**U.S. SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-KSB**

 

**ý****        ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004**

 

**o****        TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**COMMISSION FILE NUMBER 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’s telephone number, including area code:  **214-368-0200**

 

 

(Former name or former address, if changedsince last report)

 

Securities registeredpursuant to Section 12(b) of the Act:  **None**

 

Securities registeredpursuant to Section 12(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 theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject to suchfiling requirements 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 Form 10-KSB. o 

 

Issuer’s revenues for thefiscal year ended December 31, 2004 were $0.

 

On March 25, 2005,the aggregate value of voting stock held by non-affiliates of the registrantwas approximately $3,018,000.  For purposesof this computation, all officers, directors and 10% stockholders were deemedaffiliates.  Such determination shouldnot be construed as an admission that such officers, directors and 10%stockholders are affiliates.

 

On March 25, 2005,there were 24,649,105 shares of the registrant’s common stock outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE:**

None.

 

Transitional SmallBusiness Disclosure 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                                      |   |
|                                        |                                                                                                                   | March 2005  Change in Control           |   |
|                                        |                                                                                                                   | History of Refocus  Ocular, Inc.             |   |
|                                        |                                                                                                                   | Business and Industry  Overview              |   |
|                                        |                                                                                                                   | Products                                     |   |
|                                        |                                                                                                                   | CIBA Vision                                  |   |
|                                        |                                                                                                                   | 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                                                                                               |                                         |
| Item 8B.                                    | Other  Information                                                                                                     |                                         |
|                                        |                                                                                                                   |                                         |
| Part  III.                                  |                                                                                                                   |                                         |
| Item 9.                                     | Directors,  Executive Officers, Promoters and Control Persons; Compliance with  Section 16(a) of the Exchange Act |                                         |
| Item 10.                                    | Executive  Compensation                                                                                                |                                         |
| Item 11.                                    | Security  Ownership of Certain Beneficial Owners and Management                                                        |                                         |
| Item 12.                                    | Certain  Relationships and Related Transactions                                                                        |                                         |
| Item 13.                                    | Exhibit  Index                                                                                                         |                                         |
| Item 14.                                    | Principal  Accountant Fees and Services                                                                                |                                         |
| Signatures                                  |                                                                                                                   |
|                                        |                                                                                                                   |                                         |
| Index to  Consolidated Financial Statements |                                                                                                                   |

 

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**PART I**

 

Cautionary Statement underthe Private Securities Litigation Reform Act of 1995:  This Annual Report on Form 10-KSB containscertain “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995 that are based on the assumptions,beliefs and opinions of our management. When used in this document, the words “anticipate”, “believe”, “continue”,“estimate”, “expect”, “intend”, “may”, “should”, “plan”, “potential” andsimilar expressions are intended to identify forward-looking statements.  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.  Suchrisks and uncertainties include, among other things, those described in the “*Cautionary Statements*” section below and elsewhere inthis Form 10-KSB.  Should one or more ofthose risks or uncertainties materialize, or should underlying assumptionsprove incorrect, our actual results may vary materially from those describedherein.  The forward-looking statementsmade in this document speak only to the date on which such statements are made,and we undertake no obligation to update any forward-looking statement toreflect events or circumstances after the date on which such statement is madeor to reflect the occurrence of unanticipated events.

 

**ITEM 1****.  DESCRIPTION OF BUSINESS**

 

RefocusGroup, Inc. is a medical device company engaged in the research and developmentof treatments for human vision disorders. Our 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 surface of the white of the human eye.  The PSI and PresVIEW Incision System areutilized in our surgical procedure, the Scleral Spacing Procedure, for thetreatment of presbyopia, ocular hypertension and primary open angleglaucoma.  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 our surgical procedurephysiologically restores the human eye’s natural ability to focus as it did ata younger age.  We believe the procedureworks by reducing the crowding of the underlying tissues surrounding thecrystalline lens, which allows the muscles to once again reshape the lens andthus restore the eye’s ability to accommodate or focus.  Ocular hypertension, or elevated pressurewithin the eye, often leads to primary open angle glaucoma, or the progressiveloss 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 intraocularpressure.  We received approval from theUnited States Food and Drug Administration (the “FDA”) to begin Phase II FDAclinical trials using the PSI for the treatment of presbyopia in December 2003.  We began those trials in the first quarter of2004, and they are ongoing.  We have alsoconducted clinical trials in Canada using the PSI for the treatment of ocularhypertension and primary open angle glaucoma. Later this year, we will seek permission from Health Canada to continue theseclinical trials.  In the future, we planto apply to the FDA to start our clinical trials in the United States, usingthe PSI for the treatment of ocular hypertension and primary open angleglaucoma.  We are also seeking CE Markcertification of the PSI so that we may begin sales of our products in theEuropean Union this year.    See “Business of Refocus Group, Inc.**“ below for a complete discussion.

 

**BusinessDevelopment**

 

On November 21, 2000, VeryBestoftheInternet.com,the predecessor of Refocus Group, Inc., was incorporated in the State of Texas. In February 2003,VeryBestoftheInternet.com reincorporated in Delaware and changed its name toRefocus Group, Inc.

 

Refocus Group, Inc. (“Refocus”) completed a merger on March 6,2003 (the “Merger Closing Date”) of Refocus Acquisition Corp., a Delawarecorporation and wholly-owned subsidiary of Refocus, with and into Presby Corp (“Presby”), a Delawarecorporation.  Presby was a medical devicecompany based in Dallas, Texas, which was engaged principally in the researchand development of surgical treatments for human vision disorders.  Presby was the surviving corporation andbecame a wholly-owned subsidiary of Refocus.  The merger was consummated under Delaware lawand pursuant to an Agreement of Merger and Plan of Reorganization, dated as of March 6,2003 (the “Merger Agreement”).  Inaddition, on the Merger Closing Date, Refocus completed a private placement ofits

 

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common stock.  Presbychanged its name to Refocus Ocular, Inc. (“Ocular”) in April 2003 afterthe merger.  Prior to the merger, Refocuswas an internet website ranking service.

 

After the merger, Refocus discontinued its previousbusiness as an internet website ranking service, the founders of Refocusresigned their positions, and Refocus succeeded to the business of Ocular.  For accounting purposes, the merger wasaccounted for as a reverse merger, whereby Ocular was deemed to be theaccounting acquirer of Refocus since the former stockholders of Ocular owned amajority of the issued and outstanding shares of common stock of Refocus on theMerger Closing Date, including those shares issued in the private placementthat closed on that date.

 

Therefore, all financial information included in thisreport on Form 10-KSB prior to the Merger Closing Date is that of Ocular as ifOcular had been the registrant.  Thefinancial information since the Merger Closing Date is that of Refocus andOcular consolidated.

 

Allreferences to “Refocus”, “Presby”, “Ocular”, “we”,  “us”, “our”, or the “Company” means Refocusor Ocular, as the former Presby, separately prior to the Merger Closing Dateand Refocus, as successor to the business of Ocular, after giving effect to themerger.

 

Inaddition, you should be aware that at December 31, 2004, we did not havesufficient funds to continue as a going concern for the next twelvemonths.  However, we closed a privateplacement in March 2005 for approximately $7.0 million, which managementbelieves will provide adequate funds to pursue our currently anticipatedbusiness plans for the next twelve months. There can be no assurances, however, that there will not be delays, complicationsor other unforeseen events that prevent us from achieving our current businessplan over the next twelve months.  Wewill need to continue to seek additional funding sources by March 2006 tocontinue with our business plan.  Assumingwe receive permission to start our Phase III trials from the FDA, and subjectto customary closing conditions including the absence of a material adverseevent, we have a commitment for $7.0 million to be funded in March 2006.  If this or other funding for 2006 and beyond isnot available, or we cannot successfully commercialize our products, we may notbe able to continue as a going concern.  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.  However, our successultimately depends on our ability to obtain successful operations.  To attain successful operations, we mustsatisfactorily complete our FDA and other clinical trials and convince themedical community that we have a successful commercial product for treatingpresbyopia, ocular hypertension and primary open angle glaucoma.

 

**Business of Refocus Group, Inc****.**

 

***General***

*** ***

We area medical device company based in Dallas, Texas, engaged in the research anddevelopment of surgical treatments for human vision disorders.  Our products are the patented PresVIEWScleral Implant (the “PSI”) and the PresVIEW Incision System, which consists ofthe surgical instruments used to implant the PSI in the human eye.  The PSI and the PresVIEW Incision System areutilized in our surgical technique, the Scleral Spacing Procedure (the “SSP”),for the treatment of presbyopia, ocular hypertension and primary open angleglaucoma in the human eye.  Presbyopia,the Greek word for “old eye”, is the primary reason that a substantial portionof the population beginning in their early 40s uses bifocals, reading glassesor removes their distance glasses in order to read at a comfortabledistance.  We believe that the SSP treatspresbyopia by reducing the crowding of the underlying tissues surrounding thecrystalline lens, which allows the muscles to once again reshape the lens torestore the eye’s ability to accommodate or focus.  In the case of ocular hypertension and primaryopen angle glaucoma, we believe that the SSP restores the natural base-linetension of the muscle inside the eye, which permits the eye to drain naturallyand, thus, lower the intraocular pressure.

 

Sincethe early 1990s, extensive research has been conducted on, and extensiveinvestigational surgeries have been performed utilizing, the PSI.  By 1998, we had obtained the European CE Markand 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.

 

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In2000, we received approval from the FDA to conduct Phase I clinical trials ofthe PSI for the treatment of presbyopia on humans.  In that same year, we received approval fromHealth Canada (the Canadian equivalent of the FDA) to conduct clinical trialsof the PSI for the treatment of ocular hypertension and primary open angleglaucoma.  We decided to suspend sales in2001, however, in order to develop an automated surgical incision device tohelp simplify, standardize and automate the surgical procedure, which should makethe outcomes of the surgical procedure less dependent on each physician’ssurgical skill.  Since that time, we havedeveloped the PresVIEW Incision System, which we believe improves theconsistency 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 thetreatment of presbyopia, ocular hypertension and primary open angle glaucoma ininternational markets.  CIBA also had theright in the license agreement (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 paidus $2.0 million in advance royalties and was committed to purchase equityinterests in us if we obtained certain other investments from third-parties.  As part 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 for an aggregate purchase price of$1.25 million.

 

Underthe CIBA Agreement, CIBA was responsible for manufacturing, marketing anddistributing our products worldwide at its expense.  CIBA was also responsible for regulatorymatters outside the United States and was committed to jointly manage the FDAclinical trials with us.  In accordancewith the CIBA Agreement, we ceased all direct manufacturing and marketing ofthe PSI and related products.  As a resultof the transition of those manufacturing responsibilities to CIBA, themodifications in the packaging of the PSI and the resultant changes to thoseprocesses, the CE Mark certification we had obtained in 2000 on the PSI is nolonger applicable.  We are seeking toregain our CE Mark certification of the PSI. Late in 2003, a CE Mark certification of the components of the PresVIEWIncision System was obtained by the suppliers of those components.

 

CIBA’ssurgical business unit marketed a variety of ophthalmic products and wasprimarily responsible for performing the CIBA Agreement.  In August 2003, CIBA announced that itwas seeking strategic alternatives for its surgical business unit, includingthe sale of that unit.  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.  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 January 2004,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 and regulatorymatters.  Under the Transfer Agreement,CIBA agreed to provide us with certain transition services during 2004.  As consideration for the acquisition of CIBA’slicense rights, the forgiveness of the $2.0 million in prepaid royalties wereceived under the CIBA Agreement and the transition services to be performedby CIBA under the Transfer Agreement during 2004, we agreed to pay CIBA anaggregate of $3.0 million in twelve quarterly installments commencing in thefirst calendar quarter of 2006.  We,however, were entitled to prepay and extinguish our payment obligations bypaying an aggregate amount of $2.0 million to CIBA prior to January 1,2006.  In February 2005, we and CIBArenegotiated the terms of the debt, converting the $3.0 million liability intoa 4% royalty to be paid on sales starting in February 2005.  The maximum amount of royalty payments due is$3.25 million.  If an aggregate of $3.25million is not paid by December 31, 2009, then any portion of the totalroyalty that was not paid will be due and payable in February 2010.

 

Underthe Transfer Agreement, CIBA returned the warrant to purchase 312,500 shares ofour common stock that it acquired in the March 2003 privateplacement.  While it retained the 625,000shares of common stock acquired at the same time, these shares are subject tocertain restrictions on their transfer. CIBA also agreed to certain restrictions on their ability to solicitproxies for a two-year period.

 

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We believe that the Transfer Agreement had a materialadverse impact on our financial condition because, among other things, it reducedfuture potential revenues from minimum royalty and milestone payments, it movedour anticipated European sales launch farther into the future, and it increasedour expenses substantially for functions previously performed by CIBA when ouravailable funds were limited.  However,we believe the Transfer Agreement was in the long-term best interest of ourshareholders.

 

In November 2002, we, along with CIBA, submitted toHealth Canada an application seeking approval to commercialize the PSI insurgery for the treatment of ocular hypertension, primary open angle glaucomaand presbyopia.  In June 2003,Health Canada informed us that it had determined that the sample sizesubmitted in our application was insufficient for approval, and denied theapplication.  Based on furtherdiscussions with Health Canada in October 2003, we will need to performfurther clinical trials at more sites and with significantly more patients inorder to receive approval for commercial sales. We believe we can reinitiate the clinical trials in Canada during 2005.

 

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.  InDecember 2003, we received approval to begin our Phase II clinical trialsof the PSI and SSP for the treatment of presbyopia.  We started these clinical trials during thefirst quarter of 2004.  We have completeda little over half of our Phase II clinical trial and plan to petition the FDAto start Phase III trials this year.  Webelieve, subject to obtaining FDA approval, that all the surgeries related tothe trials should be completed by or before the middle of 2006.  We will then have to continue to monitorpatients for a period of up to two years and submit a final report on theclinical trials before the FDA will let us commercialize our procedure.

 

Wehave a single element variable focus lens (“SEVFL”) for use in commercialoptical lens applications in early stage development.  We do not plan, at this time, to spend anysignificant funds in the near future on the continued research and developmentof this product.  We may, at a latertime, continue the development of this product or find a licensee for thistechnology.

 

Wehave had no revenues since 2001 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.

 

Wehave a limited operating history and have not commercially produced anysignificant quantities of our products to date. We have not yet achieved, and may never achieve, profitability.  In addition, we expect to incur operating lossesfor 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.

 

***March 2005Change in Control***

 

On January 27, 2005, we entered into a securedbridge note with Medcare Investment Fund III, Ltd. (“Medcare”) for $500,000 toprovide us with working capital while we finalized negotiations for a privateplacement investment by Medcare.  Thenote was secured by our United States presbyopia patents and trademarks, wasguaranteed by our subsidiaries, bore interest at 8% and was to be repaid uponthe earlier of the closing of an investment by Medcare or July 26, 2005.

 

On February 25,2005, we and Medcare entered into a term sheet (the “Term Sheet”) outlining theproposed investment by Medcare in us. The Term Sheet contained both binding and non-binding terms upon which theinvestment by Medcare would be made.

 

Inanticipation of the investment transaction discussed below, on March 1,2005, our Board of Directors, pursuant to our Certificate of Incorporation,exercised its authority to issue in one or more series up to 10 million sharesof our preferred stock.  On March 1,2005, we filed a Certificate of Designation, Rights and Preferences (the “Certificateof Designation”) with the Secretary of State of the State of Delaware, which becameeffective upon its filing.

 

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The Certificate ofDesignation established a Series A-1 Convertible Preferred Stock (“Series A-1Shares”), consisting of 280,000 shares, a Series A-2 Convertible Preferred Stock(“Series A-2 Shares”), consisting of 280,000 shares, and a Series A-3Convertible Preferred Stock (“Series A-3 Shares”), consisting of 200,000 shares(collectively, the “Series A Preferred Stock”).

 

On March 1,2005, we and Medcare entered into a Securities Purchase Agreement (the “PurchaseAgreement”) that documented the transactions contemplated in the TermSheet.  Pursuant to the PurchaseAgreement, the Company issued and sold, and Medcare purchased, 280,000 sharesof Series A-1 Shares for an aggregate purchase price of $7,000,000, or $25 pershare, and a warrant to purchase 133,334 shares of Series A-3 Shares for a purchaseprice of $1,000.  A portion of the fundsreceived were used to repay the Medcare bridge loan and to repay a portion ofconvertible notes issued in October and November 2004.  The remainder of the funds will be used forgeneral working capital purposes.

 

TheSeries A-1 Shares are convertible into shares of our common stock at aneffective conversion price of $0.25 per share. The Warrant has an exercise price of $30 per share for each of theSeries A-3 Shares and expires on February 28, 2007.  The Series A-3 Shares are convertible intoshares of our common stock at an effective conversion price of $0.30 pershare.  The conversion price of theSeries A-1 Shares and Series A-3 Shares, and the exercise price of the warrant,are subject to adjustment based on customary anti-dilution protection provisions.

 

Additionally,pursuant to the Purchase Agreement, in the event that we receive authorizationin writing from the FDA to commence our Phase III clinical trials for thetreatment of presbyopia without any material limitations, Medcare has committedto purchase 280,000 shares of Series A-2 Shares for an aggregate purchase priceof $7,000,000, or $25 per share, subject to customary closing conditionsincluding the absence of a material adverse event.  The Series A-2 Shares will be convertibleinto shares of our common stock at an effective conversion price of $0.25 pershare.  Medcare, however, is under noobligation to purchase the Series A-2 Shares until March 1, 2006.  Medcare may accelerate the timing of thepurchase of the Series A-2 Shares at its discretion by waiving any of theconditions.

 

The holders of the Series A Preferred Stock are notentitled to any preferential dividends. Holders of the Series A Preferred Stock, however, are entitled toparticipate on an as-converted basis in any cash dividends declared and paid onour common stock.

 

A share of SeriesA Preferred Stock is convertible at the option of the holder of that share, atany time and from time to time, into 100 shares of our common stock, at aneffective price of $0.25 per share of common stock for the Series A-1 Sharesand the Series A-2 Shares and $0.30 per share of common stock for the Series A-3 Shares.  The Series A-1 Shares can be converted into28,000,000 shares of our common stock. The Series A-3 Shares, assuming the full exercise of the warrant forthose shares, can be converted into 13,333,400 shares of our common stock.  The conversion rate of a share of Series APreferred Stock into shares of our common stock is subject to adjustment, fromtime to time, for, among other reasons, stock splits, combinations, dividendsand distributions.  The conversion rateis also subject to an upward adjustment if we issue common stock, or an option,warrant or other instrument convertible into common stock, whose exercise priceis less than the effective price of the Series A Preferred Stock thenoutstanding.  Shares of Series APreferred Stock will be automatically converted into shares of our common stockat the then effective conversion rate upon the closing of an underwrittenpublic offering of shares of our common stock that results in gross proceeds tous of at least $45,000,000.

 

The holders of the shares of Series A PreferredStock will be entitled to vote on all matters required or permitted to be votedupon by our common stockholders.  Eachholder of a share of Series A Preferred Stock is entitled to the number of votesequal to the largest number of full shares of our common stock into which allshares of Series A Preferred Stock held by that holder could be converted.  Except as required by law on mattersrequiring class voting, the holders of the Series A-1 Shares, the Series A-2Shares, the Series A-3 Shares and our common stock will vote together as asingle class.  As a result, the holdersof the Series A-1 Shares control over 50% of our voting stock at March 1,2005 and, thus, control us.  As notedbelow, as of March 1, 2005, the directors appointed by Medcare havesignificant veto rights over many actions that require Board of Directorsapproval.  They also have control overmany day-to-day management functions as a result of their having to approveexpense and capital budgets, major variances from the budget, compensationpolicies and other items.

 

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For so long as 70,000 shares of the Series A-1 Sharesremain outstanding, the holders of the Series A Preferred Stock, as a singleclass, are entitled to elect one-half of the members of the Board of Directors(the “Series A Directors”), one of whom will be elected as the Vice-Chairman ofthe Board of Directors, and to designate at least one Series A Director toserve on each of the committees of the Board of Directors.  The Vice-Chairman is to receive $50,000annually in addition to fees normally paid to our directors.

 

In thePurchase Agreement, we represented and warranted to, and covenanted with,Medcare as to various matters.  Amongthose covenants was that for so long as 70,000 Series A-1 Shares remainoutstanding, without the prior approval of the Board of Directors, including atleast two-thirds of the Series A Directors, we will not:

 

•                  declare or pay any dividends (other than dividendspayable solely in shares of our common stock and dividends payable to us oranother subsidiary of ours) on or declare or make any other distribution,directly or indirectly, on account of any shares of our common stock now orhereafter outstanding;

 

•                  repurchase any outstanding shares of capital stock(other than repurchases of capital stock from any subsidiary of ours or any ofour employees whose employment has been terminated for any reason, not toexceed $100,000 in the aggregate);

 

•                  approve or modify by 10% or more the aggregate amountof any annual or other operating or capital budget, or approve or modify by 50%or more any single line item of any such operating or capital budget;

 

•                  increase the salary of any officer or pay any bonus toany officer, director or employee not contemplated in a budget or bonus planapproved by the Series A Directors;

 

•                  retain, terminate or enter into any salary oremployment negotiation or employment agreement with any employee or any futureemployee;

 

•                  incur indebtedness (other than trade payables) inexcess of $50,000 in the aggregate, or enter into contracts or leases whichrequire payments in excess of $50,000 in the aggregate;

 

•                  make or incur any single capital expenditure in excessof $50,000, or aggregate capital expenditures in excess of $100,000, per fiscalyear;

 

•                  award stock options, stock appreciation rights orsimilar employee benefits or determine vesting schedules, exercise prices orsimilar features;

 

•                  make any material change in the nature of the businessor enter into any new line of business, joint venture or similar arrangement;

 

•                  pledge our assets or guarantee the obligations of anyother individual or entity;

 

•                  recommend amendment of our existing restricted stockand stock option plan or approval of any new equity incentive plan; or

 

•                  form or acquire any subsidiary, joint venture orsimilar business entity.

 

In addition to any other vote or consent required,for so long as 70,000 shares of Series A-1 Shares remain outstanding, withoutthe prior vote or approval of 75% of the then outstanding Series A PreferredStock, we shall not:

 

•                  amend our Certificate of Incorporation and Bylaws inany manner that would alter or change any of the rights, preferences,privileges or restrictions of the Series A Preferred Stock;

 

•                  reclassify any outstanding securities into securitieshaving rights, preferences or privileges senior to, or on a parity with, theSeries A Preferred Stock;

 

•                  authorize or issue any additional Series A PreferredStock or any other stock having rights or preferences senior to, or on a paritywith, the Series A Preferred Stock, except for authorizations for issuancessolely to the holders of Series A Preferred Stock;

 

•                  merge or consolidate with or into any corporation ifsuch merger or consolidation would result in our stockholders immediately priorto such merger or consolidation holding (by virtue

 

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of securities issued as consideration in suchtransaction or otherwise) less than a majority of the voting power of the stockof the surviving corporation immediately after such merger or consolidation;

 

•                  sell all or substantially all our assets in a singletransaction or series of related transactions;

 

•                  license all or substantially all of our intellectualproperty in a single transaction or series of related transactions;

 

•                  liquidate or dissolve; or

 

•                  alter any rights of the Series ADirectors or the holders of the Series A Preferred Stock or change the size ofthe Board of Directors.

 

Asrequired under the Purchase Agreement, the Board of Directors also amended ourBylaws to permit any Series A Director to call a special meeting of the Boardof Directors, to permit any Series A Director or the holders of 51% of theoutstanding Series A Preferred Stock, as a single class, to call a specialmeeting of our stockholders, and to require the Board of Directors to meetbi-monthly until March 1, 2006, and at least quarterly after that date.

 

Inconnection with, and as condition to, entering into the Purchase Agreement, weand Medcare entered into an Investors’ Rights Agreement.  The Investors’ Rights Agreement grantsMedcare certain demand, piggy-back and shelf registration rights and sets forththe procedures pursuant to which such rights may be exercised andeffected.  The Investors’ RightsAgreement also grants Medcare preemptive rights to purchase any or all of oursecurities that we propose to issue on the same terms and conditions as theproposed issuance.

 

***Historyof Refocus Ocular, Inc.***

 

Ocularwas incorporated in 1994 to conduct research on, and develop a surgicaltreatment for, presbyopia.  Extensiveresearch and investigational surgeries were conducted, and by 1998, Ocular hadobtained the European CE Mark and other regulatory approvals necessary tomarket versions 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 “ScleralExpansion Band”.  We intend to market thedevice under the name, “PresVIEW Scleral Implant”.  References to the PSI in periods prior to thechange to the current name should be understood to refer to the medical deviceunder its previous name.

 

On March 6,2003, Refocus completed the merger of Refocus Acquisition Corp., a Delawarecorporation and wholly-owned subsidiary of Refocus, with and into Ocular.  Ocular was the surviving corporation andbecame a wholly-owned subsidiary of Refocus.

 

***Business and Industry Overview***

*** ***

## ***Presbyopia***.  Presbyopia(the Greek word for “old eye”) is the primary reason that a substantial portionof the population beginning in their early 40s uses bifocals, reading glassesor removes their distance glasses in order to read at a comfortabledistance.  According to widely availableindustry reports, presbyopia ultimately affects 100% of the population, withthe first effects of presbyopia generally occurring at about the age of 40 andnearly fully prevalent after age 45. There are approximately 120 million Americans who currently suffer frompresbyopia and, based on widely available estimates, the United Statespopulation over the age of 40 continues to grow.  External lenses such as bifocals and readingglasses are currently the principal alternatives available to counter theeffects of presbyopia.  We believe theSSP will be particularly attractive to the approximately 4 million Americans who,since 1996, have already demonstrated a willingness to reduce or eliminatetheir need for glasses via LASIK and laser vision correction procedures—only tofind that they need glasses again for reading as they become presbyopic afterage 40.

## ** **

## **A February 1999 study conductedby Business Valuation Services, an independent consulting firm commissioned byus, revealed that while only about 40% of the United States population underage 40 wear vision corrective lenses, over 90% of the United States populationover the age of 55 require vision correction, including reading**

 

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## **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 generallydesigned to treat other refractive imperfections of the eye, primarilynearsightedness (myopia), farsightedness (hyperopia) and astigmatism.  These techniques generally do not competewith 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 willmarket this elective procedure in similar fashion to laser procedures,especially since it complements those laser surgery procedures, which are marketedto the baby-boomer population.

 

## ***Ocular Hypertension and Primary OpenAngle Glaucoma.***  Ocular hypertension is a medical conditioninvolving elevated pressure within the eye, which may lead to serious vision damage.  Ocular hypertension is caused by an abnormal buildupof fluid pressure in the eye and is primarily associated with the inability ofthe eye to properly drain itself of fluids.  Just as with high blood pressure, abnormallyhigh levels of ocular pressure must be medically treated.  Advanced or prolonged ocular hypertension isbelieved to damage the optic nerve in the back of the eye and can result in aninitial loss of peripheral vision.  Thiscondition is deemed primary open angle glaucoma as loss of vision begins tooccur.  Continued loss of peripheralvision shrinks the person’s field of vision and eventually leads to tunnelvision and then blindness.  Ocular hypertensionand primary open angle glaucoma are considered to be genetic and related to thetissue of the eye.  The initial stages ofocular hypertension are not noticeable to a patient.  Consequently, early diagnosis is extremelyimportant because damage from primary open angle glaucoma is irreversible.

## ** **

## **Ocular hypertension and primaryopen angle glaucoma are currently treated primarily with pharmaceutical dropsand pills with varying success.  These medicationshave substantial side effects, are costly, not continuous in their action andare not fully effective due to the patient’s lack of compliance with the properuse of the medication.  Many of thesemedications have to be taken several times each day on a strict schedule forthe rest of a patient’s life.**

## ** **

## **Patients with more advanced stagesof primary open angle glaucoma must undergo other types of surgical treatmentsthat involve artificial methods to drain the fluid from the eye.  These surgical methods may have significantcomplications and side effects and typically have varying success.**

## ** **

**According to the National Institutes of Health in June 2002,it is estimated that more than five million Americans have ocular hypertension.  It also estimated that glaucoma affects threemillion Americans and many more people worldwide and is the second leadingcause of irreversible blindness.  Accordingto a recent study by SG Cowen, glaucoma medications represent approximately 40%of ophthalmic medication revenues. According to published reports by Alcon and SG Cowen in 2000, theophthalmic pharmaceutical industry has annual revenues exceeding $2.0 billionin the United States.**

** **

We believe that the SSP treats ocular hypertension andprimary open angle glaucoma by restoring the natural spacing between the muscleand the lens, which also restores the natural base-line tension of the muscleinside the eye.  Assuming that asignificant number of patients that undergo the SSP for the treatment of ocularhypertension demonstrate the same surgical results that have been shown inclinical studies, the SSP could become the first-line preferred treatment forocular hypertension and primary open angle glaucoma.  Since these eye disorders are considered tobe genetic, the SSP could become the first preventive procedure in ophthalmology.

 

***Products***

 

**PresVIEW Scleral Implant andPresVIEW Incision System**

 

ThePSI consists of four separate tiny plastic segments, each about the size of agrain of rice, made from polymethylacrylate, or PMMA.  PMMA has been implanted in the eye for othertypes of surgical procedures (intraocular lenses, hard contact lenses) for overfifty years.  The PresVIEW IncisionSystem, which consists of the surgical

 

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instruments used toimplant the PSI in the human eye, contains a mechanized device used to makeincisions in the human eye for implant of the PSI.  The PresVIEW Incision System includes acontrol box, cabling, incision hand piece, disposable blade, footplate actuatorand other related items.  The surgeonuses the PresVIEW Incision System to make four superficial incisions in thequadrants of the sclera (white of the eye). The PSI is inserted into the superficial tunnels, causing a slight liftin the sclera that in turn reduces the crowding of the underlying muscles.  The surgery is an outpatient surgicalprocedure performed under topical or local anesthesia.

 

Webelieve that 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

•                                          a reductionin intraocular pressure in patients with ocular hypertension and/or primaryopen angle glaucoma.

 

**Single Element Variable Focus Lens**

 

Ourresearch and understanding of the human lens has led to the development of theSEVFL, 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 develop a SEVFL prototypethat we believe will demonstrate that these same large optical effects can beproduced with microscopic movement in a single uniquely shaped lens.  The SEVFL is expected to be smaller, lighterand less 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.  We suspended research on this project in 2002to concentrate our resources on the PSI and SSP; however, we may resume work on,or license this technology to a third party, in the future.

 

***CIBA Visio***n

*** ***

See the discussion in “General”above for a description of our relationship with CIBA.  Under the Transfer Agreement entered into in January 2004,CIBA agreed to provide certain transition services, as described below.

 

CIBA’s transition servicesincluded the continuation of sterilization and packaging processes they hadbegun under the CIBA Agreement to result in the delivery to us of all existingPSI inventory.  Prior to the CIBAAgreement executed in March 2002, we manufactured a significant quantityof the PSI for future use.  We no longerhave those manufacturing arrangements in place because CIBA assumed responsibilityfor manufacturing under the CIBA Agreement. Due to the sufficient level of 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 at least thenext 12 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 longerapplies.   CIBA transferred theirtrademark and internet domain rights to the PresVIEW name to us as part of theTransfer Agreement.

 

Therefore, we are in theprocess of obtaining our own CE Mark certification on the PSI in order to beginsales in the European Union.  We must alsoreestablish an injection molding manufacturing source for additional productionof the PSI after existing inventory is exhausted.  As a result of the March 2005 financing,we are also now able to seek consultants or employees to reestablish or improveour marketing, distribution, and regulatory functions.

 

## ***Business Strategy and Intellectual Property***

## ** **

One ofour primary strategies has been to develop strong proprietary patents for ourproducts, including the PSI, the PresVIEW Incision System and the SEVFL.  We have 17 issued United States patents and 20issued or published international patents. We have 10 pending United States patent applications and 48 pending internationalpatent

 

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applications.  Related only to the PresVIEW technology, wehave 11 issued United States patents, 16 issued or published internationalpatents, 9 pending United States patent applications and 44 pending internationalpatent applications.  The patentsassociated with the PresVIEW technology have expiration dates ranging from 2012to 2020.  The patents and patentapplications related to our early stage products generally do not expire until after2015.

 

Wehave sought intellectual property rights for the PSI in most major economicmarkets throughout the world as long as they have a legal system that tends torecognize our rights, and we intend to continue to submit additional patentapplications and amendments to maintain and strengthen our patentprotection.  Our patents protect the PSI,as well as variations of the PSI, and the custom hand piece and disposableblade in the PresVIEW Incision System. Due to the nature of the medical discovery, we believe that we haveunusually broad patent protection.  Since2003, we have reduced the number of pending and issued international patentsbeing maintained as a result of a determining that the potential revenues fromcertain markets did not warrant the cost of obtaining and maintaining patents,or that the cost to enforce our patents in certain markets did not makeeconomic sense.

 

Wealso seek to protect our proprietary technology, in part, throughconfidentiality and nondisclosure agreements with employees, consultants andother parties.  In a severance andconsulting agreement with Dr. Ronald A. Schachar, our founder and former ChiefScientist, we granted a non-exclusive security interest in some of our patentsrelating to the SEVFL as security for the payment of his consulting fees underthat agreement.

