No. 132 but adds disclosures describing the typeof plan assets, investment strategy, measurement dates, plan obligations, cashflows and components of net periodic benefit cost recognized during interimperiods.  The revised statement isgenerally effective for fiscal years ending after December 15, 2003.  The Company does not currently have any contributoryplans that would require the additional disclosures.

 

**NOTE 2 – MERGER OFREFOCUS OCULAR, INC. AND REFOCUS GROUP, INC.**

 

Asa result of the March 2003 private placement discussed in Note 3, andimmediately before the merger of Ocular into a wholly-owned subsidiary ofRefocus, the holders of Ocular’s Series B preferred stock and Series C preferredstock converted their shares into common stock of Ocular.  At the same time, Ocular completed a2.14-to-1 reverse split, resulting in 11,940,144 shares of Ocular common stockoutstanding, including the common shares issued upon conversion of thepreferred stock.  All share and pershare amounts prior to the Merger Closing Date shown in this report have beenadjusted to reflect the reverse split.

 

Refocuswas organized in November 2000 as VeryBestoftheInternet.com, Inc.(“VeryBest”).  VeryBest was an internetwebsite ranking service.  InFebruary 2003, VeryBest reincorporated in Delaware and changed its name toRefocus Group, Inc.  Prior to the mergerin March 2003, Refocus effected a forward split of its common stock on thebasis of approximately six shares for each share issued and outstanding andalso determined to change its business

 

F-14

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operations.  Following the forward-split and immediatelyprior to the March 2003 private placement and merger, the founders ofRefocus sold substantially all of their shares back to the Company in exchangefor $25,000.  The amount paid for theseshares has been deducted from paid-in capital. As a result, immediately before the merger, Refocus had 4,097,107 sharesof common stock outstanding.

 

Onthe Merger Closing Date, a newly created, wholly-owned subsidiary of Refocuswas merged into Ocular, with Ocular surviving as a wholly-owned subsidiary ofRefocus.  Each share of Ocular commonstock outstanding on the Merger Closing Date was converted into common stock ofRefocus on a one-for-one basis. Therefore, Refocus issued 11,940,144 shares of common stock tostockholders of Ocular, representing approximately 63% of Refocus’ outstandingcommon stock following the merger and the funding of the initial tranche of theMarch 2003 private placement, in exchange for 100% of the outstandingcapital stock of Ocular.  Following themerger, all of Refocus’ business operations are conducted through Ocular.

 

Aspart of the Merger Agreement, Refocus assumed the Amended and Restated PresbyCorp 1997 Stock Option Plan, and all outstanding options (after they wereadjusted for the 2.14-to-1 reverse split) were converted into the same numberof options of Refocus.  Ocular had stockoptions outstanding to acquire 719,486 shares of common stock at the MergerClosing Date.  The exercise price of theassumed options was adjusted to reflect the 2.14-to-1 reverse split prior tothe merger.  See Note 8.

 

Asa result of the merger and prior to the March 2003 private placement, theCompany had 16,037,251 shares of common stock and options to purchase 719,486shares of common stock outstanding.

 

Sincethe stockholders of Ocular owned a majority of the issued and outstandingshares of common stock of Refocus after the merger and the initial tranche ofthe March 2003 private placement, this transaction was accounted for as areverse merger, whereby Ocular was deemed to be the accounting acquirer ofRefocus.  Because Refocus did not haveany significant business prior to the merger and its former operations werediscontinued after the merger, there was no goodwill or other intangibles thatarose from the merger.

 

Theassets and liabilities assumed from Refocus on the Merger Closing Date are asfollows:

 
| Cash                                    |   | $      | 5,102  |   |
|-----------------------------------------|--------|--------|--------|--------|
| Website technology                      |   | 2,000  |   |
| Accounts payable                        |   | (6,734 | )      |
| Net credit to shareholders’ equity |   | $      | 368    |   |

 

TheCompany sold the website technology to another company associated with the foundersof VeryBest in exchange for the forgiveness of $1,800 in debt due them and tooka $200 charge for the remaining balance of the website technology, which isincluded in “Other income (expense)” in the consolidated statement of operationsfor the year ended December 31, 2003.

 

Thefollowing tables present the unaudited pro forma results of operations for theyear ended December 31, 2003 and for the year ended December 31,2002, assuming that the merger had occurred on January 1 of each year (inthousands, except per share amounts):

 
|                                                                  |   | **For the  year ended  December 31,** |   |
|-----------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                  |   | **As  Reported**                           |   | **Pro Forma** |   |
|                                                                  |   | **2003**                                   |   | **2002** |   | **2003** |   | **2002** |   |
| Revenues                                                              |   | $                                          | — |   | $ | — |   | $ | — |   | $ | — |   |
| Loss from operations                                                  |   | (5,596                                     | )      | (3,083 | ) | (5,862 | ) | (4,745 | ) |
| Net loss                                                              |   | (5,694                                     | )      | (3,063 | ) | (5,960 | ) | (4,759 | ) |
| Net loss applicable to common shares                                  |   | (5,699                                     | )      | (5,864 | ) | (5,960 | ) | (4,759 | ) |
| Net loss per share – basic and diluted                           |   | $                                          | (0.34  | ) | $ | (0.91 | ) | $ | (0.32 | ) | $ | (0.25 | ) |
| Average number of common shares outstanding  – basic and diluted |   | 16,862                                     |   | 6,451 |   | 18,473 |   | 18,925 |   |

 

F-15

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Thedifference in the net loss for the Company as reported and the pro forma netloss is the result of the following:

 

•                  Thenet loss of Refocus from January 1, 2003 to the Merger Closing Date was$5,903. The net loss of Refocus was $60,640 for the year endedDecember 31, 2002.  Refocus priorto the merger had no revenues and had no provision for income taxes in any ofthese periods.

•                  Itwas assumed that there would be no accrual of dividends or accretion of discounton the Series B preferred stock of Ocular, as the Series B preferred stockwould be converted to common stock as part of the merger as actually occurredon the Merger Closing Date.

•                  Therewould be additional expenses for legal, audit, public relations and otherexpenses related to being a public company. The Company estimated that an additional $260,000 would have beenincurred prior to the Merger Closing Date during the year endedDecember 31, 2003.  The Companyestimated that approximately $1,635,000 in additional expenses would have beenincurred for the year ended December 31, 2002.

 

**NOTE 3 – PRIVATEEQUITY TRANSACTIONS**

 

Inconnection with the merger discussed above, and as a condition of that merger,Refocus completed a private placement of shares of its common stock andwarrants to purchase common stock on March 6, 2003.  The private placement was to be consummatedin two tranches with gross proceeds of $5,750,000 due with each tranche. The funding of the second tranche was subject to the satisfaction of certainconditions precedent.  In addition, atleast $1,000,000 was expected to be raised from a post-closing privateplacement that was to close within six months of the Merger Closing Date.

 

Thefirst tranche closed on the Merger Closing Date and consisted of 2,875,000units at $2.00 per unit.  Each unit was comprised of a share of Refocuscommon stock and a detachable warrant to purchase one-half share of Refocuscommon stock at an exercise price of $2.50 per share.  As a result, theinvestors in the first tranche of the private placement were issued 2,875,000shares of Refocus common stock and warrants to purchase 1,437,500 shares ofRefocus common stock.  In addition, 12,500 shares of Refocus common stock,warrants to purchase 1,250,000 shares of Refocus common stock at an exerciseprice of $2.50 per share and warrants to purchase 50,000 shares of Refocuscommon stock at an exercise price of $2.00 per share were issued to agents andothers involved in the private placement.  The $2.50 warrants expire inthree years, and the $2.00 warrants expire in five years.

 

Thewarrants issued in connection with the initial tranche of the private placementwere valued using the Black-Scholes option-pricing model.  The Companyassumed an expected volatility rate of 59.8%, an expected life of 2 years, a1.38% risk-free interest rate and that no dividends would be paid.  Basedon these factors, the Company determined the value of the $2.00 warrants to be$.66, and the value of the $2.50 warrants to be $.52, for each share of commonstock that could be acquired, for a total value of $1,430,500.

 

TheCompany paid certain agent and advisory fees and legal, audit and other privateplacement costs from the proceeds received from the offering as follows:

 
| Proceeds from the offering: 2,875,000 units  at $2.00 per unit |   | $        | 5,750,000 |   |
|----------------------------------------------------------------|--------|----------|-----------|--------|
| Amounts paid to placement agent and  advisors                  |   | (577,500 | )         |
| Legal and audit fees incurred                                  |   | (619,664 | )         |
| Expenses incurred by advisors                                  |   | (147,500 | )         |
| Expenses incurred by the Company                               |   | (89,595  | )         |
| Payment to founders of VeryBest for their  stock               |   | (25,000  | )         |
| Cash received from the offering                                |   | $        | 4,290,741 |   |

 

Investorswho participated in the first tranche of the private placement were irrevocablycommitted to the second tranche, with the remaining gross proceeds of$5,750,000 from the private placement to be paid at the closing of the secondtranche. The closing of the second tranche (and the funding of investor fundsin connection with the second tranche) was contingent on:

 

F-16

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(1)the initiation of the Company’s Phase II FDA clinical trial for the treatmentof presbyopia;

(2)the earlier of:

(a) approval from Health Canada to commercialize theCompany’s treatment for primary open angle glaucoma and/or ocular hypertension;or

(b) the completion, after the closing of the merger,of 500 surgical procedures in Canada and/or the European Union utilizing thePSI for the treatment of primary open angle glaucoma or ocular hypertension;and

(3)the concurrent second tranche investment by CIBA of $1,250,000.

 

TheCompany had expected that it would meet the conditions precedent to the secondtranche funding within a time frame that would allow the Company to continue tofund its operations and FDA clinical trials before funds received from thefirst tranche were exhausted.  However,in June 2003, as a result of the denial of the Company’s application byHealth Canada for the commercialization of its treatment for primary open angleglaucoma and ocular hypertension (see Note 1), the closing of the secondtranche was going to be significantly delayed.  Then, under the terms ofthe Transfer Agreement executed in January 2004, CIBA was relieved of itsobligation to make its second tranche investment.  Therefore, the investors in the first tranche can no longer becompelled to fund the second tranche and the closing of the second tranche willnot occur.

 

Theparticipants in the first tranche signed lock-up agreements that limited theamount of shares that could be sold each month to 9% of their total holdingsbeginning on the earlier of the effectiveness of a registration statementcovering the shares issued or March 6, 2004.  A registration statement covering these shares was filed but wasnot declared effective prior to March 6, 2004.  Some of the first tranche participants had their lock-upagreements waived through their participation in a December 2003 privateplacement discussed below.  Of theshares originally subject to lock-up agreements, 1,806,250 shares are stillsubject to the monthly 9% limitation.

 

InApril 2003, the Company engaged an agent to conduct a post-closing privateplacement that was contemplated as part of the financing at the Merger ClosingDate.  The post-closing privateplacement expired September 6, 2003 without being funded.  The Company wrote off $192,123 of deferredoffering expenses in connection with the offering, including the value of thewarrant discussed below.  These expensesare included in “Selling, general and administrative” expenses for the yearended December 31, 2003.  In theevent that at least $1,000,000 was not raised in the post-closing privateplacement within six months of the Merger Closing Date, another party hadsubscribed to purchase that number of units at $2.00 per unit in order tosatisfy the deficiency between the amount of additional capital successfullyraised and $1,000,000.  Each unit wouldhave consisted of a share of Refocus common stock and a detachable warrant topurchase one-half share of Refocus common stock at an exercise price of $2.50per share.  The Company has renegotiatedthe terms of this obligation deferring the due date to June 30, 2004.  However, the Company may still not receiveany funds from this party.  See Note 14– Verus Agreement.

 

InMay 2003, a warrant to purchase 200,000 shares of common stock at an exerciseprice of $2.50 per share, that expires March 6, 2006, was issued to theagent involved in the post-closing private placement.  The warrant was valuedat $130,000 using the Black-Scholes option-pricing model with an expected lifeof approximately 1.8 years, an expected volatility rate of 60% , a 1.31%risk-free interest rate and that no dividends would be paid.

 

Inaddition to fees and warrants received by advisors involved in the privateplacement in March 2003, the Company signed one-year consulting agreementswith two of the advisors to provide certain consulting services related tolong-range financial planning and investor relations.  Each of the firmswas to be paid $180,000 plus expenses over a period of twelve months for theirservices.  One of the advisors forgave all fees due after August 2003as part of the renegotiation of their $1,000,000 commitment discussedabove.  These contracts were notrenewed.