 

## ***Competition***

## ** **

*Treatment of Presbyopia*

 

We believe that the SSP provides a physiological ornatural improvement in the human eye’s ability to focus at all nearpoints.  Glasses, contact lenses and otheroptical changes to the eye only compensate for the inability of the older eyeto focus.  Many people remaindissatisfied with the alternatives as discussed below:

 

**•**                  *Glasses. *Presbyopiawas initially treated with near vision optical aids using magnifying lenses,reading glasses, and monocles.  Patients areconstantly removing reading glasses and losing them because the reading glassesinterfere with vision at all other distances. In the 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 even moreof a problem for many patients. Trifocals are needed as the advancement of presbyopia in patients intheir 50s also necessitates correction at intermediate distances.  Trifocals take even more time to get used toand still do not provide dynamic clear vision for most distances.

** **

**•**                  *Multifocal Glasses.*  Multifocallenses produce multiple images at various focal points.  Light reflected or emitted by an object mustbe dispersed by the multifocal lens over all the focal points.  This scattering of the light rays enteringthe eye causes an increase in the number of images hitting the retina.  Therefore, the intensity at any given focalpoint is reduced and the contrast sensitivity diminished.  In order to reduce these prismatic effects,the visual field of a multifocal lens is reduced.  The patient must learn to select theappropriate 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 and Multifocal Contact Lenses*.  In order toavoid the problems of external bifocal and trifocal glasses, bifocal contactlenses have been developed.  Bifocalcontact lenses have generally been unsuccessful because the distance and nearpower of the contact lens must be crowded into an area that can barely coverthe pupil.  The bifocal must be fit sothat the lens translates up to allow the patient to look through the nearportion of the contact lens (the bottom of the contact lens) when the patientshifts their gaze down.  These lenses arevery difficult to fit.  Multifocalcontact lenses are also available but have the same significant

 

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**drawbacksas multifocal glasses.  An alternatetreatment to bifocal or multifocal contact lenses for presbyopia is to wear contactlenses in monovision, i.e., with one lens in one eye for near vision, and onelens in the other eye for distance vision. Monovision can compromise depth perception, as the brain needs both eyesfor optimal stereo vision.  After 30years of contact lens usage, we believe that contact lenses remain largelyineffective in addressing presbyopia.**

** **

•                  *Laser SurgeryAlternatives.*  Someresearchers have developed plans for the use of laser refractive surgery tocreate a bifocal or multifocal cornea. In other words, the laser technique is intended to shape the cornea inthe same manner 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 thismethod, the drawbacks of monovision include reduced night vision, difficultydriving in some cases, a significant decrease in depth perception and less thanoptimal vision at both near and far distances.

 

•                  *Conductive Keratoplasty,or CK.* CK uses a controlledrelease of radio frequency energy to shrink corneal tissue, which steepens thecornea, reducing farsightedness.  CK isnot reversible, but does regress over time. CK has been used primarily for the treatment of farsightedness torestore normal distance vision.  In March 2004,the FDA approved the use of CK for the treatment of presbyopia.  However, reading vision would be improvedonly if one eye is overcorrected to become near-sighted and, thus, the patientwould have monovision.

 

•                  *Multifocal IOLs*.  During 1997, Allergan received FDA approvalfor 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 thatnon-cataract presbyopes could undergo the procedure (off-label) to help providesome near vision.  The implant of an IOLin a patient without cataracts is a procedure called a clear lensectomy.  All multifocal IOL designs reduce contrastsensitivity, cause some 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 2004issue of *Review of Ophthalmology* reported that,among a survey of 750 cataract surgeons, 84% of respondents indicated that theydo not use multifocal IOLs and two-thirds indicated that they are notinterested in using them in the next two years. The reasons cited by the surgeons for their low interest in multifocalIOLs included, among other reasons: constant blur from slight malpositioning,poor optics and decreased contrast sensitivity and visual acuity.

 

•                  *Accommodating IOLs*.  A handful of companies, including eyeonics, Inc.,are investigating the use of an accommodating IOL, which attempts to magnifythe accommodative ability of the eye through the use of hinges on either sideof the IOL.  Eyeonics’ *Crystalens*TM IOL was approved by the FDA in late 2003 for useonly with cataract patients.  Eyeonicsbelieves that changes in vitreous pressure associated with accommodative effortmoves the lens forward and backward, effectively providing some limited abilityto focus.  Surgeons are now consideringthe use of a modified version of monovision with these lenses to overcome thelimited accommodative ability found with this lens system.  In the FDA approval, it stated that theCrystalens provides approximately one diopter of monocular accommodation.  It is generally recognized that a minimum of2.5 to 3.0 dioptors of accommodation improvement are required before a patientcan become independent of reading glasses for most near readingactivities.  Problems with the accommodatingIOL, as reported in the approved Crystalens “Summary of Safety andEffectiveness Data”, include postoperative capsular fibrosis of the lenscapsule, or cystoid macular edema, and iritis, a persistent inflammation of theiris, which may limit or retard adoption among cataract patients.  While Eyeonics is expected to indirectlypromote their product for the treatment of presbyopia in non-cataract patients,the eye care community has

 

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significantethical and medical issues regarding the removal of healthy or pre-cataractlenses for such purposes.  The risksassociated with clear lens extraction to treat presbyopia in patients who donot have a cataract, the lack of reversibility and the limited gain inaccommodative amplitude may mitigate against accommodating IOLs offeringsignificant competition to the SSP.

 

•                  *Anterior CiliarySclerotomy (ACS)*.  ACS is aprocedure whereby eight incisions are made in the sclera either with a diamondblade or with a laser, allowing it to expand due to intraocular pressure andideally 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 of the sclera. We own issued patents that we believe include this technology; however,due to the limited accommodation achieved with this technique, we do notbelieve it represents significant competition to the SSP.  SurgiLight, Inc (“SurgiLight”) has announcedthat it is developing laser systems for the treatment of presbyopia.  Generally, SurgiLight intends to use a laserto perform the ACS procedure, which weakens the sclera.  We believe that this procedure structurallyweakens the globe of the eye, subjecting it to risk of rupture via a severeblow to the eye or head.  We believethat, while SurgiLight’s approach is based on our scientific theory, the use ofa laser to weaken the sclera will provide only a modest benefit, which willregress with healing.  In March 2000,we filed a patent infringement suit against SurgiLight (see “Item 3. LegalProceedings”).  Recently BiolaseTechnology, Inc. (“Biolase”) has acquired certain license rights to theSurgiLight patents.  They may pursue thisapproach; however, we believe our patents include Biolase’s potentialtreatment.  Biolase has filed a lawsuitseeking a declaratory judgment that one of our patents is invalid andunenforceable (see “Item 3. Legal Proceedings”).

 

*Treatmentof Ocular Hypertension and Primary Open Angle Glaucoma*

 

## **Glaucoma medications remain thepredominant “standard of care” in many countries, including the United States,for the treatment of primary open angle glaucoma and ocular hypertension.  While no glaucoma medication can cure orrestore vision loss due to glaucoma, most of these medications are generally effectivein the temporary reduction of intraocular pressure (“IOP”).  It is generally believed that the primarycause 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* andPharmacia’s *Xalatan*are four of the leading glaucomamedications worldwide.  While generallyeffective, selection of a patient drug regimen and therapy remains highlyindividualized and based on a number of factors such as:**

## ** **

## **•**                  efficacy,

## **•**                  ocularor systemic safety and tolerance,

## **•**                  availabilityin health plans,

## **•**                  cost,and

## **•**                  sideeffects.

## ** **

## **Many of these medications have tobe taken several times each day on a strict schedule for the rest of thepatient’s life, are not continuous in their action and are not fully effective dueto the patient’s lack of compliance with proper use of the medication.  In a study published in the American Journalof Managed Care in 2002, approximately 21% of once daily users of a particularglaucoma medication did not refill their subscription after one year.  In another study published in *Eye* in 2000, approximately 12% of glaucoma patients on onceor twice daily medication regimes reported missing a significant number ofdoses of their medication and 15% did not properly administer their medication.**

## ** **

Glaucoma medications represent approximately 40% ofall ophthalmic medications and 16% of all ophthalmology revenues worldwide,according to a recent study by SG Cowen. As such, they represent the single largest competition to SSP for thetreatment of ocular hypertension and primary open angle glaucoma.  However, we believe that the SSP may prove tohave several significant advantages over glaucoma medications:

 

•                  maintenance of lower IOP versus thetemporary reduction from medications,

•                  a one-time surgery as compared to alifetime of daily drug use,

 

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•                  less expensive over time,

•                  fewer side effects,

•                  no daily drug compliance issues,

•                  avoidance of drugeffectiveness/intolerance issues, and

•                  at the same time, a reduction orelimination of presbyopia along with IOP reduction.

 

While a variety of surgical techniques and medicaldevices exist for the treatment of ocular hypertension and primary open angleglaucoma, we believe that none of these surgical treatments work in the samemanner as the SSP and do not offer stable, continuous therapy with the addedbenefit of an improvement in near vision:

 

•                  *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.

 

•                  *Trabeculectomy orfiltering 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.

 

•                  *Glaucoma valves*involve making a drainage site in the eye whose rate of outflow is controlledby a valve.  This procedure is usuallyonly performed for very severe cases of glaucoma and where trabeculectomy hasfailed.  Glaucoma valves have highfailure rates and can cause significant adverse reactions.  A newer drainage valve, the Optonol, consistsof a miniature stainless steel pipe to drain fluid from the eye.  This device is used for uncontrolledglaucoma.  Since it is new to the market,the long-term failure rates and potential complications are unknown.

 

## ***Manufacturing***

## ** **

CIBAhad sole responsibility 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 and otherequipment previously sold by us were manufactured by independent contractorsthat specialize in the production of these types of instruments andequipment.  As a result of the TransferAgreement, we have reestablished our own manufacturing capabilities throughindependent third parties for the PresVIEW Incision System.  However, no manufacturer of the PSI has beenestablished.  We believe we havesufficient quantities of PSIs on hand to meet expected demand for at least thenext 12 months.

 

## ***Government Regulation***

## ** **

Ourprimary products are subject to regulation by governmental authorities in theUnited States 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 by theCIBA Agreement, CIBA assumed responsibility for manufacturing and marketing thePSI.  As a result of the transition ofour manufacturing responsibilities to CIBA, the modifications in the packagingof the PSI and the resultant changes to those processes, the CE Markcertification we had obtained in 2000 on the PSI no long applies.

 

We areattempting to reestablish our own CE Mark certification on the PSI in order to sellthe PSI in the European Union.

 

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**United States**

 

ThePSI and the PresVIEW Incision System are not currently approved for sale in theU.S.

 

In theUnited States, medical devices are subject to regulation by the FDA under theFood, Drug, and Cosmetic Act (the “FD&C Act”).  The FDA regulates, among other things, themanufacture, distribution, study, and marketing of medical devices sold in theUnited States.  Under the FD&C Act,the FDA classifies medical devices into one of several classes depending on therisks that the FDA believes are associated with the device and the types of controlsnecessary to assure safety and effectiveness. The PSI 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 reviewas part of the FDA approval process.

 

Beforethe PSI can be sold in the United States, FDA approval must be obtained througha Pre-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 or ourcontractors 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.

 

Priorto conducting the clinical trials in the United States, we were required toapply to the FDA for an Investigational Device Exemption (“IDE”). The IDEapplication must include, among other things, a complete report of priorinvestigations, copies of all labeling, copies of all forms and informationalmaterials used as a basis for obtaining informed consent, a description of themethods of manufacture, and a detailed description of the proposed clinicaltrial, including by way of example, the protocol, a risk analysis, monitoringprocedures and sites where the device will be tested.

 

Wereceived approval from the FDA in 2000 to conduct feasibility clinical trialsof the PSI in the United States for the treatment of presbyopia.  The feasibility clinical trials wereconducted at the Barnes-Jewish Hospital at Washington University School ofMedicine in St. Louis, Missouri, the Dean A. McGee Eye Institute at theUniversity of Oklahoma in Oklahoma City, Oklahoma, the New York Eye and EarInfirmary in New York City, New York, the Jules Stein Eye Institute at UCLA inLos Angeles, California, the Stanford University School of Medicine inStanford, California and the Storm Eye Institute at the Medical University ofSouth Carolina in Charleston, South Carolina.

 

ThePhase I clinical 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 sites generallydemonstrated a good effect in improving near vision, while patient data fromthe other three sites generally demonstrated much less of an effect or noeffect.  The Phase I surgical protocolrequired the surgeons to make the incisions to create the scleral pockets usingmanual diamond blades.  The surgeons alsoattempted to place the incision at a predetermined standard distance behind thelimbus (the line between the colored cornea and the white of the eye).  While skilled surgeons were selected toperform the clinical trials, subsequent observation determined that thelocation of the implant on the sclera and the depth of the scleral pocketsvaried from patient to patient.  Earlyduring the study, we determined that a more consistent means of making thescleral incision would be required to provide consistently good surgicalresults.  As discussed, we have developedan automated incision device, the PresVIEW Incision System, which more consistentlydetermines the placement of the implant and automatically makes an incision ofthe correct depth in the sclera.

 

Of the29 patients, 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 24 monthdata for most of the 14 patients, but a minimum of 12 month follow-up on all 14patients. 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 distancevision, a 1.5 diopter increase in the amplitude of accommodation will allow thepatient to comfortably read newspaper size print in good light.  An increase of more than 1.5 diopters willincrease the patient’s comfort, and a higher increase in diopters ofaccommodation will allow the patient to read progressively smaller print inless than ideal lighting conditions. Published investigational studies of “accommodating intraocular lenses”have generally

 

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reported improvements inaccommodation limited to about 1.5 diopters. We believe that the 14 successful cases demonstrate the potential forour surgical treatment. Phase II of the FDA clinical trials includes the use ofthe PresVIEW Incision System to try to improve the outcomes of the SSP.

 

Thesecond-year annual IDE progress report relaying the 18-month patient resultsfrom the 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 incorporatedrequests for a Phase II clinical study population of 150 patients with atwo-year follow-up period.  In December 2003,the FDA approved the start of Phase II clinical trials conditioned on thesubmittal of certain final documentation. In this prospective, multi-center, randomized study, 100 patients willreceive the SSP with 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 during 2005.  Upon submission of the initial Phase II datato the FDA, and assuming successful outcomes, we anticipate that we willrequest FDA approval to start Phase III of the trials, resulting in a total of330 eyes in the study.  Depending on thetiming of the Phase II surgeries and the surgical results, the Phase III trialcould begin in late 2005 and would run concurrent with the initial stage of 150patients.  The Company believes it may beable to finish the surgeries by mid-2006.

 

ThePhase III clinical results would be submitted to the FDA as soon as allpatients in the trial reach the one-year point. At this point, it is anticipated that we may also have two-yearfollow-up results from our Phase II clinical trial.  All patients would continue to be followedfor a required two-year period.  Aftersubmission of the final PMA, including the clinical results, the FDA generallytakes one year or longer to review and approve a Class III device for sale inthe United States.  For equivalentmedical devices, the clinical and regulatory process to FDA approval and commercializationcan take three to five years from the initiation of Phase II clinical trials.

 

Wewill also be required to submit an IDE, conduct separate clinical trials andsubmit a final PMA to obtain approval of the PSI for the treatment of ocularhypertension and primary open angle glaucoma. We may submit an IDE to the FDA during 2005 or early 2006 requestingapproval to begin a clinical trial of the SSP for the treatment of primary openangle glaucoma and ocular hypertension.

 

**Europe**

 

Theregulatory environment in Europe for medical devices differs significantly fromthat in the United States.  A total of 25European 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, Cyprus,the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary,Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal,Slovakia, Slovenia, Spain, Sweden and the United Kingdom.  Iceland, Liechtenstein, Norway andSwitzerland are members of the European Free Trade Association.  Iceland, Norway and Liechtenstein are alsomembers of the European Economic Area.

 

Productsthat comply with the requirements of a specified EU medical directive areentitled to bear the CE Mark.  Allcommercial medical device products are required to bear CE Markcertification.  It is illegal to marketthese products in the EU without CE Mark certification.  To obtain a CE Mark, the product must beassessed and found to conform to the applicable directive.  This assessment is carried out by themanufacturer, in most cases with the assistance of a third-party certificationorganization known as a “notified body.” The notified body assessment may consist of an audit of the manufacturer’squality system or specific testing of the product.  A manufacturer can sell a product throughoutthe EU once it secures an assessment by a notified body in one of the EUcountries.

 

The EUhas adopted several directives to regulate medical devices such as thePSI.  A manufacturer may affix the CEMark after a determination that the product complies with the essentialrequirements of the applicable directives and completion of the appropriateconformity assessment procedures as specified by the directives.  The conformity assessment requirements arebased upon a given product’s classification within the directive.  Products within the scope of the directiveare grouped within four classes: Class I, IIA, IIB and III.  A product with a higher classification isconsidered to have higher risk and will, therefore, be subject to more controlsin order to obtain a CE Mark.  The PSIhas been designated as a Class III device.

 

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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 ISO 9000series of standards for quality assurance and manufacturing processes is one ofthe CE Mark requirements.

 

Thereare two basic options for assessing conformity of devices designated as ClassIII.  The first option allows amanufacturer to seek a decision from the notified body that the processesemployed in the design and manufacture of a device qualify as a full qualitysystem.  Alternatively, manufacturers canseek product 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 satisfactorilycompleted the regulatory compliance tasks required by the directive andreceived a favorable decision from the notified body, it may affix the CE Markto 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 manufacturer mayhave to take remedial action, perhaps even withdrawal of the product from theEuropean market.

 

Our EUdistributor obtained “Own Brander” CE Mark certification for the PSI in November 1997.  This certification involved a limited amountof clinical testing and review of the distributor’s quality system.  The significance of the Own Brander CE Markis that the EU distributor is responsible for certain quality control issuesand record keeping.  For regulatory purposes,the product is considered to “originate” from the EU distributor, and we, inthe United States, served as a manufacturing subcontractor.

 

Wewere awarded ISO 9001 and E46001 certification and our own CE Markcertification for the PSI in January 2000. We obtained qualification of our processes as a full qualitysystem.  During 2001, we formed awholly-owned subsidiary, 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 CE Markcertification for an early prototype of the PresVIEW Incision System and thedisposable blades in 2002.  We sold ourproducts in the EU from late 1997, based on our EU distributor’s CE Mark certification,until termination of the distributor agreement in late 2000.  Product sales in 2000 and 2001 were based onour own certifications.  We ceased directsales of our products in 2001.  As aresult of the transition of those manufacturing responsibilities to CIBA, themodifications in the packaging of the PSI and the resultant changes to thoseprocesses, the CE Mark, ISO and other certifications we obtained on the PSI andour processes no longer apply.

 

ThePresVIEW Incision System is comprised of several components, which include thecustom designed snap-on drive unit and disposable blade that are covered bypatents held by us.  The remainingcomponents of the PresVIEW Incision System include a power box, cable, handheld base drive assembly and footplate. In late 2003, the manufacturers of these components received CE Markcertification for ophthalmic applications. We are in the process of gaining regulatory approval for our Refocuslabeling on these products.

 

We arein the process of reestablishing our CE Mark through our wholly-ownedsubsidiary, Refocus Ocular Europe SPRL (formerly Presby Corp – Europe SPRL).  We believe we will complete that processduring 2005.  We plan to set up certain clinicalsites in Europe during 2005 to conduct investigational surgeries.  Assuming CE Mark approval and the successfuloutcomes of these investigational surgeries, the Company plans to begin salesin Europe by 2006.  There are manyvariables involved in getting our product to market in Europe, including thetiming of the CE Mark approval, the ability to supply our products to ourEuropean customers and building an adequately trained staff to oversee ourEuropean operation.   Any unforeseenproblems related to these variables may cause our expected time to begin salesto be delayed.

 

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**Canada**

 

ThePSI is not currently approved for sale in Canada by Health Canada, theapplicable Canadian regulatory agency. Clinical trials of the PSI for the treatment of ocular hypertensionand/or primary open angle glaucoma have been conducted at one Canadianfacility.  The study of 27 patients wasconducted by Aaron Rifkind, M.D., Associate Clinical Professor of Ophthalmologyat McMaster University in Hamilton, Ontario. The study indication was “the reduction of IOP in patients with ocularhypertension and primary open angle glaucoma.” The summary two-year resultswere presented at the April 2003 meeting of the American Society ofCataract and Refractive Surgery in 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 theirnon-dominant eye as permitted by the protocol. After the SSP, if the IOP was greater than 25 mmHg, or there appeared tobe a change in 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% of thestudy 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 the patients’near visual acuity at 20 centimeters. There were no significant surgicalcomplications.  At the three-year point,exams were performed on eleven patients who have required no additionalglaucoma medications since undergoing the SSP. The mean decrease in these patients IOP was 0.8 mmHg as compared topreoperative IOP with medication and a mean decrease of 5.8 mmHg as compared tothe preoperative IOP without medication.

 

In November 2002,CIBA and we submitted to Health Canada an application for approval tocommercialize the PSI in surgery for the treatment of ocular hypertension, primaryopen angle glaucoma and presbyopia.  On June 13, 2003, Health Canadainformed us that it had determined that the sample size submitted in our ClassIII submittal for the surgical treatment of glaucoma and other ocular disorderswas 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 plan to seek permission from Health Canada to restartour trials during 2005.

 

### ***Research and Developmen***t

### *** ***

Research and development expenditures wereapproximately $34,000, $109,000 and $167,000 during the years ended December 31,2004, 2003 and 2002, respectively.  Theexpenditures for 2003 and 2002 were related primarily to the development of thePresVIEW Incision System.  Theseexpenditures for the PresVIEW Incision System decreased as development of thesystem was substantially completed in 2002. Expenditures in 2004 related primarily to the amortization of prepaidresearch and development fees paid to a consultant for work on another medicaldevice not connected with the PSI.  Wehave decided not to proceed with the development of that device.  Future research and development expenditures,if needed, will be related to improving the PresVIEW Incision System and theSSP.

 

Inorder to develop the SEVFL, further research and development will be needed.  We believe at this time that we will try tolicense this technology to a third party for development, rather than try todevelop it ourselves.  Therefore, webelieve that the SEVFL will not result in a new revenue source in the near future.

 

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***OtherMaterial Agreements***

 

**Dr. Schachar’s Separation andConsulting Agreement**

 

On February 25, 2003,Dr. Ronald A. Schachar, our founder and former Chief Scientist, and we enteredinto a Severance, Release and Consulting Agreement (the “Consulting Agreement”).  In accordance with the Consulting 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 was to assist us in conducting research and development on a productfor the treatment of age-related macular degeneration for the initial two yearsof the Consulting Agreement and assist in the maintenance of our patent portfolioand other matters for the entire term of the Consulting Agreement.

 

Subject to certainconditions, Dr. Schachar will be paid $1,750,000 over the consulting period, ofwhich $950,000 was paid in the first two years. The timing of the remaining $800,000 due in years three through five ispartially dependent on our profitability in those years; however, Dr. Schacharis guaranteed 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 security for the paymentof his consulting fees, we granted Dr. Schachar a non-exclusive security interestin certain of our SEVFL patents.

 

## ***Employees***

## ** **

Wecurrently have four employees, including one person who oversees our FDAclinical trials and three persons who perform executive and administrativefunctions.  We are not a party to anycollective bargaining agreement with a labor union, and we consider relations withour employees to be good.

 

### ***CAUTIONARYSTATEMENT***S

### *** ***

If anyof the following material risks occur, our business, financial condition and/orresults of operations would likely suffer.

 

**After giving effect to the March 2005 financing,Medcare has voting control of the Company and may take actions that may not bein the best interest of other stockholders. **Our new investor,Medcare, controls over 50% of our voting stock. This shareholder acting alone or with other stockholders will be able toexert significant control over our management and affairs requiring stockholderapproval, including approval of significant corporate transactions.  This concentration of ownership may have theeffect of delaying or preventing a change in control and might adversely affectthe market price of our common stock.  Inaddition, Medcare has the ability to appoint half of our Board of Directors,and their board members have veto rights over many matters.  This concentration of ownership may not be inthe best interests of all our stockholders.

** **

**RisksRelated to Our Business and Industry**

 

**We will require additionalfinancing to conduct our operations and fund our FDA clinical trials. **As a result of the financing obtained in March 2005,as described above, we currently believe that we have sufficient financialresources to fund our operations for the next twelve months.  There can be no assurances, however, thatthere will not be delays or other unforseen events that prevent us fromachieving our current business plan.  Inaddition, assuming we get approval from the FDA to start Phase III trials by March 2006,we will receive an additional investment of $7.0 million, subject to customaryclosing conditions including the absence of a material adverse event.  However, we may require substantialadditional capital to fund our future operations and conduct our FDA and other clinicaltrials over the next several years in addition to these funds.  Because of the uncertain nature of receivingapproval from the FDA and other international regulatory organizations topermit commercialization of our products, the amount of funds we need to expendand when these funds will be needed is uncertain.  Our ability to generate funds from revenuesgenerated in foreign markets to support our operations while we complete FDAtrials in the United States is also uncertain because of the many variablesinvolved.  Therefore, we may be requiredto seek additional funding through collaborative arrangements with corporatepartners or through public or private debt or equity financings.  Any additional

 

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equity financing may bedilutive to stockholders.  Any debtfinancing, if available, may involve restrictions on our ability to pay dividendson our capital stock, be dilutive due to possible conversion features orattached warrants, or restrict the manner in which we conduct ourbusiness.  We can give you no assurances,however, that additional funding will be available in sufficient amounts, onterms acceptable to us, or at all, when needed. Our ability to obtain additional financing depends on many factors, someof which are beyond our control, including the state of the capital markets andthe prospects for our business.  Theinability to obtain sufficient funds may require us to delay, scale back oreliminate some or all of our research and product development programs,clinical studies and/or regulatory activities or may cause us to cease our operations.Therefore, our continuation as a going concern is dependent on our ability toobtain additional financing and, ultimately, to attain successfuloperations.  To attain successfuloperations, we must satisfactorily complete our FDA and other clinical trialsand convince the medical community that we have a successful commercial productfor treating presbyopia, ocular hypertension and primary open angleglaucoma.  Until sufficient revenues aregenerated from product sales, we will need to continue to seek additionalfunding.  If this funding is notavailable or we cannot successfully commercialize our products, we may not beable to continue as a going concern.

 

**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 staff of four full-time personsand rely on a number of independent consultants.  We have no sales, manufacturing, training orcustomer service staff.  We have marketedand sold only a relatively small number of PSIs.  As a result of the Transfer Agreement withCIBA, we will have to develop new arrangements with third parties or hire asignificant number of new staff, either of which may result in substantiallyhigher costs.  Due to our lack of fundsduring 2004, we were not able to staff these positions.  As a result of the financing we received in March 2005,we will now seek to staff these positions with either new employees orconsultants.  We may be unable to hirequalified staff or may be unable to retain qualified consultants to performthese functions, which could result in a material adverse effect to our business.

** **

**We have a limited operating history, a single unprovenproduct to date, a history of net losses, and our business may never becomeprofitable.**  We have spent ten years concentrating ourefforts on the development of the PSI and the related surgical procedure forthe treatment of presbyopia and, more recently, for the treatment of ocularhypertension and primary open angle glaucoma. Sales of the PSI are pending approval of the product by the FDA in theUnited States and by other regulatory authorities in other countries.

** **

**Ourlimited history may not be adequate to enable you to fully assess our abilityto achieve market acceptance of our products or our ability to respond tocompetition.  Accordingly, we are subjectto the same uncertainties and risks associated with any company developing newproducts and beginning operations.  If weare unsuccessful in addressing the risks and uncertainties frequentlyencountered by early stage companies in a new and evolving market, our businesswill be seriously harmed.**

** **

**Wehave incurred losses every year since we began operations.  As of December 31, 2004, our accumulateddeficit was $26.4 million, including a net loss of $3.8 million for the yearended December 31, 2004.  Theselosses have resulted primarily from expenses associated with research anddevelopment activities, pre-clinical and clinical trials, obtaining regulatoryapprovals in international markets and general and administrativeexpenses.  We anticipate our operatingexpenses will increase substantially for the foreseeable future as we expandour FDA clinical trials in the United States and assume functions formerlyperformed by CIBA.**

** **

**Tobecome profitable, we must be able to generate revenues from productsales.  We have not had any revenuessince 2001.  Our revenues will bedependent on the successful deployment of the SSP for the treatment of presbyopia,ocular hypertension and primary open angle glaucoma utilizing our patented PSIand the PresVIEW Incision System.  Therecan be no assurance that the PresVIEW technology will be proven safe andeffective or that, 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 substantially completed, subject tocontinued enhancements as surgeons use the PresVIEW Incision System in theSSP.  Any unexpected problems with thePresVIEW Incision System would cause additional delays in our ability to marketour primary product, the PSI.**

** **

**Ifsubstantial growth in our revenues does not occur, we may not be able toachieve or maintain profitability in the future.  The amount of losses we will incur beforeachieving profitability, and the time required to reach profitability, are eachhighly uncertain.  No assurances can begiven that we will ever achieve profitability.**

 

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**As aresult of the CIBA Transfer Agreement, we must reestablish our own marketingand other operational functions, which will substantially increase our costsand potentially cause delays.** As a result of the Transfer Agreement with CIBA, we now need to reestablishour own manufacturing, marketing, distribution, regulatory, and otheroperational activities.  During 2004 anduntil the March 2005 private placement, we lacked the funds necessary tofully reestablish these activities.  Aswe go forward, we may determine that we prefer to establish strategic agreementswith various third parties for some operations and perform other of theseoperations internally.  We can provide noassurances, however, that we will be able to establish agreements with thirdparties or successfully reestablish such operations within a reasonabletime.  Nor can we be sure of our abilityto finance such operations. Consequently, our business, financial condition and results ofoperations may be adversely affected.

 

**As aresult of the Transfer Agreement, we will assume full management responsibilityfor the FDA clinical trials, and we have less experience and resources in thosematters than CIBA, which could result in delays or problems. **Prior to the CIBA Agreementexecuted in March 2002, we managed the feasibility phase of the FDAclinical trials in the United States. That phase of the clinical trials required a much longer period of timethan we had anticipated.  Under the CIBAAgreement, a joint technical committee of CIBA and our personnel would have managedthe FDA clinical trials going forward. CIBA retained 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 havealready retained 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.  As a result of our limited funding since theTransfer Agreement, our progress in the clinical trials has been slower than wehad anticipated.

 

**As aresult of the Transfer Agreement, we will need to reestablish our owninternational regulatory processes, which will require management time andsignificant expense.  **Inaccordance with the CIBA Agreement, we ceased all direct manufacturing andmarketing of the PSI and related products. As a result of the transition of those manufacturing responsibilities toCIBA, the modifications in the packaging of the PSI and the resultant changesto those processes, the CE Mark certification we had obtained in 2000 on thePSI is no longer applicable.  As a resultof the Transfer Agreement, we will need to reestablish our own CE Markcertification on the PSI.  In addition,we will be required to manage the process of obtaining regulatory approval forour products in other international markets. We have retained consultants to assist us in that effort; however, thisprocess is time consuming, requires considerable management effort and will beexpensive.  Due to our lack of adequatefunding in 2004 and until the March 2005 private placement, we have had tominimize our efforts in managing international regulatory processes.  Our failure to reestablish our own CE Markcertification for the PSI would prevent us from marketing our products in theEuropean Union by 2006.  Further, failureto establish regulatory approvals in other international markets on a timelybasis will have a material adverse effect on our financial condition as well.

 

**As aresult of the Transfer Agreement, we will need to reestablish manufacturingarrangements for the production of the PSI to support future sales, or we willbe unable to supply 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 at least thenext 12 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 theassociated injection molds may be high. There can be no assurances, however, that we will be able to reestablishthese arrangements in a timely and cost-effective manner prior to our need foradditional PSI inventory.  We had to putthis process on hold during 2004 until we closed the March 2005 privateplacement, due to our lack of funds.  Aninability to establish these arrangements could have a material adverse effecton our future sales.

 

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**As aresult****of the Transfer Agreement,we will need to reestablish our own marketing and distribution arrangements,which will take time and increase our costs. **Prior to the CIBA Agreement, we marketed our products throughdistribution agreements in various countries outside the United States.  Those distribution agreements provided thedistributor with a commission based upon a percentage of the sales price.  Under the CIBA Agreement, CIBA wasresponsible for worldwide marketing and distribution of our products and, thus,all of our previous distribution arrangements were terminated.  As a result of the Transfer Agreement, wewill be required to reestablish distribution agreements for the internationalmarketing and distribution of our products. We may, however, seek to market our products directly, especially in theEuropean Union.  We may also establishother distribution, license or strategic arrangements on a global or regionalbasis.  We can provide no assurances,however, that we will be able to reestablish new distribution and marketingarrangements in a timely and cost effective manner, and our failure to do sowould have a material adverse effect on our business.  Because of our lack of funding during 2004,we did not devote any significant resources to establish these arrangements.

 

**As aresult****of the Transfer Agreement,we may need to reestablish our own product development efforts, which will taketime and increase our costs. **Duringthe term of the CIBA Agreement, CIBA devoted substantial internal resources andmanpower, including hiring several consultants, to resolve problems with, andsubstantially finalize the development of, the PresVIEW Incision System.  Although we believe development of thePresVIEW Incision System is substantially complete, additional development orenhancements may be identified as the PresVIEW Incision System is further usedin the SSP.  We are also trying todevelop ways to simplify the SSP and make the outcomes more consistent.  We have retained some of the consultants usedby CIBA to finalize the development of the system and the simplification of theSSP, but we cannot guarantee that these consultants will be able to devotesufficient time to our products.  Again,our lack of available funds during 2004 resulted in only slight progress inthis area.  If significant developmentissues are later identified that require material financial resources, or ifthe consultants are not available to us on terms acceptable to us, or at all,to resolve any issues, it would have a material adverse effect on our business.