 

TheCompany conducted another private placement that closed December 23,2003.  The Company sold 4,425,000 unitsat $.50 per unit.  Each unit consistedof a share of common stock and a warrant to purchase one-half share of commonstock at an exercise price of $2.00 per share. The warrants issued to these investors will expire three years from thedate of the closing.  The agent whoconducted the private placement received a warrant to purchase 170,000 sharesof common stock with the same terms as the investors in the privateplacement.  The agent also had beenpreviously issued a warrant to purchase 200,000 shares of common stock at anexercise price of $2.50 per share that was to expire March 6, 2006.  This warrant was cancelled and a new warrantfor the same number of

 

F-17

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sharesand at the same exercise price was issued but with an expiration date ofDecember 23, 2006.  In addition,those investors who participated in the March 2003 private placement, andwho invested a dollar amount at least equal to their second tranche commitment,had their lock-up agreements on their first tranche shares waived.  A total of 1,068,750 shares of the 2,875,000shares issued in the first tranche had their lock-up agreements waived.

 

Thewarrants issued in connection with this private placement were valued using theBlack-Scholes option-pricing model.  The Company assumed an expectedvolatility rate of 111.3%, an expected life of 3 years, a 2.40% risk-freeinterest rate and that no dividends would be paid.  Based on thesefactors, the Company determined the value of the $2.00 warrants to be $.18, andthe value of the $2.50 warrant to be $.16, for each share of common stock thatcould be acquired, for a total value of $460,850.  The warrant that had been previously issued to the agent in theMarch 2003 private placement that was cancelled had a value of $104,000.

 

TheCompany paid certain agent fees and legal, audit and other private placementcosts from the proceeds received from the offering as follows:

 
| Proceeds from the offering: 4,425,000 units  at $.50 per unit |   | $        | 2,212,500 |   |
|---------------------------------------------------------------|--------|----------|-----------|--------|
| Amount paid to agent                                          |   | (185,000 | )         |
| Legal and audit fees incurred                                 |   | (69,220  | )         |
| Expenses incurred by agent                                    |   | (7,213   | )         |
| Expenses incurred by the Company                              |   | (4,915   | )         |
| Cash received from the offering                               |   | $        | 1,946,152 |   |

 

**NOTE 4 – GOING CONCERN**

 

TheCompany had expected to receive the additional gross proceeds of $5,750,000from the closing of the second tranche prior to using all the proceeds from thefirst tranche of the March 2003 private placement.  However, in June 2003, as a result ofthe denial of the Company’s application by Health Canada for thecommercialization of the PSI (see Note 3), the closing of the second tranchewas going to be significantly delayed. Therefore, without the expected funding from the second tranche,additional funds would be needed from other sources in order to continue the Company’soperations.  On December 23, 2003the Company completed a private placement that raised $1,946,152 (see Note 3).

 

Asdiscussed in Notes 1 and 5, the Transfer Agreement was executed by the Companyand CIBA in January 2004.  As aresult of the Transfer Agreement, CIBA was relieved from having to fund theirportion of the second tranche commitment. Since the funding by CIBA was a condition precedent for others to fundtheir second tranche commitments, the second tranche will not close.  The loss of the potential $5,750,000 ofgross proceeds from the closing was a significant loss for the Company.  In addition, the Company will have to assumethe manufacturing, distribution, marketing, and regulatory functions that CIBAhad previously performed under the CIBA Agreement.  The assumption of these activities could result in a substantialincrease in costs and in funds needed to continue operations.  As a result, the Company will need to findadditional financing to complete its FDA clinical trials and fund itsoperations as the Company assumes the functions formerly performed by CIBA.

 

Managementof the Company has taken certain steps to reduce cash expenditures in the nearterm while pursuing additional financing. Fees to investment advisors have been deferred or eliminated andexpenditures for public relations have been substantially reduced.  With these and other reductions, the Companybelieves that existing funds on hand are adequate to continue operations untilapproximately the first month of the third quarter of 2004, assuming theCompany continues its FDA clinical trials as planned.  Management of the Company cannotconclude, based on information available to it currently, that there areadequate cash resources and expected funds to be received that will allow theCompany to operate for the next twelve months.

 

TheCompany is seeking additional debt and/or equity financing.  There can be no assurances that additionalfinancing can be obtained on reasonable terms or at all.  TheCompany may seek a merger partner or the sale of assets if additional financingis not available.  The Company’sinability to obtain additional financing could have a material adverse effecton the Company.

 

F-18

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Theaccompanying financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. These financial statements do not include any adjustments to therecoverability and classification of recorded asset amounts or the amount andclassification of liabilities that might be necessary should the Company beunable to continue as a going concern. The Company’s continuation as a going concern is dependent upon itsability to obtain additional financing and, ultimately, to attain successful operations.

 

**NOTE 5 – CIBAAGREEMENTS**

 

In the summer of 2001, CIBA began an extensive period of due diligenceon the SSP and concluded that the PSI and the related SSP representedsignificant market potential. Negotiations between CIBA and Ocular concluded with an exclusive licenseagreement in March 2002, pursuant to which CIBA had the right to obtain anexclusive worldwide license to market, distribute and sell the PSI, thePresVIEW Incision System and related products. The CIBA Agreement was subject to a number of terms and conditions,which included a requirement for CIBA to purchase equity interests inOcular.  The Company’s products were tobe marketed under the PresVIEW trademark.

 

Under the CIBA Agreement, the Company was to receive a percentageroyalty on CIBA’s worldwide sales of the PSI and related products.  CIBA had the option to make minimum royaltypayments totaling $13,585,000 during years two through six of its agreementwith the Company if it wished to maintain its rights to an exclusive license ofthe PSI, the PresVIEW Incision System and related products.  CIBA paid the Company $2,000,000 as anadvance royalty that is shown in the consolidated balance sheets as the “CIBAobligation”.  CIBA also purchased625,000 shares of Refocus common stock and a warrant to purchase 312,500 sharesof Refocus common stock in the first tranche of the March 2003 privateplacement (see Note 3) for $1,250,000. CIBA had also committed to purchase, subject to the satisfaction ofcertain conditions precedent, an additional $1,250,000 of Refocus common stockand warrants in the second tranche of the March 2003 privateplacement.  Subject to certainconditions precedent, CIBA would purchase an additional $2,500,000 of Refocuscommon stock within 60 days following the enrollment of the first patient inthe Company’s Phase III FDA clinical trial. Further, CIBA had agreed to pay the Company additional amounts totaling$4,000,000 upon the achievement of certain FDA-related milestones. CIBA hadalso agreed to assume responsibility for the legal defense of the Company’sworldwide PresVIEW patent portfolio against patent infringement, subject tomutual agreement between CIBA and the Company. CIBA also assumed full responsibility for the manufacturing,distribution and marketing of the Company’s products at their expense.

 

At the time the CIBA Agreement was executed in March 2002, theCompany had invented and produced a prototype of the PresVIEW IncisionSystem.  In preparation for futuremarketing, the Company and CIBA decided to make further enhancements and improvementsto the incision device.  CIBA invested asignificant amount of time and money in the further development of the device.  Late in 2003, a CE Mark certification of thecomponents of the PresVIEW Incision System was obtained by the suppliers ofthose components.

 

In August 2003, CIBA announced that itwas seeking strategic alternatives for its surgical business unit, includingthe sale of that unit.  CIBA’s surgicalbusiness unit marketed a variety of ophthalmic products and was primarilyresponsible for performing the CIBA Agreement. On December 29, 2003, CIBA informed management of the Company thatit was exiting the surgical business and expected to complete the sale of thesurgical business unit’s various product lines to a variety of parties by early2004.  In conjunction with that sale,CIBA received an offer from a third-party to purchase CIBA’s rights under theCIBA Agreement.  Pursuant to the CIBAAgreement, the transfer of the license required the Company’s consent.  As a condition to the assumption of CIBA’sduties associated with that proposed license assignment, the third-partyrequested the renegotiation of certain key terms of the license agreement.  After deliberation, the Company declined torenegotiate the license and did not permit the assignment of the license to thethird-party.  As a result, the Companybegan negotiations with CIBA for the transfer of CIBA’s rights under the CIBAAgreement back to the Company and the termination of the license.

 

In January 2004, the Company enteredinto the Transfer Agreement with CIBA. Pursuant to the Transfer Agreement, the Company reacquired all worldwidelicense rights to the Company’s patents that were granted to CIBA under theCIBA Agreement, and CIBA was released from all future financial commitments,including its obligations associated with manufacturing, marketing,distribution and regulatory matters. Under the Transfer Agreement, CIBA has agreed to provide the Companywith certain transition services during 2004, including efforts to

 

F-19

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finalize the CE Mark certification of the PSI.  As consideration for the acquisition ofCIBA’s license rights, the forgiveness of the $2,000,000 in prepaid royaltiesthe Company received under the CIBA Agreement and the transition services to beperformed by CIBA under the Transfer Agreement, the Company agreed to pay CIBAan aggregate of $3,000,000 in twelve quarterly installments commencing in thefirst calendar quarter of 2006.  The Company,however, is entitled to prepay and extinguish the payment obligations by payingan aggregate amount of $2,000,000 to CIBA prior to January 1, 2006.

 

Under the Transfer Agreement, CIBA has also agreed to return thewarrant to purchase 312,500 shares of Refocus common stock that it acquired inthe March 2003 private placement. While it will retain the 625,000 shares of common stock acquired at thesame time, these shares will be subject to certain restrictions on theirtransfer.

 

CIBA’s transition services include the continuation of manufacturingprocesses to result in the delivery to the Company of all existing PSIinventory.  Prior to the CIBA Agreementexecuted in March 2002, the Company manufactured a significant quantity ofthe PSI for future use.  The Company nolonger has those manufacturing arrangements in place because CIBA assumedresponsibility for manufacturing under the CIBA Agreement.  Due to the sufficient quantity of PSIs onhand, CIBA did not establish an injection molding manufacturing arrangementduring the term of the CIBA Agreement. CIBA did, however, inspect and repackage the Company’s PSI inventory forexpected marketing by CIBA.  The Companybelieves that it will have adequate inventory of the PSI for the Company’sexpected requirements over the next 12 to 24 months.  As a result of the transition of those manufacturingresponsibilities to CIBA, the modifications in the packaging of the PSI, andthe resultant changes to those processes, the CE Mark certification obtained bythe Company on the PSI no longer applies.

 

CIBA had been seeking CE Mark certification of the PSI for its plannedmarketing efforts in the European Union in early 2004.  The CE Mark certification of the PSI isstill pending.  The Transfer Agreementrequires CIBA to continue its efforts to obtain CE Mark certification of thePSI.  If the CE Mark certification forthe PSI is obtained, CIBA and the Company will enter into a technicalagreement, which will allow the Company to directly sell its products in CIBApackaging during 2004 in the European Union. The Company cannot be assured, however, that all regulatory requirementswill be finalized, and that CIBA can finalize the issuance of the CE Markcertification for the Company’s current PSI inventory, since the certificationprocess requires extensive documentation of the manufacturing, packaging, andother processes.

 

The Company expects that the transition under the Transfer Agreementwill result in a significant increase in costs related to performing functionsthat CIBA had assumed under the CIBA Agreement.  Conversely, however, the Company will be entitled to all grossproceeds from the sale of its products instead of a royalty based on a percentageof sales as previously specified in the CIBA Agreement.  Even assuming that CIBA obtains the CE Markcertification of the PSI, the Company’s ability to directly market its productsin the European Union is currently limited. The anticipated date of the initial sale of the Company’s products inthe European Union is likely to be delayed, and the number of PresVIEW IncisionSystem and PSI units sold is likely to be reduced, in the short term andespecially in 2004, relative to the number of unit sales that could have beenachieved by CIBA.  The Company may seekto market the PSI and PresVIEW Incision System in the European Union andelsewhere directly or through other distribution, license or strategicarrangements.  Therefore, as a result ofthe increased expenses and potential for delayed revenues, management of theCompany believes that the Transfer Agreement may have a material adverse impacton the Company’ financial condition in the short term.  The Company believes that the reacquisitionof the license will be in the long-term best interest of its stockholders.

 

**NOTE 6 – SEPARATION AND CONSULTINGAGREEMENT**

 

OnFebruary 25, 2003, Dr. Ronald A. Schachar, the Company’s founder andformer Chief Scientist, and the Company entered into a Severance, Release andConsulting Agreement (the “Consulting Agreement”).  In accordance with the Consulting Agreement, Dr. Schacharresigned as an officer, director and employee of the Company at the MergerClosing Date.  The Company agreed toretain Dr. Schachar as a consultant for a period of up to five years, and heagreed not to compete with the Company during that time.  Dr. Schachar will assist the Company inconducting research and development on its products for the treatment of ARMDfor the initial two years of the Consulting Agreement and will assist inmaintenance of its patent portfolio and other matters for the entire term ofthe Consulting Agreement.

 

F-20

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Subjectto certain conditions, Dr. Schachar will be paid $1,750,000 over the consultingperiod, of which $950,000 will be paid in the first two years.  The timing of the remaining $800,000 due inyears three through five is partially dependent on the Company’s profitabilityin those years; however, Dr. Schachar is guaranteed to receive a minimum of$250,000, but not more than $400,000, for each of the third and fourth yearswith the remainder, if any, to be paid in the fifth year.  In addition, Dr. Schachar is to receive a$500 per month supplemental payment for the first 48 full months of theagreement.