 

**If we do not receive and maintain regulatory approvalsfor our products, we will not be able to market and sell our products. **We cannot market and sell our products or surgical procedure in theUnited States until the products receive approval from the FDA, and there canbe no assurance that we will receive the necessary approvals.  Before receiving FDA clearance to market andsell a product, we must demonstrate that the product is safe and effective inthe patient population that will be treated for specific indications.  Negative or inconclusive results or adversemedical events during a clinical trial could cause a clinical trial to berepeated, a program to be terminated or delays in receiving approval.  We have limited experience in conducting ormanaging the clinical trials necessary to obtain regulatory approval.  We rely on third-party clinical investigatorsto conduct our clinical trials and other third-party organizations to perform certainother tasks.  As a result, we may facedelaying factors 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.

** **

**Wereceived approval for, and have conducted, feasibility clinical trials in theUnited States on the PSI for the treatment of presbyopia.  We submitted the clinical trial data to theFDA and filed an investigational device exemption application with the FDA in March 2003to obtain approval for initiating Phase II clinical trials.  We subsequently filed amendments to thatapplication and received approval to start our Phase II clinical trials in December 2003,subject to certain final documentation.  Webegan those trials in the first quarter of 2004.  We limited the number of cases beingperformed in these trials due to our lack of funds during 2004.  With the March 2005 funding, we believewe can once again resume these trials so that we can finish Phase II and beginPhase III cases, assuming FDA approval.  TheFDA may decline to authorize additional clinical trials after the Phase IItrials or may substantially delay those trials for a variety of reasons.  We also plan to submit an application to theFDA to conduct clinical trials on the PSI for the treatment of ocularhypertension and primary open angle glaucoma. The FDA may not approve the proposed study or may significantly delaythe study, if approved.**

** **

Salesof medical 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 withthe specific regulations that must be met to sell our medical devices incertain international markets.

 

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Because of our lack offunds during 2004, we were not able to continue to pursue regulatory approvalsin international 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.

 

**The components of the PresVIEW Incision System and therelated disposable blade are available only from single sources, and othersources may not be available or they may not properly provide products.**  Under theCIBA Agreement, these items were provided through suppliers established byCIBA.  We have entered into supplycontracts with these sources.  If one ormore of these vendors are lost, delivery of our products could be delayed orprevented and our business would suffer. If we are unable to produce our products in a cost-effective or timelymanner, or if the manufacturing of our products is interrupted, our business,financial condition and results of operations could be materially adversely affected.

** **

**Manyof the manufacturing processes require a significant degree of technicalexpertise.** If these third-party vendors and manufacturers failto produce to our specifications or inadvertently use defective materials inthe manufacturing process, the reliability and performance of our products willbe compromised.

** **

**We are dependent on our management, key personnel andconsultants, and may be dependent on the recruitment of additional personnel tosucceed; and the loss of personnel or consultants may damage our business.**  Ourprincipal executive officers, consultants and key personnel have extensiveknowledge of our PresVIEW technology, the PresVIEW Incision System and theresearch and development efforts needed to bring the products to market.  The loss of the services of any of ourexecutive officers or other key personnel or consultants could have a materialadverse effect on our business and financial condition.

** **

**Inlight of the transition of certain operations from CIBA to us, our success andbusiness strategy will likely depend in large part on our ability to attractand retain key management, scientific and operating personnel.**  We may needto add skilled personnel and/or retain consultants in the areas of research anddevelopment, clinical trials, government regulatory approvals, sales, marketingand manufacturing.  These persons may bein high demand and subject to competing employment offers.  There can be no assurances that we will beable to attract and retain qualified personnel or develop the expertise neededfor our business.  We currently have asmall management group with limited operating experience.  The inability to hire additional personneland develop expertise as needed could have a material adverse effect on us.

** **

**We face various international risks that may cause anincrease in costs.  We face risks due toour expected reliance on sales in international markets. **Our future success will depend in part upon our ability to recommenceour international 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 export licenses;

**•**                  unexpected regulatory requirements;

**•**                  tariffs and other potential trade barriers andrestrictions;

**•**                  political, legal and economic instability in foreignmarkets;

**•**                  longer accounts receivable cycles;

**•**                  difficulties in managing operations across disparategeographic areas;

**•**                  foreign currency fluctuations;

**•**                  reduced or limited protection of our intellectualproperty rights in some countries;

**•**                  dependence on local distributors; and

**•**                  potential disruptions in sales or manufacturing dueto military or terrorist acts.

** **

**If oneor more of these risks materialize, our sales to international customers may beless than expected and costs may be more than expected, which could negativelyimpact our financial condition.**

** **

**Due to our dependence on the PSI, failure to achievemarket acceptance in a timely manner could harm our business. **Even if regulatory authorities approve our products, the PSI and thePresVIEW Incision System may not be commercially successful.  Acceptance of, and demand for, the PSI andthe PresVIEW Incision System will depend largely on the following factors:

 

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**•**                  safetyand effectiveness for all targeted indications (i.e., presbyopia, primary openangle glaucoma and ocular hypertension);

**•**                  awarenessand acceptance by ophthalmologists and patients of our product as safe andeffective;

**•**                  safety,effectiveness and pricing of alternative products;

**•**                  prevalenceand severity of side effects associated with our product;

**•**                  thepossibility of unknown side effects;

**•**                  pricingof our product to both the ophthalmic community and the consumer;

**•**                  ourability to decrease the technical skill level of surgery required foroutstanding outcomes via the standardization and automation steps provided bythe PresVIEW Incision System;

**•**                  theamount of training required for the proper use of the PresVIEW Incision Systemand insertion of the PSI;

**•**                  thegeneral resistance to implanting a foreign object in the eye;

**•**                  thelack of long-term follow-up data;

**•**                  thedegree of usage by the ophthalmic community as a treatment alternative;

**•**                  howquickly competitors can develop and obtain FDA approval for competitivetreatment methods;

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

**•**                  resolutionand/or clarification of the various scientific theories as to the cause ofpresbyopia and the specific mechanism of action involved in the SSP.

** **

**Becauseall of our revenues are projected to come from the sale of the PSI and relatedproducts, our financial performance will depend upon ophthalmologists’ adoptionand patient awareness of the SSP.  If weare unable to convince ophthalmologists to use the PSI, we may not be able togenerate adequate revenues to continue to fund our operations.**

** **

**Inorder for us to sell our products, ophthalmologists must recommend and endorsethem.  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.**

** **

**We are subject to extensive governmental regulationthat increases our costs and could prevent us from, or delay us in, selling ourproducts. **Our products (including the PSI and the PresVIEWIncision System) are subject to extensive governmental regulation.  Governmental regulation includes inspectionof, and controls over, testing, manufacturing, safety and environmentalcontrols, efficacy, labeling, advertising, promotion, record keeping and thesale and distribution of medical device products and samples.  We are also subject to similar governmentalregulation that affects the prices we will charge, the rebates we may offer tocustomers and the methods of our marketing. Governmental regulation substantially increases the cost of developing,manufacturing and selling our products.

** **

**Weare required to obtain the approval of regulatory agencies worldwide before wecan market and sell the PSI or other products and to undergo rigorousinspections by these agencies.  In theUnited States, we must obtain FDA approval or clearance for each medical devicebefore the 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 significantlylonger time than we expect to gain regulatory approval or may never gainapproval.  If a regulatory authoritydelays approval of a product, our 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 are unableto obtain regulatory approval of our products, we will not be able to marketthese 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 of ourproducts.**

 

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**Theclinical trials required to obtain regulatory approvals are complex andexpensive, and their outcomes are uncertain. We have incurred, and will continue to incur, substantial expense for,and will continue to devote significant time to, clinical trials, but we cannotbe certain that the trials will ever result in the commercial sale of aproduct.  Positive results frompre-clinical studies and early clinical trials do not ensure positive resultsin later clinical trials that form the basis of an application for regulatoryapproval.  We may suffer significantsetbacks in clinical trials, even after earlier clinical trials show promisingresults.  Any of our products may produceundesirable side effects that could cause us or regulatory authorities tointerrupt, delay or halt clinical trials. The FDA, another regulatory authorityor we may suspend or terminate clinical trials at any time if they or webelieve that the trial participants face unacceptable health risks.**

** **

**Weare also required to demonstrate compliance with the FDA’s quality systemregulations before we can receive FDA approval for the PSI and the PresVIEWIncision System.  The FDA enforces itsquality system regulations through pre-approval and periodic post-approvalinspections.  These regulations relate toproduct 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.  Due to our limited funding during 2004 anduntil the March 2005 private placement, we have been unable to devotesufficient resources to a quality system. Although we believe we are in compliance with all FDA regulations, weneed to acquire knowledgeable staff or consultants to ensure that we stay incompliance.**

** **

**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, criminalprosecution 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 regarding the safetyand efficacy of our product and may find that long-term data does not supportour short-term clinical results. **The SSP is a new technology with only a relativelylimited number of clinical cases to date. The long-term effects, if any, of the procedure have not been determined.  The human eye may or may not tolerate thepresence of the PSI.  The PSI mayultimately result in undesirable side effects or medical complications.  We are unaware of any patient who hassuffered any significant damage to their vision or experienced any seriouscomplications in the investigational surgeries conducted to date.  The complications experienced to date appearto be minor and related to the evolution of the surgical technique.  Further clinical testing of the PSI couldreveal other complications and side effects, which could bear on the long-termsafety and efficacy of the PSI, any of which could have a material adverseeffect on our business.  There can be noassurances, therefore, that the PSI and the related surgical procedure will notresult in latent complications or that our belief that the SSP is fullyreversible in all patients will be confirmed by clinical experience.

** **

**We face competition from alternative therapies, andsales of our products may be less than our expectations.** We competewith many domestic and foreign competitors, who conduct business in variousrapidly evolving and technologically advanced fields, including medical device,pharmaceutical and biopharmaceutical companies. For example, in the worldwide presbyopia market, the PSI will competewith reading glasses, bifocals, multifocal glasses, and the bifocal andmultifocal contact lens industry, as well as alternative surgical techniques,such as the implant of “accommodating” intraocular lenses.  There are world leaders in these markets,such as: Varilux, Bausch & Lomb, Vistakon (a subsidiary of Johnson &Johnson), Alcon, Allergan and VISX.  Forthe treatment of ocular hypertension and primary open angle glaucoma, we willcompete with major pharmaceutical companies, including

 

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** **

**Alcon,Allergan, Bausch & Lomb, Merck and Pfizer. These competitors may develop technologies and products that are moreeffective, easier to use or less costly than any of our current or futureproduct candidates or that could render our technologies and product candidatesobsolete or noncompetitive.  Many ofthese competitors have substantially more resources, as well as more productdevelopment, manufacturing and marketing experience and capabilities, than wedo.  In addition, many of our competitorshave significantly greater experience than we do in conducting pre-clinicaltesting, clinical trials and in obtaining FDA and other regulatory approvals ofproducts and therapies.**

** **

**Thevision correction industry is intensely competitive.  The significant competitive factors in theindustry include price, convenience, acceptance of new technologies, patientsatisfaction, and government approval. Our ability to compete successfully depends, in part, on our ability torespond quickly to medical and technological change and user preference throughthe development and introduction of new products that are of high quality andthat address patient and surgeon requirements. We compete with many larger companies that enjoy several competitiveadvantages, including established distribution networks; established relationshipswith health care providers and payors; additional lines of products; theability to bundle products to offer higher discounts or other incentives togain a competitive advantage; and greater resources for product development,sales and marketing and patent litigation. If we are unable to compete effectively against existing or futurecompetitors, sales of our products may be significantly less than ourexpectations.**

** **

**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. **Most of our products are covered by patents that give us a degree ofmarket exclusivity during the term of the patent.  Significant patents covering our productswill expire within the next 7 to 13 years. Upon patent expiration, our competitors may introduce products using thesame technology.  As a result of thispossible increase in competition, we may need to charge a lower price in orderto maintain sales of our products, which could result in these products becomingless profitable.  If we fail to developand successfully 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 development may notyield new products that achieve commercial success, and we would be dependentonly on the PSI for sales. **In the past, we have devoted substantial resourcesto research and development of the PSI and the SEVFL.  In the foreseeable future, we plan to devote muchless resources to research and development. We believe the development of the SEVFL may be through a licensing arrangementwith a third party.  If we are not ableto find a party to license this technology, or the licensee cannot successfullydevelop the SEVFL, we will be totally dependent on the PSI and related productsfor sales.

** **

**Surgeon training and the ability of surgeons toroutinely achieve a good surgical result for virtually all patients isimportant to our success. **Failure, for any reason, by surgeons to achieve goodresults will harm our business.  Duringthe course of the development of the PSI, the PresVIEW Incision System and therelated surgical procedure, the surgical technique and surgical instrumentshave evolved and changed as we attempted to make the surgical procedure easierfor the surgeon to perform.  The SSP,while using surgical skills similar to other ophthalmic surgical procedures, isa relatively new surgical technique that requires training and preciseexecution by the surgeon.  Some surgeonswere not able to successfully use earlier prototypes of the PresVIEW IncisionSystem.  Some surgeons have not been ableto successfully place the PSI in the sclera of the eye to achieve the necessaryeffect.  Certain of these surgeons have chosento publish their unsuccessful clinical results.

** **

**Itis critical to our sales effort to train a sufficient number of physicians toproperly perform the SSP.  We will needto educate ophthalmic surgeons through presentations at internationalconferences and through surgical training courses.  If physicians are not properly trained, theymay misuse or ineffectively use our products, resulting in unsatisfactorypatient outcomes, patient injury and related liability or negativepublicity.  If we are not successful in**

 

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**adequatelytraining surgeons, or perhaps in further improving the technique and surgicalinstruments so that all surgeons with the requisite skills can routinely obtaingood surgical results, our business 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 and sale ofmedical 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 to litigationinvolving 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.

** **

**Wehave obtained $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 in August 1994.  Despite such coverage, we may be subject toclaims that exceed the insurance coverage, and these claims may have a materialadverse effect on us.  In addition, wemay require additional product liability coverage if sales of our productsincrease.  Product liability insurance isexpensive and may not be available to us in the future on acceptable terms, orat all.  We have not been subject to anyproduct liability litigation to date.**

** **

**Althoughwe are 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 us toadverse 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 from physicians whodisagree with our return policy, and we may incur unexpected expenses toresolve the complaints. **A number of ophthalmologists with practices based inthe United States purchased surgical kits, including the PSI, at internationallocations.  While certain of thesephysicians conducted investigational surgeries at international locations forthe purpose of research, many of these physicians purchased our products with adesire to participate in the anticipated clinical trials of the PSI, which areregulated by the FDA.  All of thesephysicians were aware that the PSI was not approved by the FDA for use in theUnited States at the time of their purchase. We did not sell the products with a right of refund.  Nevertheless, in past years, several of theseophthalmologists requested a refund or informed us that if they are notselected to participate in the clinical trials, they plan to return theproducts with a request for a refund.  Wecannot ensure that all these physicians will be selected to participate in theclinical trials.  We do not believe thatwe have any liability to refund the cost of these products.

** **

**Asa result of our continued suspension of sales, we were notified in past years bytwo of our foreign distributors that they were seeking refunds on unsoldproducts remaining in their inventory. We did not sell our products with a right of refund and do not believethat we have any liability to refund the cost of these products.**

** **

**Asa result of the Transfer Agreement, we will be responsible for all futuremarketing.  As part of future marketingprograms in the United States and internationally, we may determine that it isin our best interest to provide some compensation in the form or 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 are currentlyunable to determine the amount of possible compensation, if any, that we mayagree to pay in the future.**

** **

**Weestablished a reserve of $50,000 at December 31, 2001, as an estimate ofthe cost of providing replacement PSIs to physicians that might have PSIinventory on hand.  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 that sterilitydating has expired.  We may decide toreplace the PSI inventory of these physicians with new PSIs when they are againable to perform the SSP, or, rather than replace all the expired inventory, wemay instead grant special pricing on future purchases to these physicians.  Actual claims may exceed, and/or the cost ofreplacing the PSIs may be higher than, our estimate and additional charges mayhave to be taken.**

 

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**Failure by users of our products to obtain adequatereimbursement from third-party payors could limit market acceptance of ourproducts, which could impact our sales and profits.** Theinitiatives of managed care organizations and governments to contain healthcarecosts in the United States and elsewhere are placing an increased emphasis onthe delivery of more cost-effective medical therapies. This emphasis couldadversely affect sales and prices of our products.  For example:

** **

**•**                                          major third-party payors for hospital services,including government insurance plans, Medicare, Medicaid and private healthcareinsurers, have substantially revised their payment methodologies during thelast few years, resulting in stricter standards for reimbursement of hospitaland outpatient charges for some medical procedures, including cataract andintraocular lens procedures.  Because ofincreased transparency of prices following the adoption of the euro, membergovernments in some countries in the European Union are requesting pricereductions to match prices charged in other countries in the European Union;

**•**                                          numerous legislative proposals have been consideredthat, if enacted, would result in major reforms in the United States healthcaresystem;

**•**                                          our competitors may reduce the prices of theirproducts, which could result in our competitors being reimbursed for a largernumber of procedures by third-party payors;

**•**                                          there are proposed and existing laws and regulationsgoverning product prices and the profitability of companies in the health careindustry; and

**•**                                          there have been recent initiatives by third-partypayors to challenge the prices charged for medical products, which could affectour 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-partypayors or government insurance programs may provide some level of reimbursementto patients that undergo the SSP for the treatment of ocular hypertension or primaryopen angle glaucoma.  In the UnitedStates, this reimbursement may not be available immediately at FDA approval or,if available, any reimbursement may be limited, thereby adversely affecting ourability to sell our medical devices on a profitable basis for the treatment ofocular hypertension or primary open angle glaucoma.  Further, an adverse coverage decision by theCenters for Medicare and Medicaid Services, the United States government agencythat oversees the Medicare and Medicaid programs, could adversely influenceprivate insurers, as well as other public payors.**

** **

**Reductionsin the prices for our products in response to the trends noted above couldreduce our profits.  Moreover, the SSPfor the treatment of ocular hypertension and primary open angle glaucoma maynot be covered in the future by third-party payors.  Consequently, ophthalmologists, out-patientsurgical facilities, hospitals and other health care providers may be reluctantto purchase our products if they do not receive substantial reimbursement forthe cost of our products and for procedures performed using our surgicalmedical device products from third-party payors, including Medicare andMedicaid in the United States and health insurance programs, both governmentaland private.  Therefore, the failure ofour products to be so covered could cause our profits to decline.**

** **

**Sincethe SSP treats presbyopia, as well as ocular hypertension and primary openangle glaucoma, 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 may causesales of our products used in elective surgical procedures to decline andreduce our profitability. **Sales of our products used in elective surgicalprocedures may be adversely impacted by economic conditions.  Generally, the costs of elective surgicalprocedures are borne by individuals without reimbursement from their medicalinsurance providers or government programs. Accordingly, individuals may be less willing to incur the costs of theseprocedures in weak or uncertain economic conditions and, therefore, there maybe a decline in the number of these procedures. Sales of the PSI worldwide may come under pressure if weak economicconditions exist and, therefore, our revenues would likely be negativelyimpacted.

 

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**We may be required to bring litigation to enforce ourintellectual property rights, which may result in substantial expense. **We rely on patents to protect our intellectual property rights.  The strength of our patent portfolio,however, could be challenged.  Inparticular, our competitors and others may allege that:

** **

**•**                                          our patents and pending patent applications usetechnology that we did not invent first, or

**•**                                          we were not the first to file patent applicationsfor these inventions.

** **

**Further,because of the uncertain nature of patent protection, we cannot be certainthat:**

** **

**•**                                          others will not independently develop similar oralternative technologies;

**•**                                          others will not develop enhancements to ourtechnology that are beneficial to us, which we may not be able to utilizeunless we license or pay compensation for those enhancements;

**•**                                          any of our pending patent applications will resultin further issued patents; or

**•**                                          any patents issued to us will provide a basis forcommercially viable products, will provide us with any competitive advantagesor will not face third-party challenges or be subjected to further proceedingslimiting their scope.

** **

**Wemay become involved in interference proceedings in the U.S. Patent andTrademark Office to determine the priority of our inventions.  We could also become involved in oppositionproceedings in foreign countries challenging the validity of our patents.  In addition, costly litigation could benecessary to protect our patent position. In some jurisdictions, patent laws relating to the scope of claims inthe technology fields in which we operate is still evolving and, consequently,patent positions in our industry are somewhat uncertain.  We may not prevail in any lawsuit or, if wedo prevail, we may not be awarded commercially valuable remedies.  Further, it is possible that we will not havethe resources required to pursue necessary litigation or to otherwise protectour patent rights.  Failure to protectour patent rights could harm us.**

** **

**Wehave been involved as plaintiffs or defendants in various lawsuits in theUnited States related to our patented technology for the SSP.  For more information on these lawsuits, see “Item3. Legal Proceedings”.**

** **

**Patentrights in jurisdictions outside of the United States are even more uncertainand difficult 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.**

** **

**Werely on trade secrets, unpatented proprietary know-how and continuingtechnological innovation, which we seek to protect with confidentialityagreements with employees, consultants and others with whom we discuss ourbusiness.  We may not be able to preventthe unauthorized 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.**

** **

**Ifour intellectual property rights are not adequately protected, we may be unableto keep other companies from competing directly with us, which could result ina decrease 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 divert management’sattention from carrying on with our core business.**

** **

**Our products could infringe upon the intellectualproperty rights of others, which may cause us to engage in costly litigationand, if we are not successful, could cause us to pay substantial damages andprohibit us from selling our products. **Third parties may assert infringement or otherintellectual property claims against us based on their patents or otherintellectual property claims.  We may berequired to pay substantial damages, including

 

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**trebledamages, for past infringement if it is ultimately determined that our productsinfringe a third-party’s patents.  Evenif infringement claims against us are without merit, defending a lawsuit takessignificant time, may be expensive and may divert management’s attention fromother business concerns.  Further, we maybe prohibited from selling our products before we obtain a license from theowner of the relevant technology.  Ifsuch a license is available, it may require us to pay substantial royalties.**

** **

**We may implement a product recall or voluntary marketwithdrawal due to product defects or product enhancements and modifications,which would significantly increase our costs. **The manufacturing andmarketing of medical devices and surgical equipment and instruments involves aninherent risk that our products may prove to be defective or cause a healthrisk.  In that event, we may voluntarilyimplement a recall or market withdrawal or may be required to do so by aregulatory authority.  The occurrence ofa recall could result in significant costs to us, potential disruptions in thesupply of our products to our customers and potential adverse publicity, all ofwhich could harm our ability to market our products.  A recall of one of our products, or a similarproduct manufactured by another manufacturer, could impair sales of theproducts we market as a result of confusion concerning the scope of the recall.

** **

**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.**

** **

**We are subject to critical accounting policies andactual results may vary from our estimates. **We follow accountingprinciples generally accepted in the United States of America in preparing ourfinancial statements.  In preparing thefinancial statements, we must make many estimates and judgments about futureevents.  These affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities, and the reported amounts revenues and expenses.  We believe that these estimates and judgmentsare reasonable, and we make them in accordance with our accounting policiesbased on information available to us at the time.  Actual results, however, could differ fromour estimates, and this could require us to record adjustments to the reportedamounts of assets and liabilities, change the disclosures related to contingentassets and liabilities, and/or adjust the recorded amounts of revenues andexpenses.  These changes could bematerial to our financial condition and results of operations.

** **

**Risks Related to Our Common Stock**

** **

**We maydecide to take the Company private to reduce costs associated with being apublic company. **We maydecide that the costs of being a public company result in the use of funds thatcould be better deployed in other aspects of the business, and, therefore, itis in our best interest and that of our stockholders, creditors and other stakeholdersfor us not to remain a public company. Accordingly, we may propose to undertake a transaction so that we canterminate the registration of our common stock under the Securities ExchangeAct of 1934 (the “Exchange Act”), and thereby suspend our obligations as apublic company under United States securities laws.

 

Weincur significant direct and indirect costs complying with the periodicreporting and other obligations under the Exchange Act, including legal,auditing, printing, mailing, public relations, compliance, administrative andtransfer agent costs.  We also incurhigher insurance premiums for our directors and officers insurance.  The cost of administering to a large numberof shareholders who hold only a minor number of shares of our common stock iscostly and an inefficient use of our resources. We will also face increased expenses related to the Sarbanes-Oxley requirementof the audit of our internal controls beginning in 2006, which will make remaininga public company for a company of our small size harder to justify.

 

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If wedo decide to go private, shares of our common stock will no longer beregistered; we will no longer file periodic reports under the Exchange Act; andour shares may no longer be quoted on the OTC Bulletin Board.  It will make the shares outstandingilliquid.  It will be difficult to get avalue for the shares or sell the shares. It will be more difficult for out shareholders to receive currentinformation about our business, operations or finances.  As a result, certain current shareholders maydecide to reduce their investment now before any decision to go private ismade, which could exert negative pressure on our stock price.

 

Ifaction is taken to take the Company private, neither the Company nor Medcarehas made any decision regarding any future plans to provide liquidity for theCompany’s investors, including Medcare. Typically however, privately held companies would ultimately seek aliquidity event for its holders.  Thoseevents could include a sale of the company, a sale of its assets, a merger or atraditional initial public offering.  Ifthe Company ultimately pursues this latter option, it would once again become apublic reporting entity.

 

**Medcare has certain registration rights that have beengranted to them as part of their March 2005 private placement.  Medcare may be able to register its shareswithout registering shares of other shareholders. **Under an Investors’ Rights Agreement (the “Rights Agreement”) enteredinto on March 1, 2005 in connection with the Purchase Agreement, Medcare wasgranted certain registration rights. Medcare has demand registration rights, which they can exercise on twooccasions under the Rights Agreement.  If,however, this registration is to be an underwritten public offering, and theunderwriter believes that the number of shares proposed to be sold will interferewith the successful marketing of Medcare’s shares, then the shares availablefor sale will be reduced first for other stockholders and then for Medcare tothe number of shares the underwriter has specified.

** **

**Medcarealso has piggyback registration rights should we register securities other thanunder Medcare’s demand rights.  If thisregistration is to be an underwritten public offering, and the underwriterbelieves that the number of shares to be sold will interfere with thesuccessful marketing of our shares, then the shares available for sale will bereduced for all shareholders first and then for shares the Company isoffering.  The reduction for shareholdersother than the Company shall be pari passu for all shareholders with piggybackrights.**

** **

**Finally,Medcare also has preemptive rights to purchase their pro rata share of any newsecurities we may issue on the same terms as the proposed sale.  This right terminates on the earlier of apublic offering of at least $45 million or when Medcare owns fewer than 70,000shares of Series A-1 Convertible Preferred Stock.**

** **

**Therefore,because of these registration rights, Medcare may be able to register theirshares without registering shares of common stock of other investors.**

** **

**The liquidity of our common stock is affected by itslimited trading market. **Shares of our common stock are traded on the OTCBulletin Board under the symbol “RFCG.OB.” There is currently no broadly followed, established trading market forour common stock.  An established tradingmarket may never develop or be maintained. Active trading markets generally result in lower price volatility andmore efficient execution of buy and sell orders.  The absence of an active trading marketreduces the liquidity of our shares.  Thetrading volume of our common stock, historically, has been limited andsporadic.  As a result of this tradingactivity, the quoted price for our common stock on the OTC Bulletin Board isnot necessarily a reliable indicator of its fair market value.  Further, if we cease to be quoted, holderswould find it more difficult to dispose of, or to obtain accurate quotations asto the market value of, our common stock, and the market value of our commonstock would likely decline.

** **

**Our common stock may be subject to regulationsprescribed by the Securities and Exchange Commission relating to “penny stock.” **The Securities and Exchange Commission has adopted regulations thatgenerally define a penny stock to be any equity security that has a marketprice (as defined in these regulations) of less than $5.00 per share, subjectto certain exceptions.  If our commonstock meets the definition of a penny stock, it will be subject to theseregulations, which impose additional sales practice requirements onbroker-dealers who sell these securities to persons other than establishedcustomers and accredited investors, generally institutions with assets inexcess of $5.0 million and individuals with a net worth in excess of $1.0million or annual income exceeding $0.2 million (individually) or $0.3 million(jointly with their spouse).

 

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**Our common stock will likely be subject to substantialprice and volume fluctuations.**  The market price of our common stock has beenvolatile and could fluctuate widely in response to several factors, some ofwhich are beyond our control, including:

** **

**•**                                          our quarterly operating results;

**•**                                          additions or departures of key personnel;

**•**                                          changes in the business, earnings estimates ormarket perceptions of our competitors;

**•**                                          the introduction of new products by us or ourcompetitors;

**•**                                          future sales of our common stock by us or otherselling stockholders;

**•**                                          changes in general market or economic conditions;and

**•**                                          announcements of legislative or regulatory changes.

** **

**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 withoutregard to specific operating performance. In addition, there has been a limited public market for our commonstock.  We cannot predict the extent towhich investor interest in us will be maintained.  Interest in our common stock is necessary foran active, liquid trading market for our common stock.  Active trading markets generally result inlower price volatility and more efficient execution of buy and sell orders forinvestors.  The price and trading volumesof our common stock may fluctuate widely due to the limited public market forour stock.**

** **

**Salesof a significant number of shares of our common stock in the public marketcould harm the market price of our common stock.  In March 2005, except for thosestockholders who are considered affiliates and shares held by CIBA, almost allof our common stock that had been subject to lock-up agreements becameavailable for sale under Rule 144(k).  Asa result, the prior lack of trading ability due to these lock-up arrangements,and the expense involved in trading shares under Rule 144 or under ourRegistration Statement on Form SB-2, has been eliminated.  Therefore, a significant number of our sharesare now available for sale.  Another4,425,000 shares will be eligible for sale under Rule 144(k) in December 2005.**

** **

**We do not anticipate paying dividends in theforeseeable future, and the lack of dividends may have a negative effect on thestock price. **We have never declared or paid any cash dividends ordistributions on Refocus common stock. We currently intend to retain our future earnings to support operationsand to finance expansion and, therefore, do not anticipate paying any cashdividends on our common stock in the foreseeable future.  In addition, we cannot declare dividendswithout the consent of the directors appointed by Medcare.

** **

**Ourcertificate of incorporation and Delaware law contain certain anti-takeoverprovisions that may inhibit a takeover, and we may adopt other measures todiscourage 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.

 

## **ITEM2**.  DESCRIPTION OF PROPERTIES

## ** **

Ourcorporate headquarters are located at 10300 North Central Expressway, Suite104, Dallas, Texas, in approximately 1,274 square feet of space with a monthlyrental rate of $1,473.  There is no leaseagreement; we are on a month-to-month rental basis.Mr. Walts, a director and our Chief Executive Officer and President, is basedin Atlanta, Georgia.

 

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**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.

 

On March 4,2005, we were served with a lawsuit filed on February 24, 2005, in theUnited States District Court, Central District of California, Case No. CV051415WMB, by Biolase Technology, Inc., (“Biolase”).  In the complaint, Biolase is seeking adeclaratory judgment that our patent titled “Treatment of Presbyopia and OtherEye Disorders” is invalid, unenforceable and not infringed upon byBiolase.  This patent relates to ourmethods for the treatment of presbyopia by weakening of the sclera.

 

In thefourth quarter of 2004, we were contacted by Biolase regarding a potentiallicense of our patent that is the subject of this lawsuit.  We, consistent with our stated intent topursue all alternative sources of financing, entered into negotiations for alicense, but continued negotiations for alternative sources of financing.  Our negotiations with Biolase did notconclude in any license being granted to Biolase, and we, instead, finalizedthe previously described financing with Medcare (see “March 2005 Change inControl” in Item 1 above).  This lawsuitwas filed by Biolase immediately prior to the completion of the financingobtained from Medcare.

 

Webelieve that the claims asserted by Biolase lack both procedural andsubstantive merit.  Although we areunable to predict the ultimate outcome of this matter, we believe that ourpatent rights are valid and enforceable. Accordingly, we intend to vigorously defend this patent against thisdeclaratory relief action.

 

In March 2000,we filed suit against SurgiLight for patent infringement in the United StatesDistrict Court for the Middle District of Florida, Orlando Division.  We own multiple domestic and internationalpatents.  Certain of these patents aredirected to methods, devices and systems for the treatment of presbyopia andother 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 ciliary musclein a presbyopic eye.  By using lasers toablate the sclera, we asserted that SurgiLight infringed upon one or more ofour patents.

 

In December 2001,we accepted a cash settlement from SurgiLight. In conjunction with that settlement, SurgiLight acknowledged thevalidity and enforceability of our patents. The settlement did not include a license of any of our technology to SurgiLight.  In February 2005, Biolase entered into alicense agreement with SurgiLight, in which Biolase licensed certain patents ofSurgiLight related to the treatment of presbyopia.