 

Assecurity for the payment of his consulting fees, the Company granted Dr.Schachar a non-exclusive security interest in its patent rights relating to theARMD device and the SEVFL.  Dr. Schacharalso received an assignment of the Company’s patents for the ARMD device outsidethe United States, which is revocable under certain conditions.  The capitalized value of these assignedpatents was $120,355.

 

TheCompany determined that the present value of the future cash payments for the$1,750,000 base payment under the Consulting Agreement plus the $24,000 insupplemental payments under the Consulting Agreement was $1,437,270.  The present value calculation assumed a 12%interest rate and payments of $400,000 per year in the third and fourth yearsso that all payments would have been made at the end of four years.

 

Therefore,the total cost of the Consulting Agreement to the Company is the present valueof future cash payments plus the $120,355 capitalized value of the ARMD patentsassigned to Dr. Schachar, or $1,557,625. These payments have been allocated to prepaid consulting paymentsrelated to our outstanding patents, to prepaid research and developmentconsulting for the treatment of ARMD, to a non-compete agreement and, finally,to severance costs as follows:

 
| Amount allocated to:                                |   |    |      |
|-----------------------------------------------------|--------|---------|-----------|
| Non-compete agreement                               |   | $       | 781,134   |   |
| Consulting over term of the Consulting  Agreement   |   | 246,673 |      |
| Research and development for the treatment  of ARMD |   | 57,557  |      |
| Severance                                           |   | 472,261 |      |
| Total cost of the Consulting Agreement              |   | $       | 1,557,625 |   |

 

Theamount allocated to the non-compete agreement and prepaid consulting will beexpensed over four years.  The amountallocated to research and development will be expensed over two years.  Therefore, for the year endedDecember 31, 2003, there were charges totaling $831,650 in connection withthe Consulting Agreement.

 

**NOTE 7 – PREFERRED STOCK, COMMONSTOCK AND WARRANTS**

 

Ocularhad designated 4,500,000 shares of $.001 par value preferred stock as Series Band 65,000 shares of $.001 par value preferred stock as Series C.

 

BetweenApril 1998 and April 2000, Ocular had issued 2,443,815 shares ofSeries B preferred stock.  Each sharewas convertible into 2.52 shares of common stock of Ocular at the option of theholder or automatically based on the closing of a public offering.  Each share bore interest at 12%.  Dividends were accrued but were deferreduntil October 31, 2002.  In theevent of liquidation, the Series B preferred stockholders were entitled to$2.046 per share plus unpaid dividends prior to any distribution to the SeriesC preferred or common stockholders.  TheSeries B preferred stock was redeemable at the option of the holders after May1, 2005.

 

EffectiveJuly 15, 2002, Ocular reached an agreement with the Series B preferredstockholders whereby Ocular issued 2,012,344 shares of Series B preferred stockin lieu of accrued dividends and in lieu of any future dividends on the SeriesB preferred stock.  The shares werevalued at par value and the value of the shares issued over the amount ofdividends accrued of $2,454,867 was accounted for as additional dividends onthe Series B preferred stock.  No futuredividends were accrued after this date. The agreement changed the automatic conversion feature by adding aprovision that if Ocular completed a sale of common stock where the aggregategross proceeds were at least $5,000,000, the Series B stock would automaticallybe converted.  This provision wastriggered as of the Merger Closing Date.

 

F-21

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Ocularhad an agreement with an entity, RAS Service LP (“Service LP”), owned by theSeries B preferred stockholders and certain then current employees ofOcular.  The agreement was cancelled inJuly 2002, and Ocular issued 25,237 shares of Ocular Series B preferred stockto Service LP in lieu of $112,277 due Service LP under their agreement.  The difference in the value of the sharesissued and the amount due Service LP of $60,642 was added to paid-in capital.  These shares were also automaticallyconverted to Ocular common stock on the Merger Closing Date.

 

TheSeries C preferred stock was convertible into 21 shares of Ocular’s commonstock at any time and would automatically convert upon certain events, one ofwhich was the conversion of a majority of the Series B preferred stock intoOcular common stock.  In the event ofliquidation, the Series C preferred stock would be entitled to received $100per share after the distribution to holders of the Series B preferred stock butbefore common stockholders.  InJune 2001, holders exercised warrants to purchase 214 shares of Series Cpreferred stock at $100 per share. During 2002, the remainder of the warrants to purchase Series Cpreferred stock expired.  These shareswere automatically converted to Ocular common stock on the Merger Closing Dateas a result of the conversion of the Series B preferred stock.

 

Priorto the merger, Ocular had 30,000,000 shares of $.001 par value common stockauthorized.  On the Merger Closing Date,there was a 2.14-to-1 reverse split of the Company’s common shares prior to themerger.  At the Merger Closing Date,there were 4,481,396 shares of Series B preferred stock and 21,614 shares ofSeries C preferred stock outstanding. The Series B preferred stock was converted into 5,277,164 shares ofOcular common stock (after the 2.14-to-1 reverse split).  The Series C preferred stock was convertedinto 212,102 shares of Ocular common stock (after the 2.14-to-1 reversesplit).  Therefore, with the 6,450,878shares of Ocular common stock outstanding prior to the conversion of thepreferred stock and after the 2.14-to-1 reverse split, there were a total of11,940,144 shares of common stock outstanding at the Merger Closing Date (seeNote 2).  These shares were exchanged bythe stockholders of Ocular for shares of Refocus on March 6, 2003 as partof the merger of Ocular into a wholly-owned subsidiary of Refocus.

 

Currently,the Company has 60,000,000 shares of $.0001 par value common stock and10,000,000 shares of $.0001 par value preferred stock authorized.  There are no shares of preferred stockissued or outstanding.  The number ofshares of common stock outstanding at December 31, 2003 was 23,368,887.

 

InMay 2003, in connection with a consulting contract with an investment banker,in addition to the monthly retainer, the Company issued to the investmentbanker a warrant to purchase 200,000 shares of the Company’s common stock at anexercise price of $2.50 per share that expires March 6, 2006.  The Company estimated the value of thiswarrant to be $130,000, using the Black-Scholes option-pricing model.  The value of the warrant was charged toexpense as a consulting fee.

 

Thefollowing table lists the exercise price, expiration date and the number ofshares of common stock that could be purchased by the exercise of the Company’soutstanding warrants at December 31, 2003:

 
| **Exercise  Price** |   | **Expiration  Date** |                   | **Number of  common shares  issuable on exercise** |      |
|---------------------|--------|----------------------|------------------------|----------------------------------------------------|-----------|
| $                   | 2.00   |                 | December 23, 2006 |                                               | 2,382,500 |   |
| $                   | 2.00   |                 | March 6, 2008     |                                               | 50,000    |   |
| $                   | 2.50   |                 | March 6, 2006     |                                               | 2,887,500 |   |
| $                   | 2.50   |                 | December 23, 2006 |                                               | 200,000   |   |

 

Warrantsfor the purchase of 200,000 shares of common stock with an exercise price of$2.50 per share that expire March 6, 2006 cannot be exercised unless thesecond tranche of the March 2003 private placement is funded.  Since the second tranche will not be funded(see Note 3), these warrants will never be exercised.

 

TheCompany has reserved 5,520,000 shares of common stock for issuance upon theexercise of outstanding warrants.  TheCompany has also reserved 4,216,465 shares of common stock for grant orissuance under the Amended and Restated Stock Option Plan discussed below.

 

F-22

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**NOTE 8 – STOCK OPTIONS**

 

On February 25, 2003, Ocular’s Board of Directors adopted theAmended and Restated Presby Corp 1997 Stock Option Plan (the “Plan”).  Shareholders of Ocular approved the Plan onMarch 4, 2003.  Refocus assumedthis Plan on the Merger Closing Date. The Plan provides for the issuance of incentive stock options andnon-qualified stock options to key employees, directors and independentcontractors of the Company.  Theexercise price for each incentive stock option granted under the Plan may notbe less than the market value of the common stock on the date of the grant.  The exercise price for non-qualified stockoptions granted under the Plan are set by the Board but are, generally, set atthe market value of the common stock at the grant date.  Unless otherwise determined by the Board,incentive and non-qualified stock options granted under the Plan have a maximumduration of ten and fifteen years, respectively.  The vesting periods for these options vary, but they aregenerally for periods of three years or less.

 

The total number of shares of common stock available for new grantsunder the Plan after March 4, 2003, is 4,100,000 shares.  There were options to purchase 161,851shares of common stock outstanding prior to the amendment and restatement ofthe Plan.  Options to purchase 3,105,414shares of common stock are still available for grant under the Plan atDecember 31, 2003.

 

In March 2003, after the Plan was amended and restated, theCompany granted options to purchase 557,635 shares of common stock pursuant tothe employment and option contracts with our Chief Executive Officer.  These options were contingent on the closingof the merger.  In addition, the Companyissued additional options to purchase 510,000 shares of common stock todirectors and officers during 2003.  SeeNote 1 for the calculation of the weighted average fair value of options issuedfor the three years ended December 31, 2003, as well as the weightedaverage factors used to calculate that value.

 

The following table summarizes the information with respect to stockoptions for the years ended December 31, 2003, 2002 and 2001,respectively:

 
|                           |   | **2003**   |   | **2002**                               |   | **2001**   |    |
|--------------------------------|--------|------------|--------|----------------------------------------|--------|------------|---------|
|                           |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   | **Shares** |    | **Weighted  Average  Exercise  Price** |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
| Outstanding, beginning of year |   | 161,851    |   | $                                      | 0.104  |       | 189,922 |   | $ | 0.098 |   | 180,693 |   | $ | 0.092 |   |
| Granted                        |   | 1,067,635  |   | $                                      | 1.986  |       | 7,010   |   | $ | 0.193 |   | 11,682 |   | $ | 0.193 |   |
| Exercised                      |   | (19,136    | )      | $                                      | 0.092  |       | —  |   | — |   | — |   | — |   |
| Canceled or expired            |   | (99,299    | )      | $                                      | 1.509  |       | (35,081 | ) | $ | 0.092 |   | (2,453 | ) | $ | 0.092 |   |
| Outstanding, end of year       |   | 1,111,051  |   | $                                      | 1.787  |       | 161,851 |   | $ | 0.104 |   | 189,922 |   | $ | 0.098 |   |
|                           |   |       |   |                                   |   |       |    |   |   |   |   |   |   |
| Exercisable                    |   | 323,648    |   |                                   |   | 143,159    |    |   |   | 178,240 |   |   |   |

 

The following table summarizes information for options outstanding andexercisable at December 31, 2003:

 
|                |   | **Options Outstanding** |   | **Options  Exercisable**                               |   |
|---------------------|--------|-------------------------|--------|--------------------------------------------------------|--------|
| **Exercise Prices** |   | **Shares**              |   | **Weighted  Average Re-  maining Con-  tractual Life** |   | **Weighted  Average  Exercise  Price** |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
| $ 0.092-$ 0.193     |   | 116,465                 |   | 4.2 years                                              |   | $ | 0.108 |   | 109,455 |   | $ | 0.103 |   |
| $ 1.98 - $2.31      |   | 994,586                 |   | 5.6 years                                              |   | $ | 1.984 |   | 214,193 |   | $ | 1.998 |   |
|                |   | 1,111,051               |   | 5.5 years                                              |   | $ | 1.787 |   | 323,648 |   | $ | 1.357 |   |

 

F-23

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**NOTE 9 – SUPPLEMENTAL CASH FLOW ANDBALANCE SHEET INFORMATION**

 

Thefollowing supplemental cash flow information is provided for interest andincome taxes paid and for non-cash transactions for the years endedDecember 31:

 
|                                                                  |   | **2003**  |   | **2002**  |   | **2001** |   |
|-----------------------------------------------------------------------|--------|-----------|--------|-----------|--------|----------|--------|
| Interest paid                                                         |   | $         | 667    |      | $      | —   |   | $ | — |   |
| Income taxes paid                                                     |   | —    |   | —    |   | —   |   |
| Non-cash transactions:                                                |   |      |   |      |   |     |   |
| Accretion of discount on Series B preferred  stock                    |   | 4,306     |   | 23,482    |   | 23,501   |   |
| Accrual of dividends on Series B preferred  stock                     |   | —    |   | 322,195   |   | 594,106  |   |
| Series B preferred stock issued in lieu of  dividends                 |   | —    |   | 2,454,867 |   | —   |   |
| Series B preferred stock issued to RAS  Service LP                    |   | —    |   | 112,277   |   | —   |   |
| Value of warrants issued in private  placements to agents or advisors |   | 641,600   |   | —    |   | —   |   |
| Conversion of Series B preferred stock                                |   | 9,118,450 |   | —    |   | —   |   |
| Conversion of Series C preferred stock                                |   | 1,049,104 |   | —    |   | —   |   |
| Value of separation and non-compete  agreement                        |   | 1,557,625 |   | —    |   | —   |   |
| Value of warrant issued to investment  banker                         |   | 130,000   |   | —    |   | —   |   |
| Value of warrant issued to agent in  post-closing private placement   |   | 130,000   |   | —    |   | —   |   |
| Value of Refocus common stock issued to  advisor                      |   | 21,750    |   | —    |   | —   |   |
|                                                                       |        |           |        |           |        |          |        |  |  |  |