 

In May2000, we filed a patent infringement suit against Howard N. Straub, D.O., theColorado Eye Institute, Restorvision, Inc. and LensTec, in the United StatesDistrict Court for the District of Colorado. We alleged that Straub had performed, or arranged for the performanceof, surgical procedures on United States citizens and in foreign countries inwhich 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 Courthas granted additional twelve month stays until 2005.  During this period, the United States Patentand Trademark Office will continue its investigation into the validity of Restorvision’spatent applications.

 

If thePatent 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.

 

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We contend, among otherthings, that in order for activities to be undertaken solely for the purposesof submitting information to the FDA, the activities must comply with theregulations of the FDA.  We believe thatthe defendants have violated FDA regulations and are not protected by theexemption.  We further believe that anyactivities not permitted under this exemption, such as commercial activities inthe United States, are violations of our patents.

 

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 SECURITYHOLDERS**

 

None

 

**PART II**

 

**ITEM 5****.  MARKET FOR CORPORATION’S COMMON EQUITY ANDRELATED STOCKHOLDER MATTERS**

 

Shares of our common stock are quoted on the NASDElectronic Bulletin Board under the symbol “RFCG.OB”.  No trades, however, were made with respect toshares of Refocus common stock prior to the Merger Closing Date, which waseffective March 6, 2003.  As aresult, the range of high and low bid information for shares of Refocus commonstock for the period prior to March 6, 2003 is not available. The range ofhigh and low bids for shares of Refocus common stock by quarter are as follows,based on bids that represent prices quoted by broker-dealers on the OTCBulletin Board System (these quotations reflect inter-dealer prices, withoutretail mark-up, mark-down or commissions, and may not represent actual transactions):

 
| ** **     | ** ** | **2004** | ** ** | **2003** | ** ** | **Dividends Paid** | ** ** |
|----------------|------------|----------|------------|----------|------------|--------------------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High**           | ** ** | **Low** | ** ** | **2004** | ** ** | **2003** | ** ** |
| First Quarter  |       | $        | 0.92       |     | $          | 0.40               |       | $ | 5.50 |   | $ | 3.50 |   | $ | 0.00 |   | $ | 0.00 |   |
| Second Quarter |       | $        | 0.90       |     | $          | 0.42               |       | 3.70 |   | 1.50 |   | 0.00 |   | 0.00 |   |
| Third Quarter  |       | $        | 0.46       |     | $          | 0.09               |       | 2.25 |   | 1.05 |   | 0.00 |   | 0.00 |   |
| Fourth Quarter |       | $        | 0.35       |     | $          | 0.10               |       | 1.80 |   | 0.36 |   | 0.00 |   | 0.00 |   |
|                |            |          |            |          |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ocularstock, prior to the Merger Closing Date, was not traded on a public tradingmarket, and Ocular had no registered securities outstanding.

 

As of March 25, 2005, there were 24,649,105shares of Refocus common stock outstanding with approximately 384 stockholdersof record. As of March 25, 2005, there were 280, 000 shares of Series A-1Convertible Preferred Stock outstanding held by Medcare Investment Fund III,Ltd., which are convertible into 28,000,000 shares of our common stock. MedcareInvestment Fund III, Ltd. has the right to vote these shares on all matters onwhich our common stockholders can vote on an as-converted basis.

 

# ***Dividend Policy***

# ** **

While there wereno restrictions on the payment of dividends prior to March 2005, we have neverdeclared or paid any cash dividends on shares of Refocus common stock andpresently have no intention of paying any cash dividends in the foreseeablefuture.  As a result of a privateplacement in March 2005, we cannot declare a dividend without the consentof the directors appointed by the investor in that private placement, and anycash dividends would not only be payable to the common stockholders but to thestockholders of the convertible preferred stock, which was issued as a resultof the private placement, on an as-converted basis.

 

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*Equity Compensation Plan Information*

 

The following table provides information regarding thestatus of our existing equity compensation plans at December 31, 2004.

 
| **Plan Category**                                           | ** ** | **Number of  securities to  be issued  upon  exercise of  outstanding  options,  warrants  and rights** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of  securities  remaining  available for  future  issuance  under equity  compensation  plans  (excluding  securities  reflected in  the second  column)** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | ** **                                                                                              | ** ** | ** **                                                                          | ** ** | ** **                                                                                                                                                          | ** ** |
| Equity  compensation plans approved by Security holders (1) |       | 1,738,428                                                                                               |       | $                                                                                   | 1.11       |                                                                                                                                                                | 2,464,742  |   |
|                                                        |       |                                                                                                    |       |                                                                                |       |                                                                                                                                                                |       |
| Equity  compensation plans not approved by Security holders |       | 0                                                                                                       |       | 0                                                                                   |       | 0                                                                                                                                                                   |       |
|                                                        |       |                                                                                                    |       |                                                                                |       |                                                                                                                                                                |       |
| Total                                                       |       | 1,738,428                                                                                               |       | $                                                                                   | 1.11       |                                                                                                                                                                | 2,464,742  |   |

 

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(1)          Consistsof Ocular’s Amended and Restated 1997 Stock Option Plan, which Refocus assumedin the merger consummated on March 6, 2003.

 

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

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

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

**DECEMBER 31, 2004**

 

The following discussion andanalysis of the financial condition and results of operations of Refocus Group,Inc. and its subsidiaries should be read in conjunction with the financialstatements and related footnotes included in Item 7.  All dollar amounts presented in this section havebeen rounded to the nearest thousand, except per share amounts.

 

The following discussion andanalysis contains “forward-looking statements” that are based on theassumptions, 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***

 

We area medical device company based in Dallas, Texas, engaged in the research anddevelopment of surgical treatments for human vision disorders.  Our products are the patented PresVIEW ScleralImplant (the “PSI”) and the PresVIEW Incision System, which consists of thesurgical instruments used to implant the PSI in the human eye.  The PSI and the PresVIEW Incision System areutilized in our surgical technique, the Scleral Spacing Procedure (the “SSP”),for the treatment of presbyopia, ocular hypertension and primary open angleglaucoma in the human eye.  Presbyopia,the Greek word for “old eye”, is the primary reason that a substantial portionof the population beginning in their early 40s uses bifocals, reading glassesor removes their distance glasses in order to read at a comfortabledistance.  We believe that the SSP treatspresbyopia by reducing the crowding of the underlying tissues surrounding thecrystalline lens, which allows the muscles to once again reshape the lens torestore the eye’s ability to accommodate or focus.  In the case of ocular hypertension and primaryopen angle glaucoma, we believe that the SSP restores the natural base-linetension of the muscle inside the eye, which permits the eye to drain naturallyand, thus, lowers the intraocular pressure.

 

Wehave an additional product in early-stage research, a single element variablefocus lens (“SEVFL”), for use in commercial optical applications.  However, we do not expect to fund anyadditional research in the near future. We may seek to license this technology to third parties for furtherdevelopment.

 

Thedecision by CIBA Vision AG (“CIBA”) to sell its surgical business unit and oursubsequent reacquisition of our license from CIBA had a materially adverse impacton our financial condition (see “CIBA Agreements” below). We now have to fundall the functions that CIBA had been performing for us under their licenseagreement.  We also would not receive anyminimum royalty payments that we believed CIBA would have made to keep theirexclusive license in effect.  Inaddition, the potential $5.75 million investment from a second tranche of a March 2003private placement was eliminated as a result of CIBA being released from fundingtheir share of that investment.  Thus,our anticipated investment from outside parties was eliminated and, at the sametime, our expenses were significantly increased at a time when our ability tofund these additional expenses was very limited.  Management spent a significant amount of timeduring 2004 trying to raise additional capital and was not able to concentrateon our business plan.  While we haddiscussions with several parties about participating in some form of financing,and two parties were engaged on a best efforts basis, no private placement wasconsummated during 2004.  In October 2004,as discussed below, certain related parties and other investors loaned us$510,000 in the form of convertible notes. The proceeds were expected to be adequate to fund operations, althoughat a much reduced level, until February 2005.  At the end of January 2005, an investorloaned us $500,000 in a bridge loan while we negotiated the terms of a largerprivate placement by that investor.  Thisprivate placement of $7,001,000 was consummated in March 2005, as discussedbelow.

 

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***The October 2004Private Placement***

 

On October 8,2004, we entered into a loan agreement pursuant to which we issued $500,000aggregate principal amount of our convertible promissory notes (the “Notes”) ina private placement.  We subsequentlyissued an additional $10,000 in Notes in November 2004.  We also issued warrants to purchase 510,000shares of our common stock (the “Warrants”) to these investors, each investorreceiving a warrant to purchase the number of shares of our common stock equalto each dollar of Notes they purchased.  TheWarrants have an exercise price of $0.22 per share and expire in fiveyears.  The loan proceeds were used forworking capital and general corporate purposes as well as to fund other actionsthat were necessary to secure additional financing.

 

TheNotes bear interest at a rate of 12% per annum. Unless the Notes are converted into our common stock in accordance withtheir terms (see discussion below), the principal amount and all accrued andunpaid interest due under the Notes is payable in one lump sum by April 8,2005.

 

TheNotes issued to investors, other than $250,000 in Notes issued to Verus InternationalGroup Ltd. (“Verus International”) and its designees, would automaticallyconvert into our common stock if, among other things, on or prior to thematurity date of the Notes, we consummated a financing that was in the form ofequity securities aggregating at least $2,000,000 in new funds, where theproceeds for the financing were to be used for general working capitalpurposes.  The conversion rate of theNotes was based on the equivalent price paid for our common stock by investorsin the financing that triggered the automatic conversion.  We completed a financing that met thecriteria for automatic conversion on March 1, 2005, resulting in a totalof 1,088,795 shares of our common stock being issued (see below).

 

Verus Internationalagreed to participate in the private placement as part of a settlement of anobligation to us that arose out of the March 2003 private placement,whereby a related company of theirs had agreed to make an additional investmentin us if funds were not received from other parties.  A dispute later arose as to whether they wererequired to make this investment, which dispute was settled in October 2004.  The settlement included the provision thatVerus International or their designees would purchase $250,000 in Notes.  The Notes issued to Verus International andits designees were repaid on March 17, 2005.

 

***The March 2005Private Placement***

 

On January 27, 2005, we entered into a securedbridge note with Medcare Investment Fund III, Ltd. (“Medcare”) for $500,000 toprovide us with working capital while we finalized negotiations for a privateplacement investment by Medcare.  Thenote was secured by our United States presbyopia patents and trademarks, wasguaranteed by our subsidiaries, bore interest at 8% and was to be repaid uponthe earlier of the closing of an investment by Medcare or July 26, 2005.

 

On February 25,2005, we and Medcare entered into a term sheet (the “Term Sheet”) outlining theproposed investment by Medcare in us. The Term Sheet contained both binding and non-binding terms upon which theinvestment by Medcare would be made.

 

Inanticipation of the investment transaction discussed below, on March 1,2005, our Board of Directors, pursuant to our Certificate of Incorporation,exercised its authority to issue in one or more series up to 10 million sharesof our preferred stock.  On March 1,2005, we filed a Certificate of Designation, Rights and Preferences (the “Certificateof Designation”) with the Secretary of State of the State of Delaware, whichbecame effective upon its filing.  TheCertificate of Designation established a Series A-1 Convertible Preferred Stock(“Series A-1 Shares”), consisting of 280,000 shares, a Series A-2 ConvertiblePreferred Stock (“Series A-2 Shares”), consisting of 280,000 shares, and aSeries A-3 Convertible Preferred Stock (“Series A-3 Shares”), consisting of200,000 shares (collectively, the “Series A Preferred Stock”).

 

On March 1,2005, we and Medcare entered into a Securities Purchase Agreement (the “PurchaseAgreement”) that documented the transactions contemplated in the TermSheet.  Pursuant to the PurchaseAgreement, the Company issued and sold, and Medcare purchased, 280,000 sharesof Series A-1 Shares for an aggregate purchase price

 

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of $7,000,000, or $25 pershare, and a warrant to purchase 133,334 shares of Series A-3 Shares for apurchase price of $1,000.  A portion ofthe funds received were used to repay the Medcare bridge loan and to repay aportion of convertible notes issued in October 2004.  The remainder of the funds will be used forgeneral working capital purposes.

 

TheSeries A-1 Shares are convertible into shares of our common stock at aneffective conversion price of $0.25 per share. The Warrant has an exercise price of $30 per share for each of theSeries A-3 Shares and expires on February 28, 2007.  The Series A-3 Shares are convertible intoshares of our common stock at an effective conversion price of $0.30 pershare.  The conversion price of theSeries A-1 Shares and Series A-3 Shares, and the exercise price of the warrant,are subject to adjustment based on customary anti-dilution protection provisions.

 

Additionally,pursuant to the Purchase Agreement, in the event that we receive authorizationin writing from the FDA to commence our Phase III clinical trials for thetreatment of presbyopia without any material limitations, Medcare has committedto purchase 280,000 shares of Series A-2 Shares for an aggregate purchase priceof $7,000,000, or $25 per share, subject to customary closing conditionsincluding the absence of a material adverse event.  The Series A-2 Shares will be convertibleinto shares of our common stock at an effective conversion price of $0.25 pershare.  Medcare, however, is under noobligation to purchase the Series A-2 Shares until March 1, 2006.  Medcare may accelerate the timing of thepurchase of the Series A-2 Shares at its discretion by waiving any of the conditions.

 

The holders of the Series A Preferred Stock are notentitled to any preferential dividends. Holders of the Series A Preferred Stock, however, are entitled toparticipate on an as-converted basis in any cash dividends declared and paid onour common stock.

 

A share of SeriesA Preferred Stock is convertible at the option of the holder of that share, atany time and from time to time, into 100 shares of our common stock, at aneffective price of $0.25 per share of common stock for the Series A-1 Sharesand the Series A-2 Shares and $0.30 per share of common stock for the SeriesA-3 Shares.  The Series A-1 Shares can beconverted into 28,000,000 shares of our common stock.  The Series A-3 Shares, assuming the fullexercise of the warrant for those shares, can be converted into 13,333,400shares of our common stock.  The conversionrate of a share of Series A Preferred Stock into shares of our common stock issubject to adjustment, from time to time, for, among other reasons, stocksplits, combinations, dividends and distributions.  The conversion rate is also subject to an upwardadjustment if we issue common stock, or an option, warrant or other instrumentconvertible into common stock, whose exercise price is less than the effectiveprice of the Series A Preferred Stock then outstanding.  Shares of Series A Preferred Stock will beautomatically converted into shares of our common stock at the then effectiveconversion rate upon the closing of an underwritten public offering of sharesof our common stock that results in gross proceeds to the Company of at least$45,000,000.

 

The holders of the shares of Series A PreferredStock will be entitled to vote on all matters required or permitted to be votedupon by our common stockholders.  Eachholder of a share of Series A Preferred Stock is entitled to the number ofvotes equal to the largest number of full shares of our common stock into whichall shares of Series A Preferred Stock held by that holder could beconverted.  Except as required by law onmatters requiring class voting, the holders of the Series A-1 Shares, theSeries A-2 Shares, the Series A-3 Shares and our common stock will votetogether as a single class.  As a result,the holders of the Series A-1 Shares control over 50% of our voting stock at March 1,2005 and, thus, control us.  As notedbelow, as of March 1, 2005, the directors appointed by Medcare havesignificant veto rights over many actions that require Board of Directorsapproval.  They also have control overmany day-to-day management functions as a result of their having to approveexpense and capital budgets, major variances from the budget, compensation policiesand other items.

 

For so long as 70,000 shares of Series A-1 Sharesremain outstanding, the holders of the Series A Preferred Stock, as a singleclass, are entitled to elect one-half of the members of the Board of Directors(the “Series A Directors”), one of whom will be elected as the Vice-Chairman ofthe Board of Directors, and to designate at least one Series A Director toserve on each of the committees of the Board of Directors.  The Vice-Chairman is to receive $50,000annually in addition to fees normally paid to directors.

 

In thePurchase Agreement, we represented and warranted to, and covenanted with,Medcare as to various matters.  Amongthose covenants was that for so long as 70,000 Series A-1 Shares remainoutstanding, without the prior approval of the Board of Directors, including atleast two-thirds of the Series A Directors, we will not:

 

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**•**                  declare or pay any dividends (other than dividendspayable solely in shares of our common stock and dividends payable to us oranother subsidiary of ours) on or declare or make any other distribution,directly or indirectly, on account of any shares of our common stock now orhereafter outstanding;

 

**•**                  repurchase any outstanding shares of capital stock(other than repurchases of capital stock from any subsidiary of ours or any ofour employees whose employment has been terminated for any reason, not toexceed $100,000 in the aggregate);

 

**•**                  approve or modify by 10% or more the aggregate amountof any annual or other operating or capital budget, or approve or modify by 50%or more any single line item of any such operating or capital budget;

 

**•**                  increase the salary of any officer or pay any bonus toany officer, director or employee not contemplated in a budget or bonus planapproved by the Series A Directors;

 

**•**                  retain, terminate or enter into any salary oremployment negotiation or employment agreement with any employee or any futureemployee;

 

**•**                  incur indebtedness (other than trade payables) inexcess of $50,000 in the aggregate, or enter into contracts or leases whichrequire payments in excess of $50,000 in the aggregate;

 

**•**                  make or incur any single capital expenditure in excessof $50,000, or aggregate capital expenditures in excess of $100,000, per fiscalyear;

 

**•**                  award stock options, stock appreciation rights orsimilar employee benefits or determine vesting schedules, exercise prices orsimilar features;

 

**•**                  make any material change in the nature of the businessor enter into any new line of business, joint venture or similar arrangement;

 

**•**                  pledge our assets or guarantee the obligations of anyother individual or entity;

 

**•**                  recommend amendment of our existing restricted stockand stock option plan or approval of any new equity incentive plan; or

 

**•**                  form or acquire any subsidiary, joint venture orsimilar business entity.

 

In addition to any other vote or consent required,for so long as 70,000 shares of Series A-1 Shares remain outstanding, withoutthe prior vote or approval of 75% of the then outstanding Series A PreferredStock, we shall not:

 

**•**                  amend our Certificate of Incorporation and Bylaws inany manner that would alter or change any of the rights, preferences,privileges or restrictions of the Series A Preferred Stock;

 

**•**                  reclassify any outstanding securities into securitieshaving rights, preferences or privileges senior to, or on a parity with, theSeries A Preferred Stock;

 

**•**                  authorize or issue any additional Series A PreferredStock or any other stock having rights or preferences senior to, or on a paritywith, the Series A Preferred Stock, except for authorizations for issuancessolely to the holders of Series A Preferred Stock;

 

**•**                  merge or consolidate with or into any corporation ifsuch merger or consolidation would result in our stockholders immediately priorto such merger or consolidation holding (by virtue of securities issued asconsideration in such transaction or otherwise) less than a majority of thevoting power of the stock of the surviving corporation immediately after suchmerger or consolidation;

 

**•**                  sell all or substantially all our assets in a singletransaction or series of related transactions;

 

**•**                  license all or substantially all of our intellectualproperty in a single transaction or series of related transactions;

 

**•**                  liquidate or dissolve; or

 

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**•**                  alter any rights of the Series A Directors or the holders of the SeriesA Preferred Stock or change the size of the Board of Directors.

 

Aspart of the Purchase Agreement, the Board of Directors also amended our Bylawsto permit any Series A Director to call a special meeting of the Board ofDirectors, to permit any Series A Director or the holders of 51% of theoutstanding Series A Preferred Stock, as a single class, to call a specialmeeting of our stockholders, and to require the Board of Directors to meetbi-monthly until March 1, 2006, and at least quarterly after that date.

 

Inconnection with, and as condition to, entering into the Purchase Agreement, weand Medcare entered into an Investors’ Rights Agreement.  The Investors’ Rights Agreement grantsMedcare certain demand, piggy-back and shelf registration rights and sets forththe procedures pursuant to which such rights may be exercised andeffected.  The Investors’ RightsAgreement also grants Medcare preemptive rights to purchase any or all of oursecurities that we propose to issue on the same terms and conditions as theproposed issuance.

 

*CIBA Agreements*

 

In March 2002,we entered into a license agreement with CIBA (the “CIBA Agreement”) pursuantto which CIBA obtained an exclusive license to our patents related to thetreatment of presbyopia, ocular hypertension and primary open angle glaucoma ininternational markets.  CIBA also had theright in the CIBA Agreement to acquire a license for our products in the UnitedStates.  We were entitled to receive apercentage royalty on CIBA’s worldwide sales of the PSI and related productsunder the CIBA Agreement.  Upon enteringinto the CIBA Agreement, CIBA paid us $2,000,000 in advance royalties and wascommitted to purchase equity interests in us if we obtained certain otherinvestments from third-parties. Simultaneously with our receipt of third-party investments in the firsttranche of a March 2003 private placement, 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 $1,250,000.  In addition, CIBA wascommitted to make an additional $1,250,000 investment at the closing of the secondtranche of the March 2003 private placement.

 

Underthe CIBA Agreement, CIBA was responsible for manufacturing, marketing anddistributing our products worldwide at its expense.  CIBA was also responsible for regulatorymatters outside the United States and was committed to jointly manage the FDAclinical trials with us.  In accordancewith the CIBA Agreement, we ceased all direct manufacturing and marketing ofthe PSI and related products.  As aresult of the transition of those manufacturing responsibilities to CIBA, themodifications in the packaging of the PSI and the resultant changes to thoseprocesses, the CE Mark certification we had obtained in 2000 on the PSI is nolonger applicable.  We are now seeking toregain our own CE Mark for the PSI.   Late in 2003, a CE Mark certification of thecomponents of the PresVIEW Incision System was obtained by the suppliers ofthose components.

 

CIBA’ssurgical business unit marketed a variety of ophthalmic products and wasprimarily responsible for performing the CIBA Agreement.  In August 2003, CIBA announced that itwas seeking strategic alternatives for its surgical business unit, includingthe sale of that unit.  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.  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 January 2004,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 its commitmentto fund $1,250,000 at the closing of the second tranche of the March 2003private placement and its obligations associated with manufacturing, marketing,distribution and regulatory matters. Under the Transfer Agreement, CIBA agreed to provide us with certaintransition services during 2004.  Thesetransition services helped us with the transfer of manufacturing, distributionand marketing functions back to us from CIBA. As consideration for the acquisition of CIBA’s license rights, the forgivenessof the $2,000,000 in prepaid royalties we received under the CIBA Agreement andthe transition services to be performed by CIBA under the Transfer Agreement,we agreed to pay CIBA an aggregate of $3,000,000 in twelve quarterlyinstallments commencing

 

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in the first calendarquarter of 2006.  We, however, wereentitled to prepay and extinguish our payment obligations by paying theaggregate amount of $2,000,000 to CIBA prior to January 1, 2006.

 

Underthe Transfer Agreement, CIBA returned the warrant to purchase 312,500 shares ofour common stock that it acquired in the March 2003 privateplacement.  While it retained the 625,000shares of common stock acquired at the same time, these shares are subject tocertain restrictions on their transfer. CIBA also agreed to certain restrictions on their ability to solicitproxies for a two year period.

 

We believe that the Transfer Agreement had a near termmaterial adverse impact on our financial condition because, among other things,it reduced future potential revenues from minimum royalty and milestonepayments, it moved our anticipated European sales launch farther into thefuture, and it increased our expenses substantially for functions previouslyperformed by CIBA when our funds available to pay for these increased expenseswere limited.  However, we believe theTransfer Agreement was in the long-term best interest of the shareholders.

 

In February 2005, weentered into an amendment to the Transfer Agreement.  Under the amended terms of the TransferAgreement, the $3,000,000 due in quarterly installments has been replaced by a4% royalty on all products that were formerly covered by CIBA’s license up to amaximum aggregate royalty payment to CIBA of $3,250,000.  If an aggregate of $3,250,000 is not paid toCIBA by December 31, 2009, we are required to remit the difference in themaximum amount due and the aggregate paid to CIBA in February 2010.  We can still remit an aggregate of $2,000,000to CIBA prior to January 1, 2006 to extinguish our liability.

 

*Dr. Schachar’s Separation andConsulting Agreement*

 

On February 25, 2003,Dr. Ronald A. Schachar, our founder and former Chief Scientist, and we enteredinto a Severance, Release and Consulting Agreement (the “Consulting Agreement”).  In accordance with the Consulting Agreement,Dr. Schachar resigned as an officer, director and employee of us on March 6,2003.  We agreed to retain Dr. Schacharas a consultant for a period of up to five years, and he agreed not to competewith us during that time.  Dr. Schachar wasto assist us in conducting research and development on our products for thetreatment of age-related macular degeneration (“ARMD”) for the initial twoyears of the Consulting Agreement and assist in the maintenance of our patentportfolio and other matters for the entire term of the Consulting Agreement.

 

Subject to certainconditions, Dr. Schachar will be paid $1,750,000 over the consulting period, ofwhich $950,000 was paid in the first two years, including $400,000 for thetwelve-month period ending March 2005. The timing of the remaining $800,000 due in years three through five ispartially dependent on our profitability in those years; however, Dr. Schacharis guaranteed 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.

 

*Other*

 

In November 2002, we 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 plan to seekapproval from Health Canada in 2005 to restart our clinical trials.

 

In March 2003,an investigational device exemption application was submitted to the FDA toobtain approval for initiating our Phase II clinical trials for the surgicaltreatment of presbyopia utilizing the PSI and SSP.  In December 2003, we received approvalto begin our Phase II clinical trials of the PSI and SSP for the treatment of presbyopia.  We started these clinical trials in the firstquarter of 2004.  We plan to seekapproval from the FDA during 2005 to start Phase III clinical trials.

 

*See* “*Liquidity and Capital Resources*” below for a discussion ofour expected cash inflows, cash requirements and operating plan.

 

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***Application of CriticalAccounting Policies***

 

The process of preparingfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires the use of estimates andassumptions that affect the reported amounts of assets, liabilities, revenuesand expenses.  These estimates andassumptions are based upon the best information available at the time.  These estimates and assumptions could changematerially as conditions within and beyond our control change.  Accordingly, actual results could differmaterially from these estimates.  Thefollowing are the most significant accounts affected by these estimates.

 

*Revenue recognition* – Sales willbe recognized when product has been shipped to our customer.  We do not sell our products with a right ofreturn.

 

As a result of thesuspension of sales of our products in 2001, while we were developing thePresVIEW Incision System, and the continued suspension of sales as a result ofCIBA Agreement, pursuant to which CIBA was supposed to exclusively handle ourfuture sales and marketing, we have encouraged customers not to perform the SSPusing the PSI until the PresVIEW Incision System was available, and we and/orCIBA 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 ofPSIs that had been sold by us less an estimate of the number already used.  Rather than replace all the expired inventory,we may instead grant special pricing on future purchases to these surgeons.  Actual claims by customers may exceed, and/orthe cost of replacing the PSIs may be higher than, our estimates and additionalcharges may have to be taken.

 

In addition, certainphysicians may have purchased surgical kits in anticipation of taking part inthe FDA clinical trials.  The physicianswere aware that the product was not yet approved for use in the United States,and we did not sell the surgical kit with a right of return.  Several of these physicians have requested arefund or have informed us that if they are not selected to participate in theclinical trials, they will be seeking a refund. Since we did not sell our products with a right of return, we do notbelieve we have any liability to repurchase these products.

 

As a result of our continuedsuspension of sales, we have been notified by two of our former foreign distributorsthat they were seeking refunds on unsold products remaining in theirinventory.  We did not sell our productswith a right of return and do not believe we have any liability to repurchasethese products.

 

As a result of the TransferAgreement, we will be responsible for all future marketing.  As part of future marketing programs in theUnited States or internationally, we may determine that it is in our bestinterest to provide some compensation in the form of 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.

 

*Income taxes* – Deferredincome taxes are provided for temporary differences between the basis of assetsand liabilities for tax and financial reporting purposes.  A valuation allowance is established for anyportion of the deferred tax assets for which realization is not likely.  We maintain a 100% valuation allowance againstour deferred tax assets.  The valuationallowance is subject to periodic review, and we may determine that a portion ofour deferred tax assets may be realizable in the future.

 

*Patentcosts, trademarks, non-compete agreement and property and equipment* – These assetsare subject to periodic review to determine our ability to recover theircost.  We must make estimates about theirrecovery based on future cash flows and other subjective data.  We, in the future, may determine that some ofthese costs may not be recoverable, which may require us to adjust theircapitalized value by writing off all or a portion of the value of these assets.  The patents for the SEVFL have a carryingvalue of $166,000 at December 31, 2004. Since these patents involve a new technology that has not been proven, wecannot yet determine whether these costs are recoverable.  We believe that this technology can bedeveloped and will continue to carry these patents at their amortizedvalue.  At some future point, if webelieve that we cannot develop this technology or this technology cannot be profitabilitydeveloped, we will reduce the carrying value of these assets at that time totheir estimated fair value.

 

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# **Resultsof Operations**

# ** **

*The Year Ended December 31, 2004 Compared tothe Year Ended December 31, 2003*

 

**Revenues. **There were no revenues for the years ended December 31,2004 or December 31, 2003.  The lackof sales resulted from (i) our suspension of sales in 2001 while we developedthe PresVIEW Incision System and (ii) the CIBA Agreement in March 2002,pursuant to which CIBA assumed responsibility for all marketing and sales ofthe PSI and related surgical instruments. As a result of the Transfer Agreement with CIBA that was effective in January 2004,we, instead of CIBA, are responsible for sales. We cannot sell our products in the United States or Canada until ourclinical trials are completed.  We cannotsell in the European Union until we obtain CE Marks on our products.  We are in the process of obtaining the CEMarks, but our lack of funds during 2004 has delayed this process.  We expect that we will have the CE Marks inplace by the end of 2005.

 

We hadpreviously anticipated that future revenues would be generated from royaltieson product sales and from milestone payments made under the CIBAAgreement.  As a result of the TransferAgreement, future revenues are instead expected to be generated by sales of theproduct by us.

 

AssumingCE Mark approval, we expect to start selling our products in the EuropeanUnion. These sales probably will not start until late 2005 or early 2006.  Therefore, sales revenue is not expected tobe significant until 2007.  We will haveto depend on sales revenue from international markets for the next few years toprovide needed working capital while we complete FDA clinical trials in theUnited States.  We do not currently havepersonnel with experience in international regulatory requirements orsales.  We may have to depend ondistributors and consultants to perform these functions, or we will need tohire personnel with the necessary skill requirements.  In either case, it will take some time to getthese operations in place.  Sales revenuewill be limited until we can provide an organizational structure to supportthese revenues.

 

**Cost ofSales. **There were no cost of sales for the years ended December 31,2004 or 2003, as there were no revenues, as discussed above.  Until we determine how we are going to produceand distribute our products in international markets where we may receiveapproval to sell, we cannot accurately estimate what profit margins are to beexpected from future sales.

 

**Selling,General and Administrative Expenses.**  For the yearended December 31, 2004, selling, general and administrative (“SG&A”)expenses were $931,000 compared to $1,172,000 for the year ended December 31,2003, a decrease of $241,000.  The decreasewas primarily due to decreased costs for public relations of $235,000.

 

Thedecrease in public relations expense reflects our efforts to conserve our fundsto cover essential operating expenses. We concluded that, because of limited funds available, significant publicrelations efforts were not yet necessary to support the eventualcommercialization of our products.

 

Becauseof our lack of funding until March 2005, we had purposely kept ourexpenses as low as possible by reducing all but essential SG&Aexpenses.  However, SG&A expenses,other than public relations costs, decreased only $6,000 in 2004 as compared to2003.  While we were able to reduce costsin many areas, higher insurance premiums and expenses related to functionsformerly performed by CIBA almost entirely offset these other costs savings.

 

Withthe funding we received in March 2005, we are now planning to go forwardwith our business plan to complete the clinical trials in the United States,restart the clinical trials in Canada, obtain needed CE Marks in Europe and initiateother activities essential to moving our products towardcommercialization.  Therefore, it islikely that our SG&A expenses will increase; however, the timing of theincrease will depend on our ability to execute our business plan, includingobtaining regulatory approvals.

 

**Salaryand Related Expenses. **For the year ended December 31, 2004,these expenses were $504,000 compared to $1,224,000 for the year ended December 31,2003.  The decrease of $720,000 wasprincipally due to (i) a severance charge of $595,000 in 2003 related toemployee terminations, including Dr. Schachar’s Consulting

 

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Agreement,as described above and (ii) bonus payments of $73,000 in 2003.  No severance charges were incurred or bonusespaid in 2004.  Salaries and relatedexpenses were approximately $52,000 less than in the prior year.

 

Thedecrease in salaries and related expenses was primarily due to the resignationof our Chief Scientist on March 6, 2003.  The bonus payments in 2003 were primarilyrequired to maintain key staff during the downsizing we experienced as a resultof the CIBA Agreement.

 

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.  Because of our lack offunding during 2004, we could not afford to hire additional personnel toperform the functions we had assumed from CIBA. We cannot, at this time, determine to what extent our salary andbenefits costs will increase.

 

**Stock-basedCompensation: **Stock-based compensation was $231,000 forthe year ended December 31, 2004 compared to $792,000 for the year ended December 31,2003.  The decrease was primarily due to thecharge in 2003 related to options issued to officers and directors inconnection with our merger with Refocus and the completion of a privateplacement in March 2003.  Inaddition, stock-based employee compensation included $178,000 in reductions in2004 in previously recognized compensation expense due to the forfeiture ofcertain options prior to their vesting.