 

Thefollowing supplemental balance sheet information is provided for prepaidexpenses, other long-term assets and accrued expenses:

 
|                                                           |   | **December 31,  2003** |    | **December 31,  2002** |   |
|----------------------------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|
| Prepaid expenses:                                              |   |                        |    |                        |   |
| Prepaid insurance                                              |   | $                           | 62,826  |                        | $      | 79,022 |   |
| Prepaid consulting expenses                                    |   | 61,668                      |    | —                      |   |
| Prepaid research and development costs                         |   | 28,779                      |    | —                      |   |
| Prepaid FDA trial costs                                        |   | 75,007                      |    | —                      |   |
| Other prepaid expenses                                         |   | 2,184                       |    | 4,711                       |   |
| Total                                                          |   | $                           | 230,464 |                        | $      | 83,733 |   |
|                                                           |   |                        |    |                        |   |
| Other long-term assets:                                        |   |                        |    |                        |   |
| Prepaid consulting expenses                                    |   | $                           | 133,615 |                        | $      | — |   |
| Prepaid research and development costs                         |   | 4,797                       |    | —                      |   |
| Deferred offering expenses                                     |   | —                      |    | 194,447                     |   |
| Total                                                          |   | $                           | 138,412 |                        | $      | 194,447 |   |
|                                                           |   |                        |    |                        |   |
| Accrued expenses:                                              |   |                        |    |                        |   |
| Accrued salaries, wages and benefits                           |   | $                           | 36,228  |                        | $      | 46,848 |   |
| Liability for possible replacement of  product already shipped |   | 50,000                      |    | 50,000                      |   |
| Audit fee accrual                                              |   | 30,000                      |    | 45,000                      |   |
| Accrual for amount due on former office  lease                 |   | —                      |    | 48,000                      |   |
| Director fees                                                  |   | 131,500                     |    | —                      |   |
| Accrued taxes                                                  |   | 9,779                       |    | 1,135                       |   |
| Other                                                          |   | 19,805                      |    | —                      |   |
| Total                                                          |   | $                           | 277,312 |                        | $      | 190,983 |   |

 

F-24

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**NOTE 10 – COMMITMENTS ANDCONTINGENCIES**

 

TheCompany is involved in various legal proceedings arising in the normal courseof business.  Management believes theoutcome of these matters will not materially affect the financial condition,results of operations or cash flows of the Company.

 

TheCompany leases a facility in Dallas, Texas and, until September 2003, afacility in Denison, Texas.  Total leaseexpense for the years ended December 31, 2003, 2002 and 2001 wereapproximately $48,000, $204,000 and $141,000, respectively.  There are no leases with remaining terms ofone year or more at December 31, 2003.

 

UntilApril 1, 2003, the Company carried product liability insurance coveragewith a limit of $10,000,000 in the aggregate and per occurrence.  At that time, the policy was changed to alimit of $5,000,000 in the aggregate and $1,000,000 per occurrence.  The change was made as a result of theassumption of manufacturing and distribution by CIBA under the CIBAAgreement.  As a result of the TransferAgreement, the Company has again assumed responsibility for the manufacturingand distribution of the PSI and related equipment.  Although the Company has reassumed this responsibility, it willlikely not increase the amount of product liability coverage until highervolumes of its products are being used.

 

Asa result of the Company’s suspension of sales of the PSI in 2001, while theCompany was developing the PresVIEW Incision System, and the continuedsuspension of sales as a result of the CIBA Agreement, pursuant to which CIBAwas supposed to exclusively handle the Company’s future sales and marketing,the Company has encouraged customers not to perform the SSP using the PSI untilthe PresVIEW Incision System was available, and the Company and/or CIBA wasready to begin sales of the PSI again. The packaging of the PSI provided guaranteed sterility only for alimited period of time, and the sterility dating on PSIs still held by theCompany’s customers has expired.  Anestimated liability of $50,000 was established for the possible replacement ofthese PSIs.  The liability was based onthe Company’s estimated manufacturing cost and the total number of PSIs thathad been sold less an estimate of the number already used.  Rather than replace all the expiredinventory, the Company may instead grant special pricing on future purchases tothese surgeons.  The actual claims bycustomers may exceed, and/or the cost of replacing the PSIs may be higher than,the Company’s estimate and additional charges may have to be taken.

 

TheCompany has been informed by two of its former foreign distributors that theyare seeking refunds on unsold products remaining in their inventory.  The Company did not sell its products with aright of return and does not believe it has any liability to repurchase theseproducts.

 

Certainphysicians may have purchased surgical kits in anticipation of taking part inthe FDA clinical trials.  Several ofthese physicians have requested a refund or have informed the Company that ifthey are not selected to participate in the clinical trials, they will beseeking a refund.  These kits were notsold with a right of return.  Since theCompany did not sell its products with a right of return, the Company does notbelieve it has any liability to repurchase these products.

 

Asa result of the Transfer Agreement, the Company will be responsible for allfuture marketing.  As part of futuremarketing programs in the United States or internationally, the Company maydetermine that it is in its best interest to provide some compensation in theform of product discounts or by other means to the surgeons who bought ourkits, and did not get to participate in the FDA trials, or to foreigndistributors of our products.  At thistime, the Company is currently unable to determine the amount of possiblecompensation, if any, that it may agree to pay in the future.

 

Asupplier had indicated to Ocular that it believed it had a firm order for 150prototypes of the PresVIEW Incision System, which the Company disputed.  The Company settled this claim for $15,000during the year ended December 31, 2003. The charge for the settlement is included in “Research and development”in the consolidated statement of operations for the year endedDecember 31, 2003.

 

In2001, the Company received $115,094, net of legal fees, related to a legalsettlement in defense of one of the Company’s patents.  Two additional settlements also in thedefense of the Company’s patents resulted in a net expense when netted againstthe associated legal expenses in 2001. The net settlements are included in “Other income (expense)” in theconsolidated statement of operations for the year ended December 31, 2001.