 

**ProfessionalServices. **Professional service fees were $725,000for the year ended December 31, 2004 compared to $1,337,000 for the yearended December 31, 2003.  The $612,000decrease in professional services was the result of a decrease of $10,000 inauditing fees, $444,000 in consulting fees and $172,000 in legal fees partiallyoffset by an increase of $14,000 in other fees.

 

Thedecrease in auditing fees is primarily due to a slight decrease in fees relatedto work performed to review our private placement offerings and issue consentsfor our security registrations.  Weexpect that audit fees will probably not change significantly over the nextyear as a result of the deferral of the Sarbanes-Oxley requirement for theaudit of our internal controls until fiscal year 2006.  The decrease in consulting fees is almostentirely related to investment advisors and bankers that provided servicesrelated to long-range financial planning and investor relations in the prioryear.  We terminated all the contractswith these providers at the end of their original terms.  This decrease was partially offset by fees toconsultants we hired to provide services formerly performed by CIBA under theCIBA Agreement.  We currently expectcosts related to these consultants participating in the transition from CIBAwill continue to increase over the next twelve months now that we have moreadequate funding.  Legal fees decreasedbetween the two periods primarily because of expenses incurred in 2003 related tothe negotiation and drafting of the Consulting Agreement and in associationwith our becoming a public company.  We believe,as a result of the financing that was received in March 2005, that costsrelated to financings and being a public company will decrease for the portionof 2005 after the completion of that offering.

 

Becauseof our lack of funds during 2004, costs related to defending our patents,hiring consultants for regulatory matters in various countries and hiringconsultants to assist in the transition and management of operations assumedfrom CIBA under the Transfer Agreement was kept at a minimum.  We believe that we can now hire consultantsto perform these functions as we move forward with our business plan, which willcause an increase in our consulting costs; however, the amount and timing ofthat increase cannot be determined at this time.

 

**ClinicalTrials: **The cost incurred for our FDA and other clinicaltrials increased $549,000 to $907,000 for the year ended December 31, 2004compared to $358,000 for the year ended December 31, 2003.  The increase directly relates to our startingour FDA Phase II clinical trials in the first quarter of 2004.  Costs incurred during 2003 were primarilyrelated to seeking approval to start Phase II trials and in preparing sites tostart surgeries once FDA approval was received. The increase in clinical trial costs consisted of an increase of $434,000in consulting fees, $43,000 in salary expense associated with clinical trials,$51,000 in equipment purchased for doctors participating in the clinical trialsand $29,000 in travel expenses, partially offset by a decrease of $8,000 in otherexpenses.

 

Theincrease in consulting fees primarily relates to our contract with PromedicaInternational (“Promedica”), who managed our Phase II FDA clinical trials, andto our FDA investigators who were conducting surgeries using the SSP as part ofour Phase II clinical trials.  Theincreases in salaries and travel expenses reflect a full year of

 

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expensefor our director of clinical affairs compared to approximately seven months inthe prior year.  Equipment purchasesincreased as we bought equipment for doctors participating in our Phase IIclinical trials.

 

Weexpect that costs in the coming months will be materially higher thancomparable periods of the prior year as we increase the number of investigationalsites participating in our Phase II clinical trials to eight and, subject toFDA approval, begin Phase III surgeries. We also expect to apply to restart our clinical trials in Canada forocular hypertension and primary open angle glaucoma, which we believe could beapproved during 2005.  We currently expectto request approval for three sites in Canada to conduct these trials.  In Europe, we may start investigational sitesduring 2005 before trying to commercialize our products in Europe by 2006,assuming CE Mark approval.

 

**Researchand Development Expense.** The expense in the current yearwas related to further research being done on a device for ARMD carried out byour former Chief Scientist under his Consulting Agreement.  We decided not to continue to pursue thedevelopment of that device during 2004. The expense in 2003 was primarily related to the finalization of thedevelopment of the PresVIEW Incision System.

 

We mayspend additional funds on the further enhancement of the SSP and PresVIEWIncision device now that we have more funds available.  The amount and timing of these expenditureswill depend on the ongoing results of our clinical trials and the feedback wereceive from our investigators and patients. We do not expect to fund any further research on the SEVFL in the nearfuture, but we may try to license that technology to other parties.

 

**Depreciationand Amortization Expense. **Depreciation and amortization expense was$361,000 for the year ended December 31, 2004 compared to $604,000 for theyear ended December 31, 2003.  Ofthe $243,000 decrease, amortization of patents and trademarks decreasedapproximately $266,000, amortization of the non-compete agreement was $32,000higher and depreciation decreased approximately $9,000.

 

The decreasein patent and trademark amortization reflects (i) a $127,000 decrease in the write-offof certain of our PSI, ARMD and SEVFL patents, (ii) the write-off of Presby andrelated device trademarks of $95,000 in 2003 and (iii) a decrease in the amortizationof capitalized patent costs due to the write-offs taken in 2004 and 2003.  The write-off of the patents is the result ofour decision not to maintain or pursue patents in countries where the cost ofobtaining or defending those patents appeared to outweigh the potential returnfrom sales of our products.  Write-offsdecreased in 2004 and should decrease in 2005 as most patents in countries orregions where we have decided to not maintain or pursue a patent have alreadybeen written-off.  We have continued tomaintain or pursue patents in most major markets in the world.  The write-off of the trademarks related tothe change in the Presby name to Refocus Ocular in 2003.  The amortization of the non-compete agreementbegan in March 2003 as a result of the capitalization of the non-competecomponent of the Consulting Agreement. The increase in the amortization of the non-compete agreement is theresult of a full year of amortization compared to ten months in 2003.

 

**OtherIncome (Expense), Net. **Other expense of $148,000 for the yearended December 31, 2004 consisted of interest expense of $158,000partially offset by $10,000 in interest income on our cash balances.  Interest expense consisted primarily ofinterest accreted on the discounted liability for the Consulting Agreement andon the discounted carrying value of the convertible debt issued in October 2004.

 

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 in February 2003to fund operations until the completion of the merger and private placement in March 2003and $121,000 that represented the accretion of discount on the liability forthe Consulting Agreement.

 

**IncomeTaxes.** We recorded no income tax benefit for eitherperiod.  Any benefit related to thecurrent or prior year’s loss was offset by a corresponding increase in thedeferred tax asset valuation allowance.

 

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*The Year Ended December 31, 2003 Compared tothe Year Ended December 31, 2002*

 

**Revenues. **There were no revenues for the years ended December 31,2003 or December 31, 2002.  The lackof sales resulted from (i) our suspension of sales in 2001 while we developedthe PresVIEW Incision System and (ii) the CIBA Agreement in March 2002, pursuantto which CIBA assumed responsibility for all marketing and sales of the PSI andrelated surgical instruments.  We had previouslyanticipated that future revenues would be generated from royalties on productsales and from milestone payments made under the CIBA Agreement.  As a result of the Transfer Agreement thatwas effective in January 2004, future revenues are instead expected to begenerated by sales of the product by us directly or through other distributors.

 

**Cost ofSales. **There were no cost of sales for the years ended December 31,2003 or 2002, as there were no revenues, as discussed above.  Until we fully assume manufacturingoperations from CIBA under the Transfer Agreement, and determine how we aregoing to distribute our products in international markets where we may receiveapproval to sell, we cannot accurately estimate what profit margins are to beexpected from future sales.

 

**Selling,General and Administrative Expenses.**  For the yearended December 31, 2003, SG&A expenses were $1,172,000 compared to $889,000for the year ended December 31, 2002, an increase of $283,000.  The increase was due to increased costs for publicrelations of $266,000, director fees of $132,000 and other public company expensesof $68,000.  In addition, insurance costsincreased $158,000 as compared to the prior year.  These increases were partially offset by decreasedcosts for leases of $156,000, for the write off of excess property andequipment of $61,000 and for other SG&A expenses of $124,000 compared tothe 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 2003.  The decrease in the write off of our propertyand equipment was also related to our downsizing, as was the decrease in otherSG&A expenses.  Both the downsizingand closing of our Denison facility were the result of the CIBA Agreement,whereby CIBA had assumed manufacturing, distribution, marketing and other operationsfrom us starting in March 2002.

 

**Salaryand Related Expenses. **For the year 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 wasprincipally due to (i) a severance charge of $595,000 related to employeeterminations, including Dr. Schachar’s Consulting Agreement, as described aboveand (ii) bonus payments of $73,000.  Theincreases were offset by a $614,000 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 required tomaintain 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, including$30,000 in bonuses, of compensation of certain personnel for the year ended December 31,2003 involved full-time in research and development work.

 

**Stock-basedCompensation: **Stock-based compensation was $792,000 forthe year ended December 31, 2003 compared to $8,000 for the year ended December 31,2002.  The increase was primarily due tooptions issued to officers and directors in connection with our merger withRefocus and the completion of the private placement in March 2003.

 

**ProfessionalServices. **Professional service fees were $1,337,000for the year ended December 31, 2003 compared to $534,000 for the yearended December 31, 2002.  The $803,000increase in professional services was the result of an increase of $38,000 in auditingfees, $539,000 in consulting fees and $226,000 in legal fees.

 

Higherauditing fees are associated with being a public company. The higher consultingfees are almost entirely related to investment advisors and bankers thatprovided services related to long-range financial planning and investor

 

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relations.  While legal fees increased between the twoperiods, the prior year costs related primarily to litigation expenseassociated with defending our patents, while the current year costs relatedprimarily to the negotiation and drafting of the Consulting Agreement and toour being a public company.

 

**ClinicalTrials: **The cost incurred for our FDA and other clinicaltrials increased $295,000 to $358,000 for the year ended December 31, 2003compared to $63,000 for the year ended December 31, 2002.  The increase in clinical trial costs consistedof an increase of $109,000 in consulting fees, $75,000 in salary expenseassociated with clinical trials, $77,000 in equipment purchased for doctorsparticipating in the clinical trials, $20,000 in travel expenses and $14,000 inother expenses.  The increase inconsulting fees primarily relates to our contract with Promedica who will bemanaging our Phase II FDA clinical trials and had already started preliminarywork for those trials in 2003.  Theincrease in salaries and travel expenses reflects our hiring of a full timedirector of clinical affairs to oversee the trials and work with Promedica andthe physicians performing the clinical surgeries.  Equipment purchases increased as we boughtequipment for doctors participating in our Phase II clinical trials.  Expenses have increased in the current yearbecause we did not incur any material clinical trial expenses in the prior yearwhile we continued development of the PresVIEW Incision System.

 

**Researchand Development Expense.** Research and development expensedecreased $58,000 to $109,000 for the year ended December 31, 2003compared to $167,000 for the year ended December 31, 2002.  The decrease was the result of incurring $162,000less in expenses, which was partially offset by (i) a charge of $89,000 for salariesin 2003 for certain personnel devoting full time to research and developmentand (ii) a charge of $15,000 for the settlement of a dispute with amanufacturer of prototypes of the PresVIEW Incision System in 2003.  Of the $162,000 decrease, $161,000 related toa decrease in costs incurred for the production and testing of the prototypesof the PresVIEW Incision device.  Otherresearch and development expenses decreased $1,000.  The increase in salaries was the result of theallocation of salaries for employees who were working full-time in this area in2003.  These employees were terminated duringthe quarter ended June 30, 2003. Most of our expenditures related to the development of the PresVIEWIncision System were incurred prior to 2003.

 

**Depreciationand Amortization Expense. **Depreciation and amortization expense was$604,000 for the year ended December 31, 2003 compared to $123,000 for theyear ended December 31, 2002.  Ofthe $481,000 increase, amortization of patents and trademarks increasedapproximately $345,000, amortization of the non-compete agreement was $163,000,and depreciation decreased approximately $27,000.

 

Theincrease in patent and trademark amortization primarily reflects (i) the $253,000write-off of certain of our PSI and SEVFL patents and (ii) the write-off ofPresby and related device trademarks of $95,000, partially offset by a $3,000decrease in amortization of patents.  Thewrite-off of the patents was related to a cost-benefit analysis performed by usand our patent attorney, whereby we decided not to maintain or pursue patentsin countries where the cost of obtaining or defending those patents appeared tooutweigh the potential return from sales of our products.  We have continued to maintain or pursuepatents in most major markets in the world. The write-off of the trademarks related to the change in the Presby nameto Refocus Ocular.  Amortizationdecreased primarily as a result of the write-offs during the year.  The amortization of the non-compete agreementbegan in March 2003 as a result of the capitalization of the non-competecomponent of the Consulting Agreement. Depreciation decreased primarily due to the write-off of surplusfurniture and equipment in 2002, due to the reduction in their value inconnection with the downsizing of our operations after the CIBA Agreement.

 

**OtherIncome (Expense), Net. **Other expense of $98,000 for the yearended December 31, 2003 consisted primarily of interest expense of $122,000which was partially offset by $24,000 in interest income on our cashbalances.  Interest expense consisted of$1,000 paid on a bridge loan received in February 2003 to fund operationsuntil the completion of the merger and private placement in March 2003 and$121,000 that represented the accretion of discount on the liability for theConsulting Agreement.  Other income of $20,000for the year ended December 31, 2002 was primarily interest income earnedon cash balances held by us.

 

**IncomeTaxes.** We recorded no income tax benefit for eitherperiod.  Any benefit related to thecurrent or prior year’s loss was offset by a corresponding increase in the deferredtax asset valuation allowance.

 

**PreferredDividends.** Preferred dividends and the accretion ofdiscount on the preferred stock were $4,000 for the year ended December 31,2003.  Preferred dividends and accretionof discount were $2,801,000 for the year

 

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ended December 31,2002.  The decrease from 2002 to 2003 wasdue to (i) the July 2002 agreement with the Series B preferredstockholders, whereby the Series B preferred stockholders received approximately1,199,837 additional shares of Series B preferred stock in 2002 in lieu of anyfuture dividends on their shares, and (ii) the subsequent conversion of theSeries B preferred stock to common stock in conjunction with the merger, whichwas consummated in March 2003.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Cash and cash equivalents were approximately $200,000at December 31, 2004.  Thisrepresents a decrease of $2,800,000 since December 31, 2003.  The decrease was primarily the result of $3,179,000in funds used for operations, additions to patents and trademarks of $131,000and additions to property and equipment of $2,000.  In order to fund operating expenses until wecould obtain permanent financing, we borrowed $510,000 in October and November 2004in a private placement of convertible notes that would mature in April 2005,a portion of which would be automatically converted into our common stock as aresult of subsequent financing efforts.

 

Sincethe merger between Refocus and Ocular in March 2003, we have beenattempting to raise adequate capital to be able to conduct our FDA trials forthe treatment of presbyopia, continue our clinical trials in Canada for thetreatment of ocular hypertension and primary open angle glaucoma, apply tobegin clinical trials for ocular hypertension and primary angle glaucoma in theUnited States, obtain CE Mark and other regulatory approvals to begin sales inEurope and in other international markets, and continue to improve theprocedure, making it simpler and with more consistent results.   Management has had to devote a significantamount of time to raising capital rather than to these matters.  Our management took certain steps in 2004 and2003 to reduce cash expenditures while pursuing additional financing.  Even with the $510,000 raised in October andNovember 2004 (see above), the Company previously anticipated it would beout of funds by February 2005.  In January 2005,a bridge loan of $500,000 was made by an investor who later funded a $7,001,000private placement of preferred stock and warrants in March 2005 (seeabove).  Management believes, as a result of the March 2005private placement that it has adequate funds on hand to pursue our currentlyanticipated business plan for the next twelve months.  There can be no assurances, however,that there will not be delays, complications or other unforeseen events,including increased costs, which prevent us from achieving our current businessplan over the next twelve months.

 

Wecannot sell our products in the United States until we 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 trail could causesubstantial delays in receiving approval. Delays may also arise from additional government regulation from futurelegislation, administrative actions or changes in FDA policies.  Therefore, the actual timing and amounts ofexpenditure required to pursue FDA approval cannot be predicted with certainty,and the additional funding needed for these clinical trials may not beavailable when needed.

 

Additionalfunding sources will be needed by March 2006 to continue with our businessplan.  Assuming we receive permission tostart our Phase III trials from the FDA, and subject to customary closingconditions including the absence of a material adverse event, we have acommitment for $7,000,000 to be funded in March 2006 by Medcare.  While the Company anticipates thereintroduction of the SSP in the European Union during 2005 or early 2006,assuming appropriate CE Mark approvals, it does not expect to generate any significantamount of revenues until 2007.  Theserevenues will provide a source of additional funding for us.  However, the additional funding in March 2006by Medcare and the anticipated revenues from international sales may notprovide adequate funds to continue our business plan for the next fewyears.  Therefore, we may still requireadditional debt and/or equity financing to complete our business plan in atimely manner.  There can be noassurances that additional financing can be obtained on reasonable terms or atall.

 

Ourcontinuation as a going concern is dependent upon our ability to obtainadditional financing and, ultimately, to attain successful operations.  To attain successful operations, we mustsatisfactorily complete our FDA and other clinical trials and convince themedical community that we have a successful commercial product for treatingpresbyopia, ocular hypertension and primary open angle glaucoma.  Until sufficient revenues are generated fromproduct sales, we will need to continue to seek additional funding.  If this funding is not available or we cannotsuccessfully commercialize our products, we may not be able to continue as agoing concern.

 

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Theaccompanying financial statements and management’s discussion and analysis havebeen prepared on a going concern basis, which contemplates the realization ofassets and the satisfaction of liabilities in the normal course ofbusiness.  These financial statements donot include any adjustments to the recoverability and classification ofrecorded asset amounts or the amount and classification of liabilities thatmight be necessary should we be unable to continue as a going concern.

 

**OTHER**

 

**Recently Issued AccountingPronouncements:**  InDecember 2003, the Financial Accounting Standards Board (the “FASB”)issued Interpretation 46(R), “Consolidation of Variable Interest Entities”.  Currently, entities are required to includein their consolidated financial statements subsidiaries in which the enterprisehas a controlling financial interest, usually considered a majority votinginterest.  But, in many instances, theconsolidated financial statements do not include variable interest entitieswith similar relationships.  TheInterpretation requires a company with a controlling financial interest in avariable interest entity to consolidate the assets, liabilities and results ofthe activities of the entity.  ThisInterpretation is effective for special-purpose entities for periods endingafter December 15, 2003 and for other entities for periods ending after December 15,2004.  The adoption of thisInterpretation did not have any effect on our consolidated financialstatements.

 

In December 2004, the FASB issued Statementof Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-BasedPayment”.  This statement revised SFASNo. 123 originally issued in October 1995. The statement eliminates the alternative to use APB Opinion No. 25, “Accountingfor Stock Issued to Employees” in accounting for stock-based employeecompensation.  Under the revised SFAS123, public entities are also required to measure liabilities incurred toemployees in share-based payment transactions at fair value.  Entities are also required to estimate thenumber of instruments for which the requisite service is expected to berendered rather than accounting for forfeitures as they occur, as permittedunder the original statement. Incremental compensation cost for modification of the terms or conditionsof an award under the revised statement is now to be measured by comparing thefair value of the modified award with the fair value of the award immediatelybefore the modification.  The originalstatement required that the value of the award before modification bedetermined on the shorter of its initially expected life or the expected lifeof the modified award.  The revisedstatement also clarifies and expands guidance in several areas, includingmeasuring fair value, classifying an award as equity or as a liability andattributing compensation cost to reporting periods.  It also requires that excess tax benefits bereported as a financing cash flow.  Theeffective date is as of the beginning of the first interim period or annualreporting period that begins after December 15, 2005.  The Company has already adopted SFAS No. 123;however, the Company does not recognize forfeitures until they occur.  Therefore, the Company will have to estimatethe number of awards expected to be forfeited for any non-vested awards as ofthe required effective date and recognize the change, if any, as a cumulativechange in accounting principle.  Theadoption of this statement is not expected to have a material effect on theresults of operations.

 

In December 2004, the FASB issuedSFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No.29”.  The guidance in APB Opinion No. 29,“Accounting for Nonmonetary Transactions”, is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged.  The guidanceincluded certain exceptions to that principle. This statement amends APB Opinion No. 29 to eliminate the exception fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance.  A nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange.  This statement is effective for nonmonetaryexchanges occurring in fiscal periods beginning after June 15, 2005.  The Company does not believe that theadoption of this statement will have a material effect on its financialstatements.

 

**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.**

 

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**ITEM 8****.****  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

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

 

At the end ofthe period covered by this report, an evaluation was performed under thesupervision and with the participation of Company’s management, including theprincipal 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 tothe Company and its consolidated subsidiaries that are required to be disclosedby the Company 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 defined in ExchangeAct Rules 13a-15(f) and 15d-15(f)) during the quarter ended December 31,2004 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**ITEM 8B**.  **OTHERINFORMATION.**

 

None.

 

**PART III**

 

**ITEM 9****.**** DIRECTORS, EXECUTIVEOFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OFTHE EXCHANGE ACT.**

 

**ExecutiveOfficers and Directors**

 

Ourboard of directors currently consists of six persons. The following table setsforth information about all of our directors and executive officers, includingthe period of time they served in these positions for Ocular prior to its acquisitionby merger with Refocus in March 2003:

 
| **Name**                   | ** ** | **Age** | ** ** | **Office**                                             | ** ** | **Year First Elected** |
|----------------------------|------------|---------|------------|--------------------------------------------------------|------------|------------------------|
| Terence A. Walts           |       | 57      |       | President and  Chief Executive Officer, Director       |       | 2002                   |
| Mark A. Cox                |       | 54      |       | Vice President,  Chief Financial Officer and Secretary |       | 1997                   |
| Glen Bradley,  Ph.D.       |       | 62      |       | Director                                               |       | 2003                   |
| Kenneth N.  Elmgren        |       | 50      |       | Director                                               |       | 2004                   |
| Thomas W.  Lyles, Jr. |       | 48      |       | Director                                               |       | 2005                   |
| Grady E.  Schleier         |       | 52      |       | Director                                               |       | 1998                   |
| Douglas C.  Williamson     |       | 54      |       | Director                                               |       | 2005                   |

 

**Directors**

 

*TerenceA. Walts*****joined us in September 2002as president and chief executive officer. Additionally, he was appointed to our board of directors in March 2003.  He has worked exclusively in themedical/medical devices industry since 1988. Form 1988 to 1998, Mr. Walts was employed by CIBA Vision and servedas senior vice president of sales and marketing in the United States contactlens and lens care business and as senior vice president of new businessdevelopment.  In this latter position, heserved full-time as director and chief marketing officer for AutonomousTechnologies, a refractive laser surgery startup, from 1995 to 1998.  In 1998 and 1999, Mr. Walts served aspresident and chief operating officer of Medjet Inc., a medical startupdeveloping novel water-jet technology for surgical applications, includingrefractive surgery.  In 2000, he servedas interim president and chief executive

 

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officerfor PointDx, Inc., a radiology startup developing virtual colonoscopy andstructured radiology reporting software. In 2001 and through August 2002, he served as chief operatingofficer and a director for Oncose, Inc., a diagnostics startup developingblood tests for early cancer detection.

 

*GlenBradley, Ph.D.*became one of our directors and chairman ofour board of directors in March 2003. Dr. Bradley was the chief executive officer of CIBA Vision from1990 until just prior to his retirement in January 2003.  CIBA Vision manufactures and markets contactlenses and lens care solutions.  He isalso a past chairman of the Contact Lens Institute and serves on the boards ofdirectors of Biocure, Inc and Rosedale Medical.

 

*KennethN. Elmgren*became one of our directors in May 2004.  Mr. Elmgren has served as the managingprincipal of Beverly Capital, a Dallas, Texas based investment and advisoryfirm involved in general investment banking, since March 2004.  From September 2001 until 2004, Mr. Elmgrenwas a principal of Wydown Capital, a privately-held investment company involvedin general investment banking.  From 2000to 2001, Mr. Elmgren was a managing director of Southwest Securities, Inc.,where he provided investment banking services to clients in the telecomindustry.  From 1994 to 2000, Mr. Elmgrenwas a managing director of Bank of America Securities, Inc., where heprovided investment banking services related to structured finance to clientsin various industries.

 

*Thomas W.Lyles, Jr.* has served as a director since March 1,2005.  Mr. Lyles has served aspresident, since 1998, and general counsel, since 1990, of Mission City Management, Inc.in San Antonio, Texas.  Mr. Lyleshas also served as president of Medcare Investment Funds since 1991.  Mr. Lyles serves as an advisory directorto Majesty Hedge Funds.

 

*Grady E.Schleier* has served as a director of Ocular, which became awholly-owned subsidiary of us in March 2003, since 1998 and joined ourboard of directors in March 2003.  Mr. Schleierhas been the chief executive officer and co-chairman of Chemlink Laboratories,LLC (“Chemlink”) since December 2002. Chemlink is primarily engaged in the development, manufacture anddistribution of effervescent tablets and granule formulations for use incleaning, disinfecting and sterilization applications.  From 1999 until joining Chemlink, Mr. Schleierserved as the senior vice president, chief financial officer and treasurer ofAvatex Corporation.  Avatex Corporationfiled for relief under Chapter 11 of the United States Bankruptcy Code in December 2002.

 

*Douglas C.Williamson*became one of our directors and vice-chairman ofour board of directors on March 1, 2005. Mr. Williamson, since June 2002, has served as the presidentand chief executive officer of The Williamson Group, which is engaged inprivate equity and debt investments, as well as consulting and raising fundsfor companies in early stage development. Mr. Williamson has also been chairman, president and chiefexecutive officer of Takeout Taxi Holdings, Inc., a restaurant deliveryservice, since June 2002.  TakeoutTaxi Holdings, Inc. filed for relief under the United States BankruptcyCode in October 2003.  From October 1989to June 2002, Mr. Williamson was a senior vice president and managingdirector of the Venture Capital Group of Bank of America Capital Investorswhere he was responsible for reviewing, investigating and negotiating equityinvestments in privately held companies. Mr. Williamson is currently also a member of the board of directorsof CallWare Technologies, Inc.

 

**ExecutiveOfficers**

 

Informationconcerning the business experience of *Terence A. Walts*is set forth above under “Directors.”

 

*Mark A. Cox*.has served as Vice President, Secretary and ChiefFinancial Officer since July 1997.  Priorto joining us, Mr. Cox was director of corporate finance and assistanttreasurer of FoxMeyer Health Corporation from 1992 to 1997.  From 1985 to 1991, Mr. Cox was treasurerof Enserch Exploration, Inc.  Mr. Coxis a certified public accountant in Texas.

 

Ourofficers are elected annually by our board of directors at a meeting heldfollowing each annual meeting of stockholders, or as necessary and convenientin order to fill vacancies or newly created offices.  Each officer serves at the discretion of ourboard of directors.  Any officer electedor appointed by our board of directors may be removed by our board of directorswhenever, in its judgment, our best interests will be served, but a removalshall be without prejudice to the contractual rights, if any, of the person soremoved.  See “Employment Agreements”.

 

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**Family relationships**.

 

We arenot aware of any “family relationships” (as defined in Instruction to Item 401(c) ofRegulation S-B promulgated by the SEC) among directors or executive officers.

 

**Involvement in certain legal proceedings.**

 

Exceptas set forth above, we are not aware of any event (as listed in Item 401(d) ofRegulation S-B promulgated by the SEC) that occurred during the past five yearsthat is material to an evaluation of the ability or integrity of any director,executive officer, promoter or control person of us.

 

**Other**

 

Noneof our directors or officers or their respective immediate family members oraffiliates is indebted to us.  As of thedate of the filing of this Annual Report on Form 10-KSB, there is nomaterial proceeding to which any of our directors, officers, affiliates orstockholders is a party or has a material interest adverse to us.

 

**Board ofDirectors**

 

Ourboard of directors currently consists of six voting members.  All voting members of our board of directorsserve in this capacity until their terms expire or until their successors havebeen duly elected and qualified.  Ourboard of directors is divided into three classes that serve staggeredthree-year terms, as follows:

 
| **Members**                | ** ** | **Class**      | ** ** | **Expiration of Term** |
|----------------------------|------------|----------------|------------|------------------------|
|                       |       |           |       |                   |
| Glen Bradley,  Ph.D.       |       | Class II  |       | 2005                   |
| Kenneth N.  Elmgren        |       | Class II  |       | 2005                   |
| Thomas W.  Lyles, Jr. |       | Class II  |       | 2005                   |
| Terence A. Walts           |       | Class III |       | 2006                   |
| Douglas C.  Williamson     |       | Class III |       | 2006                   |
| Grady E.  Schleier         |       | Class I   |       | 2007                   |

 

Newly-electeddirectors and any additional directorships resulting from an increase in thenumber of directors will be distributed among the three classes so that, asnearly as possible, each class will consist of one-third of the directors.  Under the Securities Purchase Agreement betweenus and Medcare Investment Fund III, Ltd. (“Medcare”), Medcare has the option toappoint one-half of the members of our board of directors (the “Series A Directors”).  The Series A Directors appointed on March 1, 2005 were Douglas C.Williamson and Thomas W. Lyles, Jr. At least one Series A Director can beappointed to each committee of the board of directors.  Mr. Williamson was appointed to theaudit and compensation committees.  Mr. Lyleswas appointed to the compensation committee. The Series A Directors have substantialveto rights over many actions of the board of directors and have significantinfluence over many management functions. See “Change in Control” below.

 

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**BoardCommittees**

 

Thefollowing three committees: the Audit and Finance Committee, the CompensationCommittee and the CIBA Committee, were in effect during 2004.  The CIBA Committee has been terminated due tothe successful completion of its negotiations for an amendment to the TransferAgreement, which was executed on February 28, 2005.  These committees are constituted to assistour board of directors in carrying out its duties.  In particular, committees of the board ofdirectors will work on key issues in greater detail than would be practical ata full meeting of the board of directors. Each committee reviews the results of its meetings with the full boardof directors.  The following table showsthe membership of the current committees of the board of directors:

 
| **Name**                   | ** ** | **Audit and  Finance  Committee** | ** ** | **Compensation  Committee** |
|----------------------------|------------|-----------------------------------|------------|-----------------------------|
| Kenneth N.  Elmgren        |       | X                                 |       | X                           |
| Grady E.  Schleier         |       | Chairman                          |       | Chairman                    |
| Thomas W.  Lyles, Jr. |       |                              |       | X                           |
| Douglas C.  Williamson     |       | X                                 |       | X                           |

 

*Audit and Finance Committee*.  The Audit and Finance Committee selects ourindependent auditors, reviews our filings with the Securities and Exchange Commission(the “SEC”), reviews the results and scope of audit and other services providedby our independent auditors, including auditor fees, reviews and evaluates ouraudit and control functions and investigates other areas of concern that may bemanifested in our financial reports or underlying accounting controls andsystems.  The Audit and Finance Committeealso assists in the review of financing opportunities.  The Audit and Finance Committee is governedby a charter.  Our board of directors hasreviewed the education, experience and other qualifications of each of memberof the Audit and Finance Committee.  After review, our board of directors hasdetermined that Mr. Schleier meets the SEC’s definition of an “auditcommittee financial expert” and is independent under the applicable rules promulgatedby the SEC.

 

*Compensation Committee*.  The Compensation Committee is responsible forall of our compensation plans, which includes determining salaries andincentive compensation for our executive officers, as well as reviewing andadministering those plans.  TheCompensation Committee also makes recommendations to our board of directorsconcerning compensation for our directors and advises our board of directors onthe adoption of employee benefit and other compensation plans.

 

Ourboard of directors currently serves as our nominating committee.  Recommendations of director candidates bystockholders should be forwarded to our Secretary.  Our Bylaws require that stockholders giveadvance notice and furnish certain information to us in order to nominate aperson for election as a director.

 

**DirectorCompensation**

 

Priorto March 2003, we did not pay our directors a fee for attending scheduledand special meetings of the board of directors. We now pay each non-employee director a $2,500 quarterly retainer and afee of $1,000 for each meeting of the board of directors that the directorattends, up to two meetings per quarter. We also pay an amount equal to 50% of these fees for each meeting of acommittee of the board of directors, up to two meetings per quarter, if suchcommittee meetings are not held in conjunction with a meeting of the board ofdirectors.  Fees will be paid annually atthe time of the annual meeting of stockholders. Mr. Williamson was appointed as a Series ADirector to the board of directors on March 1, 2005 as vice-chairman and willreceive $50,000 annually, paid in monthly installments, in addition to hisregular director fees.  We also reimburseeach director for reasonable travel expenses related to that director’sattendance at board of directors and committee meetings.

 

In March andApril of 2004, the Compensation Committee of our board of directors andthe board of directors amended the director compensation policy for 2004 toprovide for the following:

 

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•                                          all cash compensation accrued through March 18,2004, was paid on the date of the 2004 annual meeting of stockholders, based onthe decision made on March 18, 2004 by each non-employee director, eitherfully in cash or 20% in cash and 80% in shares of our common stock at a valueper share equal to the closing price as reported on March 18, 2004, or$0.52 per share;

 

•                                          at the close of business on the date ofthe 2004 annual meeting of stockholders, all cash compensation earned after March 18,2004 and through the date of the 2004 annual meeting of stockholders was paid,at the discretion of each non-employee director, either fully in cash or 20% incash and 80% in shares of our common stock at a value per share equal to theclosing price as reported on the day of the 2004 annual meeting of stockholders,or $0.64 per share;

 

•                                          in addition to the options grantedannually to our directors, each current non-employee director was awarded aone-time additional option to purchase 30,000 shares of our common stock at the2004 annual meeting of stockholders. These options were granted on the sameterms as the options annually granted to our directors at each annual meetingof stockholders (see discussion regarding annual option grants below); and

 

•                                          options granted to former members of ourboard of directors, Messrs. Keates, Butler and Estrin, under the directorcompensation plan at the 2003 annual meeting of stockholders or later werevested in part based upon their time of service.