 

F-25

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**NOTE 11 – OTHER RELATED PARTYTRANSACTIONS**

 

TheCompany leased its Denison, Texas facility under a monthly operating lease agreementwith Dr. Schachar.  The lease was terminatedAugust 31, 2003.  Total rentexpense for the years ended December 31, 2003, 2002 and 2001 was $32,000,$48,000 and $48,000, respectively.

 

Ocularleased its former Dallas, Texas facility from a substantial holder of itsSeries B preferred stock.  Due to thedownsizing of its staff in conjunction with the business changes contemplatedin the CIBA Agreement, Ocular negotiated a settlement with its former lessor toabandon that lease for a smaller facility. Under the contract, lease payments to the lessor of approximately$98,000 for the period from January through December 2003 were stilldue.  Ocular negotiated a reduced leasepayment of $48,000 to the lessor.  Thisamount was paid by March 2003.

 

OnFebruary 26, 2003, the Chief Executive Officer, three of the Company’sother directors and others loaned the Company $250,000 to provide workingcapital until the Merger Closing Date. The annual interest rate on the loan was 12%, and the loan was due onthe Merger Closing Date.  All but$25,000 of the amounts repaid were used to purchase Refocus common stock in theMarch 2003 private placement. Interest paid on the loans was $667.

 

**NOTE 12 – INCOMETAXES**

 

No provision for income taxes has been recognized for the three yearsended December 31, 2003 as the Company incurred net operating losses forincome tax purposes.  The Company didnot record any federal income tax benefit for its losses because of theuncertainty of realizing its deferred tax assets.  The Company has adjusted the valuation allowance to maintain afull valuation allowance against the net deferred tax assets.

 

While the Company had generated substantial tax loss carryforwards inprior years, the ability to use these loss carryforwards has been substantiallyaffected as a result of an ownership change (as defined in the Internal RevenueCode of 1986, as amended) that occurred in connection with the merger of Ocularinto a subsidiary of Refocus.  Based onpreliminary calculations, the Company believes that the use of our losscarryforwards generated prior to the Merger Closing Date will be limited goingforward to approximately $1,286,000 per year. The total loss carryforwards subject to the limitation will expire asfollows: from 2009-2012 approximately $681,000 and from 2018-2023 approximately$9,514,000.

 

Deferred tax assets consist of the following:

 
|                             |   | **Year Ended  December 31,** |      |
|----------------------------------|--------|-----------------------------------|-----------|
|                             |   | **2003**                          |      | **2002** |   |
| Deferred tax assets:             |   |                              |      |   |   |
| Net operating loss carryforwards |   | $                                 | 4,943,152 |   | $ | 3,375,691 |   |
| Advance royalty payment          |   | 680,000                           |      | 680,000 |   |
| Stock option compensation        |   | 326,263                           |      | 57,086 |   |
| Consulting Agreement             |   | 86,990                            |      | — |   |
| Fixed assets and other items     |   | 20,235                            |      | 20,017 |   |
| Total deferred tax assets        |   | 6,056,640                         |      | 4,132,794 |   |
| Valuation allowance              |   | (6,056,640                        | )         | (4,132,794 | ) |
| Recognized deferred tax assets   |   | $                                 | —    |   | $ | — |   |

 

The increase in the deferred tax asset valuation allowance for the yearended December 31, 2003 was $1,923,846.

 

At December 31, 2003, the Company had net operating losscarryforwards of approximately $4,343,000 for income tax purposes since theMerger Closing Date.  These netoperating loss carryforwards will expire in 2023.

 

F-26

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The difference between the Company’s effective tax rate and the federalstatutory rate of 34% are as follows:

 
|                                 |   | **Year Ended  December 31,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
|                                 |   | **2003**                          |   | **2002** |   | **2001** |   |
| Income tax benefit at statutory rate |   | (34                               | )%     | (34 | )% | (34 | )% |
| Valuation allowance                  |   | 34                                |   | 34 |   | 34 |   |
| Total income tax expense             |   | 0                                 | %      | 0 | % | 0 | % |

 

**NOTE 13.****        EMPLOYEE BENEFIT PLAN**

 

Presby has a retirement savings plan under Section 401(k) of theInternal Revenue Code covering substantially all employees.  The Company’s contributions to the plantotaled $0, $14,713 and $2,500 for the years ended December 31, 2003, 2002and 2001, respectively.

 

**NOTE 14 – VERUSAGREEMENT**

 

In the event that at least $1,000,000 was not raised in a post-closingprivate placement within six months of March 6, 2003, on terms no lessfavorable than the private placement consummated in March 2003, anotherparty, Verus Support Services, Inc. (“Verus”) subscribed to purchase thatnumber of units at $2.00 per unit in order to satisfy the deficiency betweenthe amount of additional capital successfully raised and $1,000,000 (see Note3).  Since no funds were received from apost-closing private placement, Verus is required to fund the entire$1,000,000.  The Company had previouslygiven Verus an 120-day extension to January 6, 2004 to their fundingrequirement in exchange for their forgiveness of $60,000 in consulting fees duethem.

 

In January 2004, a dispute arose as to the continuing obligationof Verus under this agreement.  As ameans of deferring and ultimately resolving this dispute, the Company enteredinto an amendment to its agreement to further extend to June 30, 2004,Verus’ obligation to purchase up to $1,000,000 of units and to make certainother amendments.  Verus has advised theCompany that its ability to provide the original subscription amount at a stockprice well above current market is limited, and it indicated that currentmarket conditions should be considered. Therefore, the Company agreed to amend the funding obligation to permitVerus to reduce its funding obligation by:

 

•                  thesurrender and cancellation of shares of our common stock and warrants topurchase shares of our common that were issued to Verus or its affiliates,assigns or designees, or investors in the March 2003 private placement,based on the current market price of our common stock,

•                  thewaiver of the remaining $20,000 in advisory fees due to it under its existingconsulting agreement,

•                  thewaiver of up to $60,000 in advisory fees that might become due to it during theextension period, and

•                  anamount of $25,000 that was received from an investor in the December 2003private placement since that investor was introduced to the Company by Verus.

 

Further,after the credit of these amounts to the funding obligation, Verus has agreedto subscribe for and purchase, or cause to be subscribed for and purchased, anamount of Refocus common stock at prevailing market prices equal to 1.25 timesthe remaining funding obligation.  Managementof the Company believes that this agreement is in the Company’s best interestand may result in funding during this extension period; however, the Companycannot be assured that Verus will not continue to dispute this obligation.

 

F-27

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