 

Certainof our directors elected to take a portion of their compensation in stock basedon the amended compensation policy outlined above.  A total of 160,588 shares of our common stockwere issued in May 2004 to these directors in lieu of $102,776 in fees duethem.

 

On thedate of the annual meeting of stockholders and each subsequent annual meetingof stockholders, we intend to award each continuing and newly electednon-employee director options to purchase 20,000 shares of our commonstock.  These options will have anexercise price equal to the fair market value of our common stock on the dateof grant, will vest on the date of the next annual meeting of stockholders ifthe director has continued to serve until that date, and will expire five yearsfrom the date of grant.  If, however, adirector resigns prior to the vesting of the options awarded, the CompensationCommittee of the board of directors will examine the circumstances of theresignation and may authorize the vesting of all or a portion of the optionsgranted.  These stock options will besubject to any adjustments, as may be necessary, to take into account anymerger, consolidation, reorganization, recapitalization, stock dividend, stocksplit, reverse-stock split, forward-stock split, spin-off, combination ofshares, exchange of shares, dividend in kind or other like change in capitalstructure or distribution (other than normal cash dividends) tostockholders.  The compensation committeeof the board of directors may later make changes in the directors’ cash andstock option compensation arrangements. The board of directors suspended the issuance of options to newdirectors as of February 28, 2005, while the compensation committeereviewed changes it may seek to the directors’ compensation plan.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

Section 16(a) ofthe Securities Exchange Act of 1934 requires directors and certain officers,and persons who beneficially own more than ten percent (10%) of our stock, tofile initial reports of ownership and reports of changes in ownership with theSEC.  Directors, certain officers andgreater than ten percent (10%) beneficial owners are required by SEC regulationsto furnish us with copies of all Section 16(a) forms they file.

 

Basedsolely on the review of copies furnished to us and representations fromdirectors and certain officers, we believe that all Section 16(a) filingrequirements for the fiscal year ended December 31, 2004, applicable toour directors, certain officers and greater than ten percent (10%) beneficialowners were satisfied, except for the following who filed late reports on Form3 or Form 4:

 

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| **Name**                              | ** ** | **Number  of Late  Reports** | ** ** | **Number  of  transactions** | ** ** |
|---------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Charles  M. Edwards (former director) |       | 1                            |       | 1                            |       |
| Terence  A. Walts                     |       | 1                            |       | 2                            |       |
| Mark  A. Cox                          |       | 1                            |       | 2                            |       |

 

Basedon the representations from our directors and certain officers, we believe thatno Forms 5 for directors and certain officers were required to be filed withthe SEC for the period ended December 31, 2004.

 

**Code ofBusiness Conduct and Ethics**

 

Wehave adopted a Code of Business Conduct and Ethics that is applicable to ourdirectors, officers and employees.  Acopy of this code has been filed as an exhibit to our Annual Report on Form 10-KSBfor the fiscal year ended December 31, 2003.  A copy is also available upon written requestto our Secretary.  Any waivers of theprovisions of this code made with respect to any of our directors or executiveofficers will be filed under a Current Report on Form 8-K.  No waivers were given during 2004.

 

**ITEM 10****.****  EXECUTIVE COMPENSATION.**

 

Thefollowing Summary Compensation Table sets forth, for the years indicated, allcash compensation paid, distributed or accrued for services, including salaryand bonus amounts, rendered in all capacities by all executive officers whoserved during 2004 and who received or are entitled to receive remuneration inexcess of $100,000 during that period.

 

**Summary Compensation Table**

 
| ** **                       | ** ** | ** **       | ** ** | ** **      | ** ** | ** **     | ** ** | **Annual  Compensation  Awards**               | ** ** | **Long-Term  Compensation  Payouts** | ** ** | ** **                              | ** ** |
|----------------------------------|------------|------------------|------------|-----------------|------------|----------------|------------|------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| **Name  and Principal Position** | ** ** | **Fiscal  Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Securities  Underlying  Options/  SARs (#)** | ** ** | **LTIP  Payouts ($)**                | ** ** | **All Other  Compensation  ($)****(1)** | ** ** |
| Terence A. Walts (2)             |       | 2004             |       | 200,000         |       | —         |       | 510,200                                        |       | —                               |       | —                                  |       |
| President and Chief  Executive   |       | 2003             |       | 199,385         |       | —         |       | 657,635                                        |       | —                               |       | —                                  |       |
| Officer                          |       | 2002             |       | 53,333          |       | —         |       | —                                         |       | —                               |       | —                                  |       |
|                             |       |             |       |            |       |           |       |                                           |       |                                 |       |                                    |       |
| Mark  A. Cox                     |       | 2004             |       | 165,000         |       | —         |       | 157,650                                        |       | —                               |       | —                                  |       |
| Vice  President, Secretary and   |       | 2003             |       | 167,234         |       | 60,000         |       | 50,000                                         |       | —                               |       | —                                  |       |
| Chief  Financial Officer         |       | 2002             |       | 145,200         |       | —         |       | —                                         |       | —                               |       | —                                  |       |

 

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(1)   Othercompensation does not include our cost for health and welfare benefits receivedby the above-named officers.  Theaggregate amount of perquisites and other personal benefits, security orproperty, did not exceed the lesser of either $50,000 or 10% of the totalannual salary and bonus for the named executive officer.

(2)   Mr. Waltsjoined us in September 2002.

 

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**Option/SAR Grants In LastFiscal Year**

**(Individual Grants)**

 
| **Name and Principal Position** | ** ** | **Number of  Securities  Underlying  Options/SAR’s  Granted (#)** | ** ** | **Percent of  Total Options/  SAR’s Granted  to Employees  in Fiscal Year** | ** ** | **Exercise or  Base Price  ($ /SH)****(3)** | ** ** | **Expiration  Date** | ** ** |
|---------------------------------|------------|------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------|------------|
|                            |       |                                                                   |       |                                                                             |       |                                             |       |                 |       |
| Terence  A. Walts               |       | 500,000                                                                | (1)        | 68.7                                                                             | %          | $                                                | 0.52       |                 | 03/18/09   |   |
| Terence  A. Walts               |       | 10,000                                                                 | (1)        | 1.4                                                                              | %          | $                                                | 0.60       |                 | 10/08/09   |   |
| Terence  A. Walts               |       | 200                                                                    | (1)        | 0.0                                                                              | %          | $                                                | 0.60       |                 | 11/10/09   |   |
| Mark  A. Cox                    |       | 150,000                                                                | (2)        | 20.6                                                                             | %          | $                                                | 0.52       |                 | 03/18/09   |   |
| Mark  A. Cox                    |       | 7,500                                                                  | (1)        | 1.0                                                                              | %          | $                                                | 0.60       |                 | 10/08/09   |   |
| Mark  A. Cox                    |       | 150                                                                    | (1)        | 0.0                                                                              | %          | $                                                | 0.60       |                 | 11/10/09   |   |

 

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(1)          1/3of these shares vest on the grant date and an additional one-third of theseshares vest on each of the first and second anniversary date of the option.

(2)          25%of these shares vested on March 18, 2004, and the remainder vests ratablyover a 36-month period.

(3)          Theexercise price for options issued is the market value on the date of grantexcept for options expiring 10/08/09 and 11/10/09.  Themarket value on the date of grant for these options was $0.21 and $0.30, respectively.

 

**Aggregated Option/SAR Exercises in Last FiscalYearand Fiscal Year-End Option/SAR Values**

 

Thefollowing table sets forth information concerning unexercised options held bythe named executive officers as of December 31, 2004.  No options were exercised by the namedexecutive officers during 2004.

 
| ** **            | ** ** | **Number of Securities Underlying  Unexercised Options/SARs at Fiscal  Year End   (#)** | ** ** | **Value of Unexercised  In-The-Money  Options/SARs at Fiscal Year End  ($)** | ** ** |
|-----------------------|------------|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| **Name**              | ** ** | **Exercisable**                                                                         | ** ** | **Unexercisable**                                                            | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|                  |       |                                                                                    |       |                                                                         |       |   |   |   |   |
| Terence  A. Walts (4) |       | 431,201                                                                                 | (1)        | 435,511                                                                      | (1)        | — |   | — |   |
|                  |       |                                                                                    |       |                                                                         |       |   |   |   |   |
| Mark  A. Cox (4)      |       | 124,875                                                                                 | (2)        | 105,100                                                                      | (2)        | $ | 2,456 | (3) | — |   |
|                       |            |                                                                                         |            |                                                                              |            |  |  |  |  |  |

 

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(1)          Theexercisable options have an average exercise price of $1.41 per share.  Unexercisable options have an average exerciseprice of $0.84 per share.

(2)          Theexercisable options have an average exercise price of $0.85 per share.  Unexercisable options have an average exerciseprice of $0.74 per share.

(3)          Valuebased upon $0.11 per share, the closing price per share on December 31,2004, as reported by the OTC Bulletin Board.

(4)          Allthe options that were unexercisable at December 31, 2004 becameexercisable on March 1, 2005 as a result of a change in control that tookplace on that date due to a private placement of preferred stock with Medcare.

 

**EmploymentAgreements**

 

Wehave employment agreements with each of our named executive officers.  The employment agreement, dated as of September 5,2002, and amended May 29, 2003, March 18, 2004 and August 16,2004, with Terence A. Walts, our President and Chief Executive Officer, expireson September 1, 2005, unless otherwise terminated.  This agreement provides that Mr. Waltsis to receive a base salary of $200,000. In addition to and in connection with Mr. Walts’ employmentagreement, we have an agreement with Mr. Walts pursuant to which, inconnection with the closing of the private placement and the merger in March 2003,we awarded him an option to purchase 256,512 shares of our common stock at anexercise price of $1.98 per share.

 

Theamendment on March 18, 2004, provided for the grant to Mr. Walts ofadditional options to purchase our common stock.  These options will be granted to Mr. Waltsimmediately following each closing of an offering of our securities, and thenumber of shares acquirable pursuant to these options will be equal to twopercent of the aggregate

 

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numberof securities sold at each closing of an offering.  The grants of these options to Mr. Waltswill continue until the offerings, collectively, result in aggregate grossproceeds to us of $6,050,000.  Theseoptions will have an exercise price equal to the greater of $0.60 per share orthe price per share of our common stock sold in the offering and will expirefive years from the date of grant. Additionally, one-third of the shares acquirable pursuant to the optionwill vest at the date of grant and an additional one-third of the shares acquirablepursuant to the option will vest at each of the first and second anniversary ofthe closing date of the offering. Options for 10,200 shares of our common stock were granted to Mr. Waltsas a result of funds received in October and November 2004 related toa private placement of convertible debt. The remainder of the gross proceeds that would trigger the issue ofoptions under the contract were received as a resultof the March 2005 private placement with Medcare.  The compensation committee of the board ofdirectors is currently reviewing, and may revise, the terms of this optiongrant.

 

If Mr. Walts’employment is terminated as a result of death or for cause, we will have nofurther obligation to provide any compensation or other consideration,including any bonus not due prior to that date, to him.  If, however, Mr. Walts’ employment isterminated during the term of the employment agreement as a result of permanentdisability or otherwise without cause, we are obligated to pay Mr. Waltsmonthly severance payments for twelve months equal to his current annualizedsalary (excluding any bonus or other compensation) as of that date, divided bytwelve.  Mr. Walts also is entitledto participate, subject to certain conditions, in our benefit plans to the sameextent of his participation in those plans immediately prior to termination fora period of six months.  Payments to Mr. Waltsupon termination for permanent disability, however, will be reduced by theamounts payable to him under any of our benefit plans, social security orotherwise.  Further, if Mr. Walts isa member of our board of directors on the date of termination, he shall bedeemed to have resigned from that position automatically.

 

Theemployment agreement, dated as of April 24, 1998, and as amended December 1,2002 and March 18, 2004, with Mark A. Cox, our Chief Financial Officer,continues in effect until April 24, 2005, and automatically renews forsuccessive one-year terms, unless otherwise terminated.  Mr. Cox is entitled to receive a basesalary of $165,000 and a bonus that is based upon target results set by ourboard of directors.  If Mr. Cox’semployment is terminated as a result of death or for cause or without goodreason by him, we will have no further obligation to provide any compensationor other consideration, including any bonus not due prior to that date, tohim.  If Mr. Cox’s employment isterminated as a result of permanent disability or without cause or for goodreason by him, we are obligated to pay Mr. Cox a severance payment equalto (a) his base salary for a period of one year and (b) any bonus forthat fiscal year, which will be prorated for the number of days elapsed duringthat year that the executive was employed. Additionally, if Mr. Cox’s employment is terminated other than as aresult of death, Mr. Cox will be entitled to participate, subject tocertain conditions, in our benefit plans to the same extent of his participationin those plans immediately prior to termination, for up to one year.  Payments to Mr. Cox upon termination forpermanent disability, however, will be reduced by the amounts payable to himunder any of our benefit plans, social security or otherwise.

 

The March 18,2004 amendment provided for the grant to Mr. Cox of additional options topurchase our common stock.  The terms ofthis amendment were the same as the amendment for Mr. Walts except that Mr. Coxis entitled to an option grant equal to 1.5% of the aggregate number ofsecurities sold at each closing of an offering. Options for 7,650 shares of our common stock were granted to Mr. Coxas a result of funds received in October and November 2004 related toa private placement of convertible debt. The remainder of the gross proceeds that would trigger the issue ofoptions under the contract were received as a resultof the March 2005 private placement with Medcare.  The compensation committee of the board ofdirectors is currently reviewing, and may revise, the terms of this optiongrant.

 

Underboth employment agreements, the executive is entitled to participate in our401(k) plan, group health, dental, disability and life insurance plans andother benefit plans applicable to executive officers.  Additionally, both agreements containprovisions that continue after termination or expiration of the agreement,including, among other provisions, non-competition, non-disclosure and propertyrights and assignment.  Compensationpayable to Messrs. Walts and Cox is subject to review by our board ofdirectors at the end of each fiscal year; provided, however, it may not bedecreased without their written consent.

 

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**ITEM 11****.****  SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT.**

 

**SecurityOwnership of Certain Beneficial Owners**

 

Thefollowing table sets forth information regarding the voting securities of ours,including the number of shares of our common stock and voting convertible preferredstock beneficially owned on March 30, 2005, by any person or “group,” asthat term is used in Section 13(d)(3) of theSecurities Exchange Act of 1934, known to us to own beneficially more than fivepercent of the outstanding shares of our common and voting convertible preferredstock.

 
| ** **                                  | ** ** | **Common Stock**                                | ** ** | **Convertible Preferred Stock** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|
| **Name  and Address   of Beneficial Owner** | ** ** | **Amount and  Nature of  Beneficial Ownership** | ** ** | **Percent  of  Class (1)** | ** ** | **Amount and  Nature of  Beneficial Ownership** | ** ** | **Percent  of  Class (1)** | ** ** |
| Avatex  Liquidating Trust                   |       | 2,579,570                                       | (2)        | 10.5                            | %          | — |   | — |   |
| 6422 Riverview Lane                         |       |                                            |       |                            |       |   |   |   |   |
| Dallas,  Texas 75248                        |       |                                            |       |                            |       |   |   |   |   |
|                                        |       |                                            |       |                            |       |   |   |   |   |
| BTR Global Arbitrage  Trading Limited       |       | 1,875,000                                       | (3)        | 7.4                             | %          | — |   | — |   |
| P.  O. Box 1234 GT                          |       |                                            |       |                            |       |   |   |   |   |
| Queensgate  House, Georgetown               |       |                                            |       |                            |       |   |   |   |   |
| Grand  Cayman, Grand Cayman Islands         |       |                                            |       |                            |       |   |   |   |   |
|                                        |       |                                            |       |                            |       |   |   |   |   |
| Melvyn J. Estrin                            |       | 1,350,924                                       | (4)        | 5.4                             | %          | — |   | — |   |
| 7200 Wisconsin Avenue,  Suite 600      |       |                                            |       |                            |       |   |   |   |   |
| Bethesda, Maryland  20814                   |       |                                            |       |                            |       |   |   |   |   |
|                                        |       |                                            |       |                            |       |   |   |   |   |
| Medcare  Investment Fund III, Ltd.          |       | 41,333,400                                      | (5)        | 62.6                            | %          | 413,334 | (5) | 100.0 | % |
| 8122 Datapoint Drive,  Suite 1000      |       |                                            |       |                            |       |   |   |   |   |
| San Antonio, Texas  78229                   |       |                                            |       |                            |       |   |   |   |   |
|                                        |       |                                            |       |                            |       |   |   |   |   |
| Ronald  A. Schachar, M.D., Ph.D.            |       | 4,474,768                                       | (6)        | 18.2                            | %          | — |   | — |   |
| 10010  Lennox Lane                          |       |                                            |       |                            |       |   |   |   |   |
| Dallas,  Texas 75229                        |       |                                            |       |                            |       |   |   |   |   |

 

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(1)          Thecalculation is based, for common stock, upon 24,649,105 shares of common stockoutstanding on March 30, 2005, and for preferred stock, upon 280,000shares of Series A Convertible Preferred Stockoutstanding on March 30, 2005.  Theshares issuable under instruments to purchase our common or preferred stockthat are currently exercisable within 60 days of March 30, 2005, aretreated as if outstanding for computing the percentage ownership of the personholding these instruments, but are not treated as outstanding for purposes ofcomputing the percentage ownership of any other person.

(2)          Based upon a Schedule 13G filed on March 13, 2003 andother information known to us.  Includes 15,000 shares of common stock acquirable pursuant to theexercise of warrants.

(3)          Includes1,000,000 shares of common stock registered in the name of Lehman BrothersInternational Europe – Salida Capital and 250,000 shares of common stockregistered in the name of Roytor & Co. Additionally, includes 500,000 shares and 125,000 shares acquirablepursuant to the exercise of warrants registered in the names of Lehman BrothersInternational Europe – Salida Capital and Roytor & Co., respectively.

(4)          Includes918,297 shares of common stock held by Estrin New Ventures, LLC and 187,500shares held by St. Elizabeth’s Hospital, Inc., entities owned andcontrolled by Mr. Estrin.  Includes31,250 shares held by Lemer Grandchildren Irrevocable Intervivos Trust, ofwhich Mr. Estrin serves as trustee. Includes 93,750 and 15,625 shares of common stockacquirable pursuant to the exercise of warrants held by St. Elizabeth’sHospital, Inc. and Lemer Grandchildren Irrevocable Intervivos Trust,respectively.  Further, includes69,667 shares of common stock acquirable pursuant to the exercise of vestedstock options.

(5)          Basedupon a 13D filed on March 10, 2005 and other information known to us.  Medcare is the direct beneficial owner of 280,000shares of our Series A-1 Convertible Preferred Stock.  The Series A-1 Convertible PreferredStock is one of three tranches (Series A-1, Series A-2 and Series A-3)of Series A Preferred Stock which can be acquiredby Medcare under a Securities Purchase Agreement dated March 1, 2005 (see “Changein Control” below).  Each of thesetranches of the Series A Preferred Stock has thesame voting rights as our common stock on an equivalent as-converted basis onmatters on which our common stockholders may vote.  This Series A-1 has the equivalentvoting rights of 28,000,000 shares of our common stock, and can be convertedinto that number of shares of our common stock at any time by Medcare.  In addition, Medcare acquired a warrant topurchase 133,334 shares of Series A-3 Convertible Preferred Stock on March 1,2005.  The warrant is exercisable at anytime prior to its expiration date of February 28, 2007.  The Series A-3 has the equivalent votingrights of 13,333,400 shares of our common stock and can be converted into thatnumber of shares of our common stock at any time after the Series A-3shares are acquired by exercise of the warrant. In this table, the amount of preferred stock held by Medcare includesthe shares acquirable within 60 days of March 30, 2005 by the exercise ofthe warrant; the amount of common shares held by Medcare is the number ofshares that are acquirable within 60 days of March 30, 2005 by exercise ofthe warrant and the conversion of all Series A Preferred Stock held tocommon stock.  These amounts exclude the280,000 shares of Series A-2 Convertible Preferred Stock that Medcare

 

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has committed to acquire under theSecurities Purchase Agreement subject to certain conditions precedent, whichhave not all been met.  The Series A-2shares would have the equivalent voting rights of, and would be convertibleinto, 28,000,000 shares of our common stock. Therefore, the aggregate amount of shares that could be beneficiallyowned as a result of the acquisition and conversion of Medcare’s holdings is69,333,400 shares of our common stock. This would represent 73.8% of our common stock outstanding when added tothe shares of our common stock outstanding at March 30, 2005.  Medcare GP Corp, Inc. is the generalpartner of Medcare (the “General Partner”) and may also be deemed to havebeneficial ownership of the securities owned by Medcare.  The General Partner disclaims beneficialownership of such securities except to the extent of its pecuniary interesttherein.  One of our directors, Thomas W.Lyles, Jr. is the president, a director and a limited partner of Medcareand is also the president of the General Partner.  Therefore, Mr. Lyles may be deemed to be abeneficial owner of the securities owned by Medcare.  Mr. Lyles disclaims beneficial ownershipof such securities except to the extent to his pecuniary interest therein.  James R. Leininger, M.D. is a limited partnerof Medcare and the sole shareholder of the General Partner and may be deemed tobe a beneficial owner of the securities owned by Medcare.  Mr. Leininger disclaims beneficialownership of such securities except to the extent of his pecuniary interesttherein.  In addition, pursuant to theSecurities Purchase Agreement, Medcare has the right to elect one-half of themembers of the Company’s board of directors. Medcare appointed Mr. Lyles and Douglas C. Williamson to our boardof directors on March 1, 2005.

(6)          Basedupon a Schedule 13D filed on March 17, 2003, and other informationknown to us.  Includes 294,394 shares ofcommon stock held in trust for the benefit of Dr. Schachar’s minorchildren, the trustee of which is Dr. Schachar’s wife.  Excludes 441,591 shares of common stock heldby Dr. Schachar’s three other children that are over 18 years of age, allof which Dr. Schachar does not beneficially own.

 

**Security Ownership of Management**

 

Thefollowing table sets forth information regarding the number of shares of our votingcommon and preferred stock beneficially owned on March 30, 2005, by eachof our directors and each of our executive officers named in the SummaryCompensation Table in “Item 10. Executive Compensation” contained herein and all of our directors andexecutive officers as a group.  Except asotherwise set forth below, the address of each of the persons listed below isc/o Refocus Group, Inc., 10300 North Central Expressway, Suite 104, Dallas, TX 75231.

 
| ** **                                 | ** ** | **Common Stock**                                    | ** ** | **Convertible Preferred Stock** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| **Name  and Address  of Beneficial Owner** | ** ** | **Amount and  Nature of  Beneficial Ownership (1)** | ** ** | **Percent  of  Class (2)** | ** ** | **Amount and  Nature of  Beneficial Ownership (1)** | ** ** | **Percent  of  Class (2)** | ** ** |
| Glen  Bradley, Ph.D.                       |       | 429,200                                             | (3)        | 1.7                             | %          | — |   | — |   |
| 2505  Anthem Village Dr., Ste E-528        |       |                                                |       |                            |       |   |   |   |   |
| Henderson,  Nevada 89052                   |       |                                                |       |                            |       |   |   |   |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Mark  A. Cox                               |       | 385,146                                             | (4)        | 1.6                             | %          | — |   | — |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Kenneth  N. Elmgren                        |       | 20,000                                              | (5)        |                            | *          | — |   | — |   |
| 3325  Beverly Drive                        |       |                                                |       |                            |       |   |   |   |   |
| Dallas,  Texas 75205                       |       |                                                |       |                            |       |   |   |   |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Thomas  W. Lyles, Jr.                 |       | 41,333,400                                          | (6)        | 62.6                            | %          | 413,334 | (6) | 100.0 | % |
| 8122  Datapoint Drive, Suite 1000     |       |                                                |       |                            |       |   |   |   |   |
| San  Antonio, Texas 78229                  |       |                                                |       |                            |       |   |   |   |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Grady  E. Schleier                         |       | 270,563                                             | (7)        | 1.1                             | %          | — |   | — |   |
| 4416  Stanhope                             |       |                                                |       |                            |       |   |   |   |   |
| Dallas,  Texas 75205                       |       |                                                |       |                            |       |   |   |   |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Terence  A. Walts                          |       | 1,217,089                                           | (8)        | 4.8                             | %          | — |   | — |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Douglas  C. Williamson                     |       | 0                                                   | (9)        |                            | *          | — |   | — |   |
| 1291  Bradford Drive                       |       |                                                |       |                            |       |   |   |   |   |
| Coppell,  Texas 75019                      |       |                                                |       |                            |       |   |   |   |   |
|                                       |       |                                                |       |                            |       |   |   |   |   |
| Directors  and Executive                   |       |                                                |       |                            |       |   |   |   |   |
| Officers  as a Group                       |       | 43,655,398                                          | (10)       | 64.7                            | %          | 413,334 | (10) | 100.0 | % |

 

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* Less than 1%

(1)          Unlessotherwise indicated, includes shares owned by a spouse, minor children, byrelatives sharing the same home and entities owned or controlled by the named person.  Also includes shares if the named person hasthe right to acquire such shares within 60 days of March 30, 2005, by theexercise of any right or option.  Unlessotherwise noted, shares are owned of record and beneficially by the namedperson.

(2)          Basedupon 24,649,105 shares of common stock outstanding and 280,000 shares of Series A Convertible Preferred Stock outstanding on March 30,2005.  The shares issuable underinstruments to purchase our common or preferred stock that are currentlyexercisable within 60 days of March 30, 2005, are treated as ifoutstanding for computing the percentage ownership of the person holding theseinstruments, but are not treated as outstanding for purposes of computing thepercentage ownership of any other person.

(3)          Includes125,000 shares of common stock held by C. Glendon Bradley Living Trust and104,734 shares of common stock held by the Bradley Family Trust, both of which Dr. Bradleyserves as the trustee.  Also includes 62,500shares of common stock acquirable pursuant to the exercise of warrants held byC. Glendon Bradley Living Trust and 25,000 of shares of common stock acquirablepursuant to the exercise of a warrant held by the Bradley Family Trust.  Further, includes 70,000 shares of commonstock acquirable pursuant to the exercise of vested stock options  Dr. Bradley has no unvested stockoptions outstanding at March 30, 2005.

(4)          Includes229,975 shares of common stock acquirable pursuant to the exercise of vested stockoptions and 10,000 shares of common stock acquirable pursuant to the exerciseof a warrant.  Includes1,402 shares of common stock held by Mr. Cox’s son.  Mr. Cox has no unvested stock optionsoutstanding at March 30, 2005.  Mr. Cox,under the terms of his employment agreement, is to receive stock options topurchase the number of shares of our common stock equal to 1.5% of a portion ofthe equivalent number of shares of common stock issued as a result of theMedcare private placement on March 1, 2005.  The final terms of the 2005 stock optionshave not been determined by the compensation committee of the board ofdirectors and are not reflected in this table. If the stock options were issued as specified in his employmentcontract, 507,018 shares of common stock could be acquirable pursuant to thestock options due to be granted.  Theportion that would vest within 60 days of March 30, 2005 would allow theacquisition of 169,006 shares of common stock, resulting in a percentageownership of 2.2%.

(5)          Includes20,000 shares of common stock acquirable pursuant to the exercise of vested stockoptions.  Mr. Elmgren has nounvested stock options outstanding at March 30, 2005.

(6)          Thenumber of shares of convertible preferred stock includes 280,000 shares of Series A-1Convertible Preferred Stock owned by Medcare at March 30, 2005 and the133,334 shares of Series A-3 Convertible Preferred Stock acquirable within60 days of March 30, 2005 by the exercise of a warrant held byMedcare.  Mr. Lyles is thepresident, a director and a limited partner in Medcare, the president ofMedcare’s General Partner and a representative of Medcare on our board ofdirectors and, therefore, may be deemed to be a beneficial owner of thesecurities owned by Medcare.  Mr. Lylesdisclaims beneficial ownership of such securities except to the extent of hispecuniary interest therein.  The commonshares are based on the number of shares of common stock into which theconvertible preferred stock can be converted.

(7)          Includes3,125 shares of common stock acquirable pursuant to the exercise of a warrantand 130,000 shares of common stock acquirable pursuant to the exercise of vestedstock options.  Mr. Schleier has nounvested stock options outstanding at March 30, 2005.

(8)          Includes91,250 shares of common stock acquirable pursuant to the exercise of warrantsand 866,712 shares of common stock acquirable pursuant to the exercise of vestedstock options.   Mr. Walts has no unvested stock optionsoutstanding at March 30, 2005.  Mr. Walts,under the terms of his employment agreement, is to receive stock options topurchase the number of shares of our common stock equal to 2% of a portion ofthe equivalent number of shares of common stock issued as a result of theMedcare private placement on March 1, 2005.  The final terms of the 2005 stock optionshave not been determined by the compensation committee of the board ofdirectors and are not reflected in this table. If the stock options were issued as specified in his employmentcontract, 676,024 shares of common stock could be acquirable pursuant to thestock options due to be granted.  Theportion that would vest within 60 days of March 30, 2005 would allow theacquisition of 225,341 shares of common stock, resulting in a percentageownership of 5.6%.

(9)          Mr. Williamsonis one of the directors appointed by Medcare on March 1, 2005.  Mr. Williamson disclaims any beneficialownership in the securities held by Medcare.

(10)    Commonstock: Represents 7 persons and includes 1,316,687 shares acquirable pursuantto the exercise of vested stock options, 191,875 shares of common stockacquirable pursuant to the exercise of warrants and the 41,333,400 shares ofcommon stock acquirable upon the conversion of the Series A-1 and Series A-3Convertible Preferred Stock.  There areno unvested stock options outstanding at March 30, 2005 for any directoror executive officer.  Mr. Walts andMr. Cox, under the terms of their employment agreements, are to receivestock options to purchase the number of shares of our common stock equal to3.5% of a portion of the equivalent number of shares of common stock issued asa result of the Medcare private placement on March 1, 2005.  The final terms of the 2005 stock optionshave not been determined by the compensation committee of the board ofdirectors and are not reflected in this table. If the stock options were issued as specified in their employmentcontracts, 1,183,042 shares of common stock could be acquirable pursuant to thestock options due to be granted.  Theportion that would vest within 60 days of March 30, 2005 would allow theacquisition of 394,347 shares of common stock, resulting in a percentageownership of 64.9%. Preferred stock: Represents 7 persons and includes 133,334 shares of Series A-3 sharesacquirable pursuant to the exercise of a warrant.

 

**CHANGE IN CONTROL**

 

On January 27, 2005, we entered into a securedbridge note with Medcare for $500,000 to provide us with working capital whilewe finalized negotiations for a private placement investment by Medcare.  The note was secured by our United Statespresbyopia patents and trademarks, was guaranteed by our subsidiaries, boreinterest at 8% and was to be repaid upon the earlier of the closing of an investmentby Medcare or July 26, 2005.

 

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On February 25,2005, we and Medcare entered into a term sheet (the “Term Sheet”) outlining theproposed investment by Medcare in us. The Term Sheet contained both binding and non-binding terms upon whichthe investment by Medcare would be made.

 

Inanticipation of the investment transaction discussed below, on March 1,2005, our Board of Directors, pursuant to our Certificate of Incorporation,exercised its authority to issue in one or more series up to 10 million sharesof our preferred stock.  On March 1,2005, we filed a Certificate of Designation, Rights and Preferences (the “Certificateof Designation”) with the Secretary of State of the State of Delaware, whichbecame effective upon its filing.  TheCertificate of Designation established a Series A-1 Convertible Preferred Stock(“Series A-1 Shares”), consisting of 280,000 shares, a Series A-2Convertible Preferred Stock (“SeriesA-2 Shares”), consisting of 280,000 shares, and a Series A-3 ConvertiblePreferred Stock (“Series A-3 Shares”), consisting of 200,000 shares(collectively, the “Series A Preferred Stock”).

 

On March 1,2005, we and Medcare entered into a Securities Purchase Agreement (the “PurchaseAgreement”) that documented the transactions contemplated in the TermSheet.  Pursuant to the Purchase Agreement,the Company issued and sold, and Medcare purchased, 280,000 shares of Series A-1Shares for an aggregate purchase price of $7,000,000, or $25 per share, and awarrant to purchase 133,334 shares of Series A-3 Shares for a purchaseprice of $1,000.  A portion of the fundsreceived were used to repay the Medcare bridge loan and to repay a portion ofconvertible notes issued in October and November 2004.  The remainder of the funds will be used forgeneral working capital purposes.

 

The Series A-1Shares are convertible into shares of our common stock at an effectiveconversion price of $0.25 per share.  TheWarrant has an exercise price of $30 per share for each of the Series A-3Shares and expires on February 28, 2007. The Series A-3 Shares are convertible into shares of our commonstock at an effective conversion price of $0.30 per share.  The conversion price of the Series A-1Shares and Series A-3 Shares, and the exercise price of the warrant, aresubject to adjustment based on customary anti-dilution protection provisions.

 

Additionally,pursuant to the Purchase Agreement, in the event that we receive authorizationin writing from the FDA to commence our Phase III clinical trials for thetreatment of presbyopia without any material limitations, Medcare has committedto purchase 280,000 shares of Series A-2 Shares for an aggregate purchaseprice of $7,000,000, or $25 per share, subject to customary closing conditionsincluding the absence of a material adverse event.  The Series A-2 Shares will be convertibleinto shares of our common stock at an effective conversion price of $0.25 pershare.  Medcare, however, is under noobligation to purchase the Series A-2 Shares until March 1,2006.  Medcare may accelerate the timingof the purchase of the Series A-2 Shares at its discretion by waiving anyof the conditions.

 

The holders of the Series APreferred Stock are not entitled to any preferential dividends.  Holders of the Series APreferred Stock, however, are entitled to participate on an as-converted basisin any cash dividends declared and paid on our common stock.

 

A share of Series APreferred Stock is convertible at the option of the holder of that share, atany time and from time to time, into 100 shares of our common stock, at aneffective price of $0.25 per share of common stock for the Series A-1Shares and the SeriesA-2 Shares and $0.30 per share of common stock for the Series A-3Shares.  The Series A-1 Shares canbe converted into 28,000,000 shares of our common stock.  The Series A-3 Shares, assuming the fullexercise of the warrant for those shares, can be converted into 13,333,400shares of our common stock.  The conversionrate of a share of Series A Preferred Stock intoshares of our common stock is subject to adjustment, from time to time, for,among other reasons, stock splits, combinations, dividends anddistributions.  The conversion rate isalso subject to an upward adjustment if we issue common stock, or an option,warrant or other instrument convertible into common stock, whose exercise priceis less than the effective price of the Series APreferred Stock then outstanding.  Sharesof Series A Preferred Stock will be automaticallyconverted into shares of our common stock at the then effective conversion rateupon the closing of an underwritten public offering of shares of our commonstock that results in gross proceeds to the Company of at least $45,000,000.

 

The holders of the shares of Series A Preferred Stock will be entitled to vote on all mattersrequired or permitted to be voted upon by our common stockholders.  Each holder of a share of Series A Preferred Stock is entitled to the number of votes equalto the largest number of full shares of our common stock into which all sharesof Series A Preferred 

 

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Stockheld by that holder could be converted. Except as required by law on matters requiring class voting, the holdersof the Series A-1 Shares, the Series A-2 Shares, the Series A-3Shares and our common stock will vote together as a single class.  As a result, the holders of the Series A-1Shares control over 50% of our voting stock at March 1, 2005 and, thus,control us.  As noted below, as of March 1,2005, the directors appointed by Medcare have significant veto rights over manyactions that require Board of Directors approval.  They also have control over many day-to-daymanagement functions as a result of their having to approve expense and capitalbudgets, major variances from the budget, compensation policies and other items.

 

For so long as 70,000 shares of Series A-1 Sharesremain outstanding, the holders of the Series A Preferred Stock, as asingle class, are entitled to elect one-half of the members of the Board ofDirectors (the “Series A Directors”), one of whom will be elected as theVice-Chairman of the Board of Directors, and to designate at least one Series ADirector to serve on each of the committees of the Board of Directors.  The Vice-Chairman is to receive $50,000annually in addition to fees normally paid to directors.

 

In thePurchase Agreement, we represented and warranted to, and covenanted with,Medcare as to various matters.  Amongthose covenants was that for so long as 70,000 Series A-1 Shares remainoutstanding, without the prior approval of the Board of Directors, including atleast two-thirds of the Series A Directors, wewill not:

 

•                  declare or pay any dividends (other than dividendspayable solely in shares of our common stock and dividends payable to us oranother subsidiary of ours) on or declare or make any other distribution,directly or indirectly, on account of any shares of our common stock now orhereafter outstanding;

 

•                  repurchase any outstanding shares of capital stock(other than repurchases of capital stock from any subsidiary of ours or any ofour employees whose employment has been terminated for any reason, not toexceed $100,000 in the aggregate);

 

•                  approve or modify by 10% or more the aggregate amountof any annual or other operating or capital budget, or approve or modify by 50%or more any single line item of any such operating or capital budget;

 

•                  increase the salary of any officer or pay any bonus toany officer, director or employee not contemplated in a budget or bonus planapproved by the Series A Directors;

 

•                  retain, terminate or enter into any salary oremployment negotiation or employment agreement with any employee or any futureemployee;

 

•                  incur indebtedness (other than trade payables) inexcess of $50,000 in the aggregate, or enter into contracts or leases whichrequire payments in excess of $50,000 in the aggregate;

 

•                  make or incur any single capital expenditure in excessof $50,000, or aggregate capital expenditures in excess of $100,000, per fiscalyear;

 

•                  award stock options, stock appreciation rights orsimilar employee benefits or determine vesting schedules, exercise prices orsimilar features;

 

•                  make any material change in the nature of the businessor enter into any new line of business, joint venture or similar arrangement;

 

•                  pledge our assets or guarantee the obligations of anyother individual or entity;

 

•                  recommend amendment of our existing restricted stockand stock option plan or approval of any new equity incentive plan; or

 

•                  form or acquire any subsidiary, joint venture orsimilar business entity.

 

In addition to any other vote or consent required,for so long as 70,000 shares of Series A-1 Shares remain outstanding,without the prior vote or approval of 75% of the then outstanding Series A Preferred Stock, we shall not:

 

•                  amend our Certificate of Incorporation and Bylaws inany manner that would alter or change any of the rights, preferences,privileges or restrictions of the Series APreferred Stock;

 

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•                  reclassify any outstanding securities into securitieshaving rights, preferences or privileges senior to, or on a parity with, the Series APreferred Stock;

 

•                  authorize or issue any additional Series APreferred Stock or any other stock having rights or preferences senior to, oron a parity with, the Series A Preferred Stock, except for authorizationsfor issuances solely to the holders of Series A Preferred Stock;

 

•                  merge or consolidate with or into any corporation ifsuch merger or consolidation would result in our stockholders immediately priorto such merger or consolidation holding (by virtue of securities issued asconsideration in such transaction or otherwise) less than a majority of thevoting power of the stock of the surviving corporation immediately after suchmerger or consolidation;

 

•                  sell all or substantially all our assets in a singletransaction or series of related transactions;

 

•                  license all or substantially all of our intellectualproperty in a single transaction or series of related transactions;

 

•                  liquidate or dissolve; or

 

•                  alter any rights of the Series A Directors or the holders of the Series A PreferredStock or change the size of the Board of Directors.

 

Aspart of the Purchase Agreement, the Board of Directors also amended our Bylawsto permit any Series A Director to call a special meeting of the Board ofDirectors, to permit any Series A Director or the holders of 51% of theoutstanding Series A Preferred Stock, as a single class, to call a specialmeeting of our stockholders, and to require the Board of Directors to meetbi-monthly until March 1, 2006, and at least quarterly after that date.

 

Inconnection with, and as condition to, entering into the Purchase Agreement, weand Medcare entered into an Investors’ Rights Agreement.  The Investors’ Rights Agreement grantsMedcare certain demand, piggy-back and shelf registration rights and sets forththe procedures pursuant to which such rights may be exercised and effected.  TheInvestors’ Rights Agreement also grants Medcare preemptive rights to purchaseany or all of our securities that we propose to issue on the same terms andconditions as the proposed issuance.

 

**ITEM 12****.****  CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS.**

 

*Medcare*

 

Seediscussion under “Change in Control” above.

 

*ConvertibleDebt*

 

On October 8,2004, as part of a private placement of convertible debt, Mr. Walts, our chief executive officerand relatives of his, Mr. Cox, the chief financial officer, Mr. Bradley,one of our current directors, Mr. David Williams, one of our formerdirectors and our controller purchased $135,000 of the $510,000 of notes issuedin 2004.  These investors also received warrantsto purchaser 135,000 shares of our common stock at $0.22 per share that expirein five years.  The notes wereautomatically converted into 565,560 shares of common stock on March 1,2005 as a result of the private placement that occurred on that date.

 

*CIBATransactions*

 

In March 2002,CIBA and we entered into the CIBA Agreement, pursuant to which CIBA obtained anexclusive license to our patents related to the treatment of presbyopia, ocularhypertension and primary open angle glaucoma in international markets.  CIBA also had the right in the CIBA Agreementto acquire a license for our patents in the United States.  We were entitled to receive a percentage royaltyon CIBA’s worldwide sales of the PSI and related products under the CIBAAgreement.  Upon entering into the CIBAAgreement, CIBA paid us a $2.0 million advance royalty and was committed topurchase equity interests in us if we obtained certain other investments fromthird-parties.  Simultaneously with ourreceipt of third-party investments in March 2003, CIBA purchased 625,000

 

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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.

 

TheCIBA Agreement was terminated in January 2004 pursuant to the LicenseTransfer and Transition Services Agreement that we entered into with CIBA.  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 obligations associated with manufacturing,marketing, distribution and regulatory matters. Under the Transfer Agreement, CIBA agreed to provide us with certaintransition services during 2004.  Thesetransition services helped us transfer the manufacturing, distribution andmarketing functions back to us from CIBA.

 

Inexchange for the acquisition of CIBA’s license rights, the forgiveness of the$2 million prepaid royalty we received under the CIBA Agreement and thetransition services to be performed by CIBA under the Transfer Agreement, weagreed to pay CIBA an aggregate of $3 million in twelve quarterly installmentscommencing in the first calendar quarter of 2006.  We, however, were entitled to prepay andextinguish our payment obligations by paying an aggregate amount of $2 millionto CIBA prior to January 1, 2006. Under the Transfer Agreement, CIBA returned the warrant to purchase312,500 shares of our common stock that it acquired in March 2003, whileit retained the 625,000 shares of common stock that it acquired at the sametime.  The shares of common stock,however, are subject to certain restrictions on their transfer.  CIBA also agreed to certain restrictions ontheir ability to solicit proxies for a period of two years.

 

In February 2005,we entered into an amendment to the Transfer Agreement.  Under the amended terms of the TransferAgreement, the $3 million due in quarterly installments has been replaced by a4% royalty on all products that were formerly covered by CIBA’s license up to amaximum aggregate royalty payment to CIBA of $3.25 million.  If an aggregate of $3.25 million has not paidto CIBA by December 31, 2009, we are required to remit the difference inthe maximum amount due and the aggregate paid to CIBA in February 2010.  We can still remit an aggregate of $2 millionto CIBA prior to January 1, 2006 to extinguish our liability.

 

TerenceA. Walts, a director and our president and chief executive officer, is a formerCIBA Vision employee.  Further, GlenBradley, Ph.D., a director, was the chief executive officer of CIBA Vision untiljust prior to his retirement in January 2003.

 

*AvatexLiquidating Trust*

 

Priorto January 2003, we subleased approximately 4,100 square feet from AvatexCorporation (“Avatex”), a substantial holder of our common stock.  Avatex leased the office space for its ownheadquarters in the same building. Avatex did not make a profit on the lease and charged us only themarket-based lease cost billed from the building’s property manager.  Due to the downsizing of our operationsduring 2002 as a result of the CIBA Agreement, we needed less officespace.  We negotiated a settlement of theamount due for the remainder of the term of the lease, which would have expiredin December 2003.  In July 2003,substantially all of the assets of Avatex were transferred to the AvatexLiquidating Trust.

 

AbbeyJ. Butler and Melvyn J. Estrin, both former members of our board of directors,each served as co-chairman of the board of Avatex from March 1991 until December 2002and co-chief executive officer of Avatex from October 1991 until December 2002.  Grady E. Schleier, a member of our board ofdirectors, served as the senior vice president of Avatex from 1999 until December 2002and as vice president and treasurer of Avatex from 1995 until 1999.

 

*Ronald A.Schachar, M.D., Ph.D*

 

Dr. Schacharis a substantial holder of our common stock and the founder and formerchairman, chief executive officer and chief scientist of Ocular.  On February 25, 2003, Dr. Schacharand we entered into a Severance, Release and Consulting Agreement.  In accordance with this agreement, Dr. Schacharresigned as an employee, officer and director of Ocular on March 6,2003.  We agreed to retain Dr. Schacharas a consultant for a period of up to five years, and he agreed not to competewith us during that time.  Dr. Schacharwill assist us in conducting research and development on our products for thetreatment of age-related macular degeneration for the initial two years of this

 

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agreementand will assist us in the maintenance of our patent portfolio and other mattersfor the entire term of the agreement.  Dr. Schacharwas paid $950,000 between March 2003 and March 2005 of an aggregateof $1.75 million due over the consulting period.  The timing of the remaining $800,000 due inyears three through five is partially dependent on our profitability in thoseyears; 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 years, withthe remainder, if any, to be paid in the fifth year.

 

Assecurity for the payment of his consulting fees, we granted Dr. Schachar anon-exclusive security interest in certain of our patent rights relating to theSEVFL and macular degeneration device.  Dr. Schacharalso received from us an assignment of our patents for the macular degenerationdevice outside the United States.

 

Priorto September 2003, we leased a 4,000 square foot building in Denison,Texas from Dr. Schachar.  Weconstructed our clean room facility in the leased building and made totalleasehold improvements of approximately $35,000.  We leased the facility on a month-to-monthbasis for $4,000 per month, the approximate fair market rent.  This lease was terminated August 31,2003.

 

*BridgeLoan*

 

On February 26,2003, Mr. Walts, our president and chief executive officer and a director,Mr. Schleier,  C.B. EquitiesRetirement Trust, an entity for which Mr. Butler, a former director,serves as trustee and St. Elizabeth’s Hospital, Inc., an entity controlledby Mr. Estrin, a former director, made a loan to us of $187,500 aggregateprincipal amount.  The loan was evidencedby promissory notes that were unsecured and bore interest at a rate of 12% perannum.  Upon consummation of a privateplacement on March 6, 2003, $162,500 aggregate principal amount of thesepromissory notes were used to purchase units in the private placement at $2.00per unit.  Each unit consisted of oneshare of our common stock and a warrant to purchase one-half of a share of ourcommon stock at $2.50 per share.

 

*OtherMatters*

 

Inconnection with the conversion of Ocular’s Series B convertible preferredstock into Ocular common stock prior to the merger in March 2003, weagreed to appoint and nominate Messrs. Butler and Estrin, former directorsof ours, and Mr. Schleier, a current director, to our board of directors.

 

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**ITEM 13****.****  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.)                                                                         |
|             |       |                                                                                                                                                                                                                                                                                                            |
| 3.1.2            |       | Certificate of  Amendment of Certificate of Incorporation of Registrant, effective as of  October 12, 2004. (Filed as Exhibit 3.1.2 to the registrant’s  Current Report on Form 8-K filed October 14, 2004 and incorporated  herein by reference.)                                     |
|             |       |                                                                                                                                                                                                                                                                                                            |
| 3.1.3            |       | Certificate of  Designation, Rights and Preferences establishing the Series A-1  Convertible Preferred Stock, the Series A-2 Convertible Preferred Stock  and the Series A-3 Convertible Preferred Stock. *                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                            |
| 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.)                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                            |
| 3.2.2            |       | Second Amendment  to Bylaws of the Registrant filed March 1, 2005. *                                                                                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                            |
| 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.)                          |

 

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| 4.8    |   | Form of  Warrant to Purchase Common Stock at a floating exercise price issued to  certain investors, expiring October 8, 2009. (Filed as Exhibit 4.8  to the registrant’s Current Report on Form 8-K filed October 14,  2004 and incorporated herein by reference.)                        |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 4.9    |   | Form of Series  A-1 Convertible Preferred Stock.*                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 4.10   |   | Form of  Warrant to Purchase Series A-3 Preferred Stock, at an exercise price of  $30 per share, issued to a certain investor, expiring February 28, 2007.  *                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 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.)                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 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.)                 |
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 10.6.1 |   | Second Amendment  to Employment Agreement, dated as of March 18, 2004, by and between the  registrant and Mark A. Cox. (Filed as Exhibit 10.6.1 to the registrant’s  Quarterly Report on Form 10-QSB for the quarterly period ending  June 30, 2004 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.)                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                     |
| 10.8.2 |   | Second Amendment  to Employment Agreement, dated as of March 18, 2004, by and between the  registrant and Terence A. Walts. (Filed as Exhibit 10.8.2 to the  registrant’s Quarterly Report on Form 10-QSB for the quarterly period  ending June 30, 2004 and incorporated herein by reference.) |

 

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| 10.8.3  |   | Third Amendment  to Employment Agreement, dated as of August 16, 2004, by and between the  registrant and Terence A. Walts. (Filed as Exhibit 10.8.3 to the registrant’s  Quarterly Report on Form 10-QSB for the quarterly period ending  June 30, 2004 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.)                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 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 quarterly period ended September 30,  2003 and incorporated herein by reference.) |

 

67

----

 
| 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 quarterly period 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.)    |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.24.1 |   | First Amendment  to License Transfer and Transition Services Agreement, dated as of  February 28, 2005, by and among the registrant, Refocus  Ocular, Inc., CIBA Vision AG and CIBA Vision Corporation. *                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.25   |   | Termination and  Settlement Agreement, effective October 8, 2004, by and among the  registrant, Refocus Ocular, Inc., Verus Support Services Inc. and Verus  International Group Ltd. (Filed as Exhibit 10.25 to the registrant’s  Current Report on Form 8-K filed October 14, 2004 and incorporated  herein be reference.)     |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.26.1 |   | Loan Agreement,  dated October 8, 2004, by and among the registrant and the lenders party  thereto. (Filed as Exhibit 10.26.1 to the registrant’s Current Report on  Form 8-K filed October 14, 2004 and incorporated herein be  reference.)                                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.26.2 |   | Form of  Convertible Promissory Note issued to lenders other than Verus International  Group Ltd and its designees. (Filed as Exhibit 10.26.2 to the  registrant’s Current Report on Form 8-K filed October 14, 2004 and  incorporated herein be reference.)                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.26.3 |   | Form of  Convertible Promissory Note issued to Verus International Group Ltd and its  designees. (Filed as Exhibit 10.26.3 to the registrant’s Current Report  on Form 8-K filed October 14, 2004 and incorporated herein be  reference.)                                                                                             |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.27   |   | Securities  Purchase Agreement, dated March 1, 2005, by and between the registrant  and Medcare Investment Fund III. Ltd. *                                                                                                                                                                                                                               |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.28   |   | Investor Rights  Agreement, dated as of March 1, 2005, by and between the registrant and  Medcare Investment Fund III, Ltd. *                                                                                                                                                                                                                             |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.29.1 |   | Secured Bridge  Note, dated January 27, 2005, by and between the registrant and Medcare  Investment Fund III, Ltd.*                                                                                                                                                                                                                                       |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.29.2 |   | Security  Agreement for Secured Bridge Note, dated January 27, 2005, by and  between the registrant, Refocus Ocular, Inc. and Medcare Investment Fund  III, Ltd. *                                                                                                                                                                                   |

 

68

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| 10.29.3 |   | Guaranty  Agreement for Secured Bridge Note, dated January 27, 2005, by and  between Refocus Ocular, Inc., PC Lens Corp, Refocus Ocular Europe – SPRL  and Medcare Investment Fund III, Ltd. *                   |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                            |
| 14.1    |   | Refocus  Group, Inc. Code of Conduct and Ethics. (Filed as Exhibit 14.1 to  the registrant’s Annual Report on Form 10-KSB for the year ended  December 31, 2003 and incorporated herein by reference.) |
|    |   |                                                                                                                                                                                                                            |
| 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. |

 

**ITEM 14****.****  PRINCIPAL ACCOUNTANT FEESAND SERVICES.**

 

*AuditFees*

 

Feesbilled by Deloitte & Touche LLP for the audits of our 2003 and 2004annual financial statements, and the reviews of quarterly financial statementsincluded in our Forms 10-QSB for such years, totaled $66,100 and $67,000,respectively.

 

*Audit-RelatedFees*

 

Feesbilled by Deloitte & Touche LLP in 2003 and 2004 related to the reviewand consents required for registration statements filed with the Securities andExchange Commission, and for the review of private placement documents, usingour audited and unaudited financial statements totaled $89,000 and $27,100,respectively.

 

*Tax Fees*

 

Nofees were billed by Deloitte & Touche LLP for tax compliance, taxadvice and tax planning for 2003 or 2004. Deloitte & Touche Fiduciarie of Diegem, Belgium was paid 9,258and 6,642 euros during 2003 and 2004, respectively, for tax services for our Belgiumsubsidiary.

 

*All OtherFees*

 

Deloitte &Touche LLP did not bill us for any other services during 2003 or 2004.

 

*AuditorIndependence*

 

Indetermining the independence of Deloitte & Touche LLP, the Audit andFinance Committee considered whether the provision of non-audit services, ifany, is compatible with maintaining Deloitte & Touche LLP’s independence.

 

*Audit andFinance Committee’s Policy Regarding Pre-approval of Non-Audit Services*

 

**Pursuantto a policy adopted in 2003, the Audit and Finance Committee pre-approves thenature and estimated amount of non-audit services to be provided to us by ourauditors, taking into consideration the impact that the rendition of suchservices could have on auditor independence.**

 

69

----

 

**SIGNATURES**

 

In accordance with Section 13or 15(d) of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                |   | Refocus  Group, Inc. |
|---------------------|--------|---------------------------|
|                |   |                      |   |
|                |   |                      |   |
|                | By     |                      | /s/ Mark A. Cox |
|                |   | Mark A. Cox               |
| April 6,  2005 |   |                      | Vice President,  Secretary and Chief Financial Officer |
|                |   |                      | (Principal  Financial and Accounting Officer) |
|                     |        |                           |  |  |  |

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 
| **Principal  Executive Officers:**   |   |
|--------------------------------------|--------|
| ** **                           |   |
| ** **                           |   |
|  /s/ Terence A. Walts           |   |   |   |
|  Terence A.  Walts              |   | Director, Chief Executive Officer  and President (Principal Executive Officer) | April 6,  2005 |
|                                 |   |   |   |
|  /s/ Mark A. Cox                |   |   |   |
|  Mark A.  Cox                   |   | Vice President, Secretary and Chief Financial  Officer (Principal Financial and Accounting  Officer) | April 6,  2005 |
|                                 |   |   |   |
| **Additional  Directors:**** ** |   |   |   |
|                                 |   |   |   |
| /s/ C. Glenn  Bradley                |   |   |   |
|  C. Glenn Bradley, Ph.D.        |   | Director | April 6,  2005 |
|                                 |   |   |   |
|  /s/ Kenneth N. Elmgren         |   |   |   |
|  Kenneth N.  Elmgren            |   | Director | April 6,  2005 |
|                                 |   |   |   |
|  /s/ Thomas W. Lyles, Jr.  |   |   |   |
|  Thomas W.  Lyles, Jr.     |   | Director | April 6,  2005 |
|                                 |   |   |   |
|  /s/ Grady E. Schleier          |   |   |   |
|  Grady E.  Schleier             |   | Director | April 6,  2005 |
|                                 |   |   |   |
|  /s/ Douglas C. Williamson      |   |   |   |
|  Douglas C.  Williamson         |   | Director | April 6,  2005 |

 

70

----

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| Report  of Independent Registered Public Accounting Firm                                                                     |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                         |   |
| Consolidated  Statements of Operations - For the Three Years Ended December 31, 2004                                    |   |
|                                                                                                                         |   |
| Consolidated Balance Sheets  - December 31, 2004 and 2003                                                               |   |
|                                                                                                                         |   |
| Consolidated  Statements of Shareholders’ Equity (Deficiency) - For the Three Years Ended  Ended December 31, 2004 |   |
|                                                                                                                         |   |
| Consolidated  Statements of Cash Flows - For the Three Years Ended December 31, 2004                                    |   |
|                                                                                                                         |   |
| Notes to  Consolidated Financial Statements - For the Three Years Ended  December 31, 2004                              |   |

 

F-1

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors and ShareholdersRefocus Group, Inc.

 

We have audited the accompanying consolidated balancesheets of Refocus Group, Inc. (“Refocus”) and subsidiaries (collectively, the“Company”) as of December 31, 2004 and 2003, and the related consolidatedstatements of operations, shareholders’ equity (deficiency), and cash flows foreach of the three years in the period ended December 31, 2004.  These financial statements are theresponsibility of the Company’s management.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  The Company is not required to have, nor were weengaged to perform, an audit of its internal control over financialreporting.  Our audits included consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express no such opinion*.*  An audit also includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements, assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation.  We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, such consolidated financialstatements present fairly, in all material respects, the financial position ofthe Company**as of December 31,2004 and 2003, and the results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2004, in conformity withaccounting principles generally accepted in the United States of America.

 

The accompanying 2004 consolidated financialstatements have been prepared assuming that the Company will continue as agoing concern.  As described in Notes 1and 3 to the consolidated financial statements, the Company has no revenues andwill need to obtain additional financings to conclude clinical trials for itsproducts and begin generating revenues. The uncertainty of obtaining sufficient financings raises substantialdoubt about the Company’s ability to continue as a going concern. Management’splans concerning these matters are also described in Note 3.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

As discussed in Note 1 to the financialstatements, on March 6, 2003, a wholly-owned subsidiary of Refocus wasmerged with and into Refocus Ocular, Inc. (“Ocular”), with Ocular surviving as a wholly-owned subsidiary of Refocus.

 

*DELOITTE & TOUCHE LLP*

 

Dallas, TexasApril 6, 2005

 

F-2

----

 

**REFOCUSGROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                          | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                          | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| REVENUES                                                            |       | $                                 | —     |   | $ | — |   | $ | — |   |
|                                                                |       |                              |       |   |   |   |   |
| COST  OF SALES                                                      |       | —                            |       | — |   | — |   |
|                                                                |       |                              |       |   |   |   |   |
| GROSS  PROFIT                                                       |       | —                            |       | — |   | — |   |
|                                                                |       |                              |       |   |   |   |   |
| OPERATING  EXPENSES:                                                |       |                              |       |   |   |   |   |
| Selling,  general and administrative                                |       | 931,131                           |       | 1,172,124 |   | 889,147 |   |
| Salary  and related expenses                                        |       | 503,773                           |       | 1,224,248 |   | 1,170,438 |   |
| Stock-based  employee compensation                                  |       | 230,963                           |       | 791,697 |   | 7,650 |   |
| Inventory  adjustment costs                                         |       | —                            |       | — |   | 128,059 |   |
| Professional  services                                              |       | 724,539                           |       | 1,337,445 |   | 534,432 |   |
| Clinical  trials                                                    |       | 906,931                           |       | 357,739 |   | 63,275 |   |
| Research  and development                                           |       | 33,890                            |       | 108,918 |   | 166,949 |   |
| Depreciation  and amortization                                      |       | 361,291                           |       | 604,028 |   | 123,403 |   |
|                                                                |       |                              |       |   |   |   |   |
| LOSS  FROM OPERATIONS                                               |       | (3,692,518                        | )          | (5,596,199 | ) | (3,083,353 | ) |
|                                                                |       |                              |       |   |   |   |   |
| OTHER  INCOME (EXPENSE):                                            |       |                              |       |   |   |   |   |
| Interest  income                                                    |       | 10,156                            |       | 23,805 |   | 20,577 |   |
| Interest  expense                                                   |       | (158,412                          | )          | (121,947 | ) | — |   |
| Other  income (expense)                                             |       | —                            |       | 15 |   | (325 | ) |
| Total                                                               |       | (148,256                          | )          | (98,127 | ) | 20,252 |   |
| NET  LOSS                                                           |       | (3,840,774                        | )          | (5,694,326 | ) | (3,063,101 | ) |
|                                                                |       |                              |       |   |   |   |   |
| Accretion  of discount on preferred stock                           |       | —                            |       | (4,306 | ) | (23,482 | ) |
| Accrued  dividends on preferred stock                               |       | —                            |       | — |   | (2,777,062 | ) |
|                                                                |       |                              |       |   |   |   |   |
| NET  LOSS APPLICABLE TO COMMON SHARES                               |       | $                                 | (3,840,774 | ) | $ | (5,698,632 | ) | $ | (5,863,645 | ) |
|                                                                |       |                              |       |   |   |   |   |
| NET  LOSS PER SHARE APPLICABLE TO COMMON SHARES - BASIC AND DILUTED |       | $                                 | (0.16      | ) | $ | (0.34 | ) | $ | (0.91 | ) |
|                                                                |       |                              |       |   |   |   |   |
| AVERAGE  NUMBER OF COMMON SHARES OUTSTANDING - BASIC AND DILUTED    |       | 23,476,307                        |       | 16,862,075 |   | 6,450,878 |   |

 

See notes to theconsolidated financial statements.

 

F-3

----

 

**REFOCUSGROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current  Assets                                                                                                                                           |       |                  |       |   |   |
| Cash  and cash equivalents                                                                                                                                |       | $                     | 199,627    |   | $ | 2,999,784 |   |
| Accounts  receivable                                                                                                                                      |       | —                |       | 10,000 |   |
| Inventory                                                                                                                                                 |       | 8,886                 |       | — |   |
| Prepaid  expenses                                                                                                                                         |       | 141,149               |       | 230,464 |   |
| Total  current assets                                                                                                                                     |       | 349,662               |       | 3,240,248 |   |
| Property  and Equipment - net                                                                                                                             |       | 6,873                 |       | 12,252 |   |
| Patent  Costs and Trademarks - net                                                                                                                        |       | 929,398               |       | 957,227 |   |
| Non-Compete  Agreement - net                                                                                                                              |       | 423,114               |       | 618,397 |   |
| Other  Long-Term Assets                                                                                                                                   |       | 71,947                |       | 138,412 |   |
| Total  Assets                                                                                                                                             |       | $                     | 1,780,994  |   | $ | 4,966,536 |   |
|                                                                                                                                                      |       |                  |       |   |   |
| **LIABILITIES & SHAREHOLDERS’ EQUITY (DEFICIENCY)**                                                                                         |       |                  |       |   |   |
|                                                                                                                                                      |       |                  |       |   |   |
| Current  Liabilities                                                                                                                                      |       |                  |       |   |   |
| Accounts  payable                                                                                                                                         |       | $                     | 553,909    |   | $ | 419,968 |   |
| Accrued  expenses                                                                                                                                         |       | 203,099               |       | 277,312 |   |
| Current  portion of separation and consulting agreement                                                                                                   |       | 266,695               |       | 407,384 |   |
| Current  portion of CIBA obligation                                                                                                                       |       | —                |       | 375,000 |   |
| Current  portion of convertible debt                                                                                                                      |       | 231,346               |       | — |   |
| Customer  deposits                                                                                                                                        |       | 23,000                |       | 23,000 |   |
| Total  current liabilities                                                                                                                                |       | 1,278,049             |       | 1,502,664 |   |
| Long-Term  Liabilities                                                                                                                                    |       |                  |       |   |   |
| Separation  and consulting agreement                                                                                                                      |       | 509,035               |       | 688,421 |   |
| Convertible  debt                                                                                                                                         |       | 247,071               |       | — |   |
| CIBA  obligation                                                                                                                                          |       | 2,000,000             |       | 1,625,000 |   |
| Total  long-term liabilities                                                                                                                              |       | 2,756,106             |       | 2,313,421 |   |
| Commitments  and Contingencies (Note 11)                                                                                                                  |       | —                |       | — |   |
| Shareholders’  Equity (Deficiency)                                                                                                                   |       |                  |       |   |   |
| Preferred  stock: 10,000,000 shares of $.0001 par value authorized, no shares issued and  outstanding                                                     |       | —                |       | — |   |
| Warrants  for the purchase of Refocus Group, Inc. common stock                                                                                       |       | 1,961,050             |       | 2,047,350 |   |
| Common  stock: 120,000,000 shares of $.0001 par value authorized, 23,542,770 and  23,368,887 shares issued and outstanding in 2004 and 2003, respectively |       | 2,354                 |       | 2,337 |   |
| Paid-in  capital                                                                                                                                          |       | 22,183,501            |       | 21,660,056 |   |
| Accumulated  deficit                                                                                                                                      |       | (26,400,066           | )          | (22,559,292 | ) |
| Total  shareholders’ equity (deficiency)                                                                                                             |       | (2,253,161            | )          | 1,150,451 |   |
| Total  Liabilities and Shareholders’ Equity (Deficiency)                                                                                             |       | $                     | 1,780,994  |   | $ | 4,966,536 |   |

 

See notes to theconsolidated financial statements.

 

F-4

----

 

**REFOCUSGROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)**

**FOR THETHREE YEARS ENDED  DECEMBER 31,2004**

 
| ** **                                                                                                                               | ** ** | **Shares**  | ** ** | **Amount** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|
| **Series C Preferred Stock of Refocus Ocular, Inc.:**                                                                          |       |        |       |       |       |
| Balance  at December 31, 2001 and 2002                                                                                              |       | 21,614      |       | $          | 1,049,104  |   |
| Conversion  of Series C preferred stock to common in 2003                                                                           |       | (21,614     | )          | (1,049,104 | )          |
| Balance  at December 31, 2003 and 2004                                                                                              |       | —      |       | $          | —     |   |
|                                                                                                                                     |       |        |       |       |       |
| **Series C Preferred Stock Warrants of Refocus  Ocular, Inc.:**                                                                |       |        |       |       |       |
| Balance  at December 31, 2001                                                                                                       |       |        |       | $          | 4,566      |   |
| Expiration  of Series C preferred stock warrants in 2002                                                                            |       |        |       | (4,566     | )          |
| Balance  at December 31, 2002, 2003 and 2004                                                                                        |       |        |       | $          | —     |   |
|                                                                                                                                     |       |        |       |       |       |
| **Warrants for the purchase of common stock of Refocus  Group, Inc.:**                                                              |       |        |       |       |       |
| Balance  at December 31, 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  cancelled                                                                                                                       |       |        |       | (104,000   | )          |
| Balance  at December 31, 2003                                                                                                       |       |        |       | 2,047,350  |       |
| Warrants  issued in connection with convertible debt                                                                                     |       |        |       | 72,200     |       |
| Warrant  issued to agent                                                                                                                 |       |        |       | 30,000     |       |
| Warrants  cancelled                                                                                                                      |       |        |       | (188,500   | )          |
| Balance  at December 31, 2004                                                                                                       |       |        |       | $          | 1,961,050  |   |
|                                                                                                                                     |       |        |       |       |       |
| **PC Lens Corp Common Stock:**                                                                                                           |       |        |       |       |       |
| Balance  at December 31, 2001                                                                                                       |       | 8,830,546   |       | $          | 1,286      |   |
| Acquisition  of common stock of PC Lens Corp in 2002                                                                                     |       | (8,830,546  | )          | (1,286     | )          |
| Balance  at December 31, 2002, 2003 and 2004                                                                                        |       | —      |       | $          | —     |   |
|                                                                                                                                     |       |        |       |       |       |
| **Refocus Ocular, Inc. Common Stock:**                                                                                              |       |        |       |       |       |
| 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 and 2004                                                                                              |       | —      |       | $          | —     |   |
|                                                                                                                                     |       |        |       |       |       |
| **Refocus Group, Inc. Common Stock:**                                                                                               |       |        |       |       |       |
| Balance  at December 31, 2002                                                                                                       |       | —      |       | $          | —     |   |
| Common  stock outstanding when Refocus Ocular, Inc. was merged into a subsidiary  of Refocus Group, Inc. on March 6, 2003 |       | 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      |       |
| Stock  issued in lieu of cash due to vendors                                                                                             |       | 160,588     |       | 16         |       |
| Stock  options exercised                                                                                                                 |       | 13,295      |       | 1          |       |
| Balance  at December 31, 2004                                                                                                       |       | 23,542,770  |       | $          | 2,354      |   |

 

See notes to theconsolidated financial statements.

 

F-5

----

 
| ** **                                                                                                                        | ** ** | **Amount**  | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|
| **Paid-in Capital:**                                                                                                              |       |        |        |
| 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         | )           |
| Common  stock issued in private placement on March 6, 2003 (net of $1,459,259 in  expenses)                                  |       | 2,859,953   |        |
| Common  stock issued in private placement on December 23, 2003 (net of $266,348  in expenses)                                |       | 1,484,859   |        |
| Warrant  cancelled                                                                                                                |       | 104,000     |        |
| Stock  options exercised                                                                                                          |       | 1,773       |        |
| Stock-based  employee compensation                                                                                                |       | 791,697     |        |
| Balance  at December 31, 2003                                                                                                |       | 21,660,056  |        |
| Stock  issued in lieu of cash due to vendors                                                                                      |       | 102,760     |        |
| Stock  options exercised                                                                                                          |       | 1,222       |        |
| Warrants  cancelled                                                                                                               |       | 188,500     |        |
| Stock-based  employee compensation                                                                                                |       | 230,963     |        |
| Balance  at December 31, 2004                                                                                                |       | $           | 22,183,501  |   |
|                                                                                                                              |       |        |        |
| **Accumulated Deficit:**                                                                                                          |       |        |        |
| 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 | )           |
| Net  loss                                                                                                                         |       | (3,840,774  | )           |
| Balance  at December 31, 2004                                                                                                |       | $           | (26,400,066 | ) |

 

See notes to theconsolidated financial statements.

 

F-6

----

 

**REFOCUS GROUP, INC AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                              | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Cash  Flows from Operating Activities:**                                              |       |                         |       |   |   |   |   |
| Net loss                                                                                |       | $                            | (3,840,774 | ) | $ | (5,694,326 | ) | $ | (3,063,101 | ) |
| Adjustments to reconcile net loss to net  cash provided (used) by operating activities: |       |                         |       |   |   |   |   |
| Depreciation and amortization                                                           |       | 361,291                      |       | 604,028 |   | 123,403 |   |
| Loss on disposal of equipment                                                           |       | —                       |       | 6,091 |   | 66,951 |   |
| Loss on write-down of inventory                                                         |       | —                       |       | — |   | 128,059 |   |
| Stock-based employee compensation cost                                                  |       | 230,963                      |       | 791,697 |   | 7,650 |   |
| Stock-based vendor cost                                                                 |       | 102,776                      |       | — |   | — |   |
| Value of warrants expensed                                                              |       | 30,000                       |       | 260,000 |   | — |   |
| Interest accreted on discounted liability                                               |       | 144,268                      |       | 121,280 |   | — |   |
| Cash provided (used) by working capital  items:                                         |       |                         |       |   |   |   |   |
| Accounts receivable                                                                     |       | 10,000                       |       | 17,068 |   | 123,765 |   |
| Inventories                                                                             |       | (8,886                       | )          | — |   | 4,532 |   |
| Other assets                                                                            |       | 155,780                      |       | 19,088 |   | 99,020 |   |
| Accounts payable, accrued expenses and  other liabilities                               |       | (363,997                     | )          | 406,685 |   | (96,522 | ) |
| CIBA obligation                                                                         |       | —                       |       | — |   | 2,000,000 |   |
| **Net Cash  Used by Operating Activities**                                              |       | (3,178,579                   | )          | (3,468,389 | ) | (606,243 | ) |
|                                                                                    |       |                         |       |   |   |   |   |
| **Cash  Flows from Investing Activities:**                                              |       |                         |       |   |   |   |   |
| Additions to property and equipment                                                     |       | (1,584                       | )          | (13,025 | ) | (16,155 | ) |
| Additions to patents and trademarks                                                     |       | (131,217                     | )          | (225,476 | ) | (365,805 | ) |
| Purchase of Refocus Group, Inc. by Refocus  Ocular, Inc.                                |       | —                       |       | 5,102 |   | — |   |
| Other                                                                                   |       | —                       |       | 1,277 |   | (882 | ) |
| **Net Cash  Used by Investing Activities**                                              |       | (132,801                     | )          | (232,122 | ) | (382,842 | ) |
|                                                                                    |       |                         |       |   |   |   |   |
| **Cash  Flows from Financing Activities:**                                              |       |                         |       |   |   |   |   |
| Borrowings                                                                              |       | 510,000                      |       | 250,000 |   | — |   |
| Borrowings repaid                                                                       |       | —                       |       | (250,000 | ) | — |   |
| Proceeds from private placements, net of  expenses                                      |       | —                       |       | 6,431,340 |   | — |   |
| Exercise of common stock options                                                        |       | 1,223                        |       | 1,775 |   | — |   |
| Offering expenses                                                                       |       | —                       |       | — |   | (194,447 | ) |
| **Net Cash  Provided (Used) by Financing Activities**                                   |       | 511,223                      |       | 6,433,115 |   | (194,447 | ) |
|                                                                                    |       |                         |       |   |   |   |   |
| **Net  Increase (Decrease) in Cash and Cash Equivalents**                               |       | (2,800,157                   | )          | 2,732,604 |   | (1,183,532 | ) |
| Cash and Cash Equivalents, beginning of  year                                           |       | 2,999,784                    |       | 267,180 |   | 1,450,712 |   |
| **Cash and  Cash Equivalents, end of year**                                             |       | $                            | 199,627    |   | $ | 2,999,784 |   | $ | 267,180 |   |

 

See notes to the consolidated financial statements.

 

F-7

----

 

**REFOCUS GROUP, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2004**

 

**NOTE 1 –SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**GoingConcern:** These financial statements have been preparedon a going concern basis, which contemplates the realization of the assets ofRefocus Group, Inc. (“Refocus”) and the satisfaction of its liabilities andcommitments in the normal course of business. Management of Refocus believes that, as a result of $7,000,000 infunding received in March 2005 (see Note 16), Refocus has adequate resources tofund operations for the next twelve months based on its current businessplan.  There can be no assurances,however, that there will not be delays or other unforeseen events that preventit from achieving its current business plan.

 

Management of Refocus believesthe Company will still need to find additional funding in later years toconclude its clinical trials and bring its products to market.  There can be no assurance that additionalfinancing can be obtained on reasonable terms or at all.  Operating in an emerging medical technologymarket involves risks and uncertainties; the Company cannot predict withcertainty the total amount of expenditures and the amount of time required to,or whether it will, achieve its goals. The Company’s success ultimately depends on the acceptance of itsproducts and its ability to sustain profitable operations.  See Note 3 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 known asPresby Corp (“Presby”), entered into a merger agreement (the “MergerAgreement”, see Note 2).  On March 6,2003 (the “Merger Closing Date”), a 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(see Note 4).

 

Since the formerstockholders of Ocular owned a majority of the issued and outstanding shares ofcommon stock of Refocus on the Merger Closing Date after the merger and thefunding of the first tranche of the March 2003 private placement, thistransaction was accounted for as a reverse merger, whereby Ocular was deemed tobe the accounting acquirer of Refocus. Therefore, all financial information included in this report on Form10-KSB prior to the Merger Closing Date is that of Ocular, as if Ocular hadbeen the registrant.  The financialinformation since the Merger Closing Date is that of Refocus and Ocular consolidated.

 

All references to “Refocus”,“Presby”, “Ocular”, or the “Company” mean 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.

 

**Basisof Presentation:** The consolidated financial statements includethe accounts of all wholly-owned subsidiaries. All significant intercompany accounts and transactions have beeneliminated in the consolidated financial statements.  All the outstanding stock of one of thesubsidiaries, PC Lens Corp (“PCL”), was acquired in August 2002.  This acquisition was accounted for as ifpooled since the acquisition was of an entity under common control.

 

**Descriptionof Business:**  The Company’s primary business has been thedevelopment of a patented medical device, the PresVIEW Scleral Implant (the“PSI”), and the related surgical technique, the Scleral Spacing Procedure (the“SSP”), for the treatment of presbyopia, primary open angle glaucoma and ocularhypertension in the human eye.  Sale ofthis medical device is currently restricted while the Company seeks approvalfor the device in the United States, from the Food and Drug Administration (the“FDA”), and in other international markets. The Company has conducted research into and may, at a later time,develop for commercial applications a single element variable focus lens(“SEVFL”).

 

F-8

----

 

By 1998, the Company hadobtained CE Mark approval for sales of its products in the European Union andsubsequently in certain other international markets.  In 2000, the Company received approval fromthe FDA to conduct Phase I clinical trials of the PSI for the treatment ofpresbyopia.  The Company decided tosuspend international sales in 2001, however, in order to develop an automatedsurgical incision device to help simplify, standardize and automate thesurgical procedure and to make the outcomes of the surgical procedure lessdependent on each physician’s surgical skill. Since that time, the Company has developed the PresVIEW Incision System,which consists of both automated and manual surgical instruments used toimplant the PSI in the human eye.  TheCompany believes the PresVIEW Incision System will improve the consistency ofthe results of the SSP.

 

In March 2002, the Company entered into a license agreement with CIBAVision AG (“CIBA”), pursuant to which CIBA obtained an exclusive license to theCompany’s patents related to the treatment of presbyopia, ocular hypertensionand 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.  Under theCIBA Agreement, CIBA was responsible for manufacturing, distribution and marketingof the Company’s products, as well as for regulatory matters outside the UnitedStates.  In accordance with the CIBAAgreement, the Company ceased all direct manufacturing, distribution andmarketing 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.

 

CIBA’s surgical businessunit marketed a variety of ophthalmic products and was primarily responsiblefor performing the CIBA Agreement.  InAugust 2003, CIBA announced that it was seeking strategic alternatives for itssurgical business, including the sale of that unit.  In December 2003, CIBA informed the Companyof the sale and dissolution of the unit. As a result, in January 2004, the Company entered into a LicenseTransfer and Transition Services Agreement (the “Transfer Agreement”) withCIBA.  Under the Transfer Agreement, theCompany reacquired all worldwide license rights to its patents and assumedresponsibility for marketing, manufacturing, distribution and regulatoryfunctions.  See Note 5 for a discussionof the CIBA Agreement and the Transfer Agreement.

 

The Company filed aninvestigational device exemption application with the FDA in March 2003 toobtain approval for initiating Phase II clinical trials.  In December 2003, the Company receivedapproval to start Phase II clinical trials. The Company started these trials during the first quarter of 2004.

 

The Company had alsoreceived permission from Health Canada (the Canadian equivalent of the FDA) in2000 to begin clinical trials of the PSI for the treatment of ocularhypertension and primary open angle glaucoma. In November 2002, the Company submitted an application for approval tocommercialize the PSI in Canada.  On June13, 2003, Canada denied the application due to the insufficient size of theclinical trial.  In October 2003, HealthCanada indicated the Company would have to increase the size of its clinicaltrials using more sites and significantly more patients before approval couldbe reconsidered.

 

PCL was formed primarily todevelop the patented SEVFL technology. PCL has had no revenues for the three years ended December 31,2004.  In August 2002, a contract with alicensing agent to market the technology expired.  At that time, Ocular determined that itshould no longer continue to fund the operations of PCL on a promissory notebasis and that it should repurchase the outstanding common stock of PCL.  PCL had no source of funding other thanOcular.  The holders of PCL common stockagreed to sell their common stock back to Ocular at a price per share less thanpar value.  Ocular completed the purchaseof all the outstanding common stock of PCL in August 2002 at a total cost of$882.

 

**BusinessSegments:**  The Company has determined that it currentlyoperates in one segment, development of optical technologies.

 

**ManagementEstimates and Significant Risks and Uncertainties:**  Thepreparation of the consolidated financial statements, in conformity withaccounting principles generally accepted in the United States of America,requires management of the Company to make estimates and assumptions thataffect the reported amounts of assets and liabilities, and the disclosure ofcontingent assets and liabilities, at the dates of the financial statements andthe reported amounts of revenues and expenses during such reportingperiods.  Actual results could differfrom these estimates.

 

F-9

----

 

The Company is subject to anumber of risks and can be affected by a variety of factors.  For example, management of the Companybelieves 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 have sufficient funds to completeits investigational trials and bring its products to market; risks associatedwith the Company’s assumption from CIBA of the marketing, distribution,regulatory and manufacturing operations formerly performed by CIBA; failure todevelop and commercialize existing and new products or product enhancements;failure to obtain or maintain necessary regulatory approvals; failure tomaintain or obtain proprietary intellectual property rights; failure to obtainor maintain customer and physician acceptance or third party reimbursement;intense competition from companies with greater financial, technical andmarketing resources; risks associated with product liability and productdefects; and risks associated with general economic conditions.

 

**Cashand Cash Equivalents:**  Cash and cash equivalents consist principallyof amounts held in demand deposit accounts and amounts invested in financialinstruments with initial maturities of three months or less at the time of purchase.

 

**Inventories:** Inventories are valued at the lower of cost (determined using an averagecost method) or market.  All inventory atDecember 31, 2004 represents finished products. As a result of the CIBA Agreement, CIBA was to provide PSIs and surgicalinstruments under their brand name and, for the most part, would not be usingthe Company’s inventory.  Therefore,during 2002, the Company wrote off its remaining inventory at a cost of$128,059.  As a result of the TransferAgreement, the Company began purchasing inventory again in 2004, which for themost part, is being used in its on-going clinical trials.

 

**Propertyand Equipment:**  Property and equipment is stated atcost.  Depreciation is computed once anasset is placed in service using a straight-line method at rates designed todistribute the cost of the asset over its estimated useful life of from 3 to 10years for furniture and equipment. Amortization of leasehold improvements is included in depreciation andamortization expense and is based on the lesser of the asset’s useful life orthe projected term of the lease.  Thecost to maintain property and equipment is charged to expense as incurred.  During 2002, the Company wrote off asubstantial portion of its fixed assets as a result of the downsizing of itsstaff and office space in conjunction with CIBA assuming most of theresponsibility for marketing, manufacturing and regulatory matters under theCIBA Agreement.  The loss from disposalof excess fixed assets in 2002 was $66,951. Additional write-offs of $6,091, net of proceeds, were taken in 2003from the disposal of additional equipment. Property and equipment consisted entirely of furniture and equipment atDecember 31, 2004 and 2003, respectively.

 

**Intangible Assets:**  Costsincurred for patents and trademarks are capitalized and, once issued, areamortized over their actual or estimated life. If it is determined that a patent or trademark will not be issued orthat the Company no longer wants to maintain or pursue a patent or trademark,the related costs are charged to expense at the time such determination ismade.  The cost of maintaining patentsand trademarks after they are issued is charged to expense.

 

As a result of the mergerwith Refocus, discussed in Note 2, and the subsequent change of the name ofPresby to Refocus Ocular, Inc. in April 2003 as part of a rebranding of theCompany’s products, the Company decided not to continue to defend or renew anyof the 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 of March 31,2003.  The charge of $94,592 was shown in“Depreciation and amortization” in the accompanying consolidated statement ofoperations for the year ended December 31, 2003.  The Company is currently pursuing trademarkprotection for its “PresVIEW” product name.

 

In addition, under theseparation and consulting agreement with the Company’s former Chief Scientist(see Note 6), certain foreign patents related to a device for the treatment ofage–related macular degeneration (“ARMD”) were assigned to him in 2003.  While the assignment was revocable undercertain conditions, the value of these patents, for accounting purposes, ofapproximately $120,355 was considered transferred to him as part of his compensationunder the separation and consulting agreement and was removed from thecapitalized value of the patent portfolio. In addition, during 2004, the Company decided not to pursue furtherdevelopment of this device.  Therefore,the Company wrote off the remaining book value of its ARMD patents of $25,309during the quarter ended September 30, 2004.

 

F-10

----

 

Because obtaining new patents and the maintenance of issued patents isexpensive, the Company continually reviews its entire patent portfolio.  The Company determined that it would continueto pursue or maintain PSI and SEVFL patent protection in most major markets inthe world, but, if it believed the potential revenues or its ability to enforceits patents did not justify the costs to pursue or maintain patents in certainmarkets, it would abandon those patents. The net book value of the patents written off for the years endedDecember 31, 2004 and 2003, were $125,956 (including the amount written off forARMD patents discussed above) and $253,038, respectively.  These amounts were shown in “Depreciation andamortization” in the accompanying consolidated statements of operations.  There were no patents written off for theyear ended December 31, 2002.

 

The following tables showthe capitalized value of patents and trademarks as of December 31, 2004 andDecember 31, 2003, respectively.

 
| ** **                      | ** ** | **Costs** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
|---------------------------------|------------|-----------|------------|------------------|------------|---------|------------|
| PSI and related product patents |       | $         | 938,135    |             | $          | 175,911 |       | $ | 762,224 |   |
| Trademarks                      |       | 838       |       | —           |       | 838     |       |
| ARMD patents                    |       | —    |       | —           |       | —  |       |
| SEVFL Patents                   |       | 219,502   |       | 53,166           |       | 166,336 |       |
| Balance at December 31, 2004    |       | $         | 1,158,475  |             | $          | 229,077 |       | $ | 929,398 |   |
|                            |       |      |       |             |       |    |       |
| 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 |   |
|                                 |            |           |            |                  |            |         |            |  |  |  |  |

 

Amortization expense fortrademarks and patents was $159,046, $425,092 and $79,958 (including the patentsand trademarks written off), for the years ended December 31, 2004, 2003 and2002, respectively.  The estimatedaggregate amortization expense for each of the succeeding five fiscal yearswill be approximately $30,800 each year based on the capitalized costs ofpatents granted at December 31, 2004.

 

A portion of the costsincurred in connection with the separation and consulting agreement with the Company’sformer Chief Scientist was allocated to a non-compete agreement and is beingamortized over its estimated life of four years on a straight-line basis.  The $423,114 capitalized value of thenon-compete agreement at December 31, 2004 was net of $358,020 of accumulatedamortization.  Amortization of the non-competeagreement was $195,283 and $162,737 for the years ended December 31, 2004 and2003, respectively.  The estimatedamortization expense during each of the remaining fiscal years of thenon-compete agreement are as follows: for 2005 - $195,283; for 2006 - $195,284;and for 2007 - $32,547.

 

**Long-LivedAssets:**  The Company reviews long-lived assets andidentifiable intangibles for impairment whenever events or circumstancesindicate that the carrying value of an asset may not be recoverable.  Recoverability of assets to be held and usedis measured by a comparison of the carrying value of an asset to theundiscounted expected future cash flows generated by that asset.  If the carrying value of that asset exceedsthe expected future cash flows, an impairment exists and is measured by theamount the carrying value exceeds the estimated fair value of the asset.  The SEVFL patents had a carrying value of$166,336 at December 31, 2004.  Sincethese patents involve a new technology, it is not presently possible toaccurately measure whether these costs are recoverable.  However, management believes that thistechnology 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 at December31, 2004 based on their current carrying value.

 

**FairValue of Financial Instruments:**  The fair value of financialinstruments is determined by reference to various market data and othervaluation techniques, as appropriate. Unless otherwise disclosed, the fair value of financial instrumentsapproximate their recorded value due primarily to their short-term nature.

 

The carrying value of theconvertible debt plus accrued interest was $485,403 at December 31, 2004.  The Company estimates the fair value of thedebt was approximately $516,000 based on a discount rate to reflect 

 

F-11

----

 

appropriate risk.  The carrying value of the liability for theseparation and consulting agreement with the Company’s former Chief Scientistwas $775,730 at December 31, 2004.  Thatvalue was based on the assumption that all amounts due under the contract wouldbe paid by March 6, 2007.  The paymentsare now expected to be spread over an additional year.  The Company estimates the fair value of thisliability, based on the current anticipated payment schedule and a revised discountrate to reflect appropriate risk, was approximately $670,000.

 

The estimated fair value offinancial instruments has been determined by the Company based on availablemarket information and appropriate valuation methodologies as of December 31,2004 and 2003, respectively.  However,considerable judgment is necessarily required in interpreting market data todevelop the fair value estimates.  Theestimates, therefore, may not be indicative of the amount the Company mightrealize in a current market exchange at those dates.  The discount rates used at December 31, 2004do not reflect any adjustment of the risk associated with our liabilities as aresult of the March 2005 private placement (see Note 16).

 

**Revenue Recognition:**  From March 2002 through January 2004, theCompany had one main source of potential revenues: royalty and milestonerevenues earned under the CIBA Agreement. After the January 30, 2004, effective date of the Transfer Agreement,the potential sources of revenue for the Company are from product sales made directlyby the Company or through distributors. Revenue will be recognized when each of the following four criteria aremet:

 

•                  There ispersuasive evidence that an arrangement exists;

 

•                  Delivery hasoccurred or services have been rendered;

 

•                  The sellingprice is fixed or determinable; and

 

•                  Collectibilityis reasonably assured.

 

Noroyalty or milestone revenues were ever earned under the CIBA Agreement.  In addition, the Company did not generate anyrevenues from product sales after entering into the Transfer Agreement.  The Company has sold its products in thepast, and intends to continue to sell its products, without the right ofreturn.  However, see Note 11 for adiscussion of claims made by certain customers requesting refunds on productspreviously sold to them.

 

TheCompany received a $2,000,000 advance royalty from CIBA in March 2002 that hadbeen deferred and was shown in the consolidated balance sheet at December 31,2003 as the “CIBA obligation”.  None ofthe $2,000,000 advance royalty had been earned as of January 30, 2004.  The advance royalty was exchanged for anotherobligation under the Transfer Agreement on January 30, 2004 (see Note 5).

 

**Research and Development Costs:**  Research and development costs, including thecosts of certain specialized equipment and the salaries of certain personneldevoting full time to research and development, are incurred to establish thefeasibility of, and to develop, the Company’s products and are charged tooperations.  As part of the separationand consulting agreement with our former Chief Scientist, a portion of thatcontract was designated as prepaid consulting expense for research anddevelopment of the ARMD device.  Theremaining balance of the prepaid consulting expense of $11,991 at September 30,2004 was written off as a result of our determining not to continue to pursuethe development of the ARMD device.

 

**Stock-Based Compensation:**  For all periods presented, the Company hasused the fair value based method of accounting for stock-based employeecompensation as defined in Statement of Financial Accounting Standards (“SFAS”)No. 123 “Accounting for Stock-Based Compensation”.   Under this method, stock-based employee compensationexpense is measured at the grant date based on the estimated fair value of theaward and is expensed over the vesting period. The Company begins recognizing such compensation cost as if all grantswill entirely vest.

 

F-12

----

 

Foroptions issued during the three years ended December 31, 2004, the fair valueof each option grant was estimated on the date of grant by using theBlack-Scholes option-pricing model.  Thefair value of options issued during the year ended December 31, 2004 wasapproximately $0.42 per share, during the year ended December 31, 2003 was approximately$1.14 per share, and during the year ended December 31, 2002 was approximately$0.51 per share.  The following weightedaverage assumptions were used in valuing the options granted during these periods:

 
| ** **              | ** ** | **2004**  | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Expected dividend yield |       | 0.00      | %          | 0.00     | %          | 0.00     | %          |
| Expected volatility     |       | 111.12    | %          | 60.50    | %          | 69.80    | %          |
| Risk-free interest rate |       | 2.87      | %          | 2.91     | %          | 4.88     | %          |
| Expected option lives   |       | 4.6 years |       | 6 years  |       | 10 years |       |

 

TheCompany recognized stock-based employee compensation expense for the yearsended December 31, 2004, 2003 and 2002 of $230,963, $791,697 and $7,650,respectively.  For the year endedDecember 31, 2004, stock-based employee compensation included $177,592 inreductions in previously recognized compensation expense due to the forfeitureof certain options prior to their vesting. As a result of the March 2005 financing (see Note 16), there was achange in control as defined in the stock option plan, which resulted in alloutstanding non-vested options becoming vested on March 1, 2005.  The charge for stock-based employeecompensation as a result of all options vesting will be approximately $169,000in the first quarter of fiscal year 2005.

 

**Loss per share:**  The net loss applicable to common shares wasused in the calculation of earnings per share for both basic and diluted lossper share.  There was no adjustment tothe calculation of diluted loss per share for dividends accrued on the sharesof the Series B convertible preferred stock of Ocular that were outstandinguntil 2003, as they were anti-dilutive.

 

The weighted average numberof shares of common stock outstanding for calculation of both basic and dilutedearnings per share was also the same. Options to purchase 1,738,428 shares of common stock and warrants topurchase 5,967,500 shares of common stock in 2004, options to purchase1,111,051 shares of common stock and warrants to purchase 5,520,000 shares ofcommon stock in 2003 and options to purchase 161,851 shares of common stock in2002 were not included in the computation of diluted earnings per share as theeffect of including the options and warrants in the calculation would beanti-dilutive.  Conversion of theCompany’s preferred stock was also not included in the calculation of dilutedearnings per share as it would also have been anti-dilutive.

 

**Comprehensive Loss:**  For all periods presented, comprehensive lossis equal to net loss.

 

**Deferred Offering Expenses:**  The Company has deferred certain costsassociated with common stock offerings until the offers are completed and thedeferred expenses are offset against the proceeds received from theofferings.  The balance of deferredoffering expenses outstanding at December 31, 2001 was written off during theyear ended December 31, 2002 as a result of the cancellation of theoffering.  During 2004 and 2003, theCompany expensed approximately $198,938 and $192,123, respectively, related toprivate placement offerings that were initiated but not consummated during thatyear.

 

**Income Taxes:** Deferred tax assets and liabilities areestablished for temporary differences between financial statement carryingamounts and the taxable basis of assets and liabilities at rates currently ineffect.  A valuation allowance isestablished for any portion of a deferred tax asset for which realization isnot likely.  The deferred tax asset isreviewed periodically to determine the amount considered realizable.

 

**Recently Issued AccountingPronouncements:** In December 2003, the Financial Accounting Standards Board (the “FASB”)issued Interpretation 46(R), “Consolidation of Variable InterestEntities”.  Currently, entities are requiredto include in their consolidated financial statements subsidiaries in which theenterprise has a controlling financial interest, usually considered a majorityvoting interest.  But, in many instances,the consolidated financial statements do not include variable interest entitieswith similar relationships.  TheInterpretation requires a company with a controlling financial interest in avariable interest entity to consolidate the assets, liabilities and results ofthe activities of the entity.  ThisInterpretation is effective for special-purpose entities for periods endingafter December 15, 2003 

 

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andfor other entities for periods ending after December 15, 2004.  The adoption of this Interpretation did nothave any effect on the Company’s consolidated financial statements.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”.  This statement revised SFAS No. 123originally issued in October 1995.  Thestatement eliminates the alternative to use APB Opinion No. 25, “Accounting forStock Issued to Employees” in accounting for stock-based employee compensation.  Under the revised SFAS 123, public entitiesare also required to measure liabilities incurred to employees in share-basedpayment transactions at fair value. Entities must now estimate the number of instruments for which the requisiteservice is expected to be rendered rather than accounting for forfeitures asthey occur, as permitted under the original statement.  Incremental compensation cost formodification of the terms or conditions of an award under the revised statementis now to be measured by comparing the fair value of the modified award withthe fair value of the award immediately before the modification.  The original statement required that thevalue of the award before modification be determined on the shorter of itsinitially expected life or the expected life of the modified award.  The revised statement also clarifies andexpands guidance in several areas, including measuring fair value, classifyingan award as equity or as a liability and attributing compensation cost toreporting periods.  It also requires thatexcess tax benefits be reported as a financing cash flow.  The effective date is as of the beginning ofthe first interim period or annual reporting period that begins after December15, 2005.  The Company has alreadyadopted SFAS No. 123; however, the Company does not recognize forfeitures untilthey occur.  Therefore, the Company willhave to estimate the number of awards expected to be forfeited for anynon-vested awards as of the required effective date and recognize the change,if any, as a cumulative change in accounting principle.  The adoption of this statement is notexpected to have a material effect on the results of operations.

 

InDecember 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,an amendment of APB Opinion No. 29”.  Theguidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, isbased on the principle that exchanges of nonmonetary assets should be measuredbased on the fair value of the assets exchanged.  The guidance included certain exceptions tothat principle.  This statement amendsAPB Opinion No. 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. This statement is effective for nonmonetary exchanges occurring infiscal periods beginning after June 15, 2005. The Company does not believe that the adoption of this statement willhave a material effect on its financial statements.

 

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

 

As a result of the March2003 private placement discussed in Note 4, and immediately before the mergerof Ocular into a wholly-owned subsidiary of Refocus, the holders of Ocular’sSeries B preferred stock and Series C preferred stock converted their sharesinto common stock of Ocular.  At the sametime, Ocular completed a 2.14-to-1 reverse split, resulting in 11,940,144shares of Ocular common stock outstanding, including the common shares issuedupon conversion of the preferred stock. All share and per share amounts prior to the Merger Closing Date shownin this report have been adjusted to reflect the reverse split.

 

Refocus was organized inNovember 2000 as VeryBestoftheInternet.com, Inc. (“VeryBest”).  VeryBest was an internet website rankingservice.  In February 2003, VeryBestreincorporated in Delaware and changed its name to Refocus Group, Inc.  Prior to the merger in March 2003, Refocuseffected a forward split of its common stock on the basis of approximately sixshares for each share issued and outstanding and also determined to change itsbusiness operations.  Following theforward-split and immediately prior to the March 2003 private placement andmerger, the founders of Refocus sold substantially all of their shares back tothe Company in exchange for $25,000.  Theamount paid for these shares has been deducted from paid-in capital.  As a result, immediately before the merger,Refocus had 4,097,107 shares of common stock outstanding.

 

On the Merger Closing Date,a wholly-owned subsidiary of Refocus was merged into Ocular, with Ocularsurviving as a wholly-owned subsidiary of Refocus.  Each share of Ocular common stock outstandingon the Merger Closing Date was converted into common stock of Refocus on aone-for-one basis.  Therefore, Refocus issued11,940,144 shares of common stock to stockholders of Ocular, representingapproximately 63% of Refocus’ 

 

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outstanding common stockfollowing the merger and the funding of the initial tranche of the March 2003private placement.  Following the merger,all of Refocus’ business operations are conducted through Ocular.

 

As part of the MergerAgreement, Refocus assumed the Amended and Restated Presby Corp 1997 StockOption Plan, and all outstanding options (after they were adjusted for the2.14-to-1 reverse split) were converted into the same number of options of Refocus.  Ocular had stock options outstanding toacquire 719,486 shares of common stock at the Merger Closing Date.  The exercise price of the assumed options wasadjusted to reflect the 2.14-to-1 reverse split prior to the merger.  See Note 9.

 

Since the stockholders ofOcular owned a majority of the issued and outstanding shares of common stock ofRefocus after the merger and the initial 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.  Because Refocus did not have any significantbusiness prior to the merger and its former operations were discontinued afterthe merger, there was no goodwill or other intangibles that arose from themerger.

 

The assets and liabilitiesassumed from Refocus on the Merger Closing Date are as follows:

 

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

 

The Company sold the websitetechnology to another company associated with the founders of VeryBest inexchange for the forgiveness of $1,800 in debt due them and took a $200 chargefor the remaining balance of the website technology, which is included in“Other income (expense)” in the consolidated statement of operations for theyear ended December 31, 2003.

 

The following tables presentthe unaudited pro forma results of operations for the year ended December 31,2003, assuming that the merger had occurred on January 1 of that year (inthousands, except per share amounts):

 
| ** **                                                            | ** ** | **As reported** | ** ** | **Pro forma** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------|------------|---------------|------------|
| Revenues                                                              |       | $               | —     |          | $          | — |   |
| Loss from operations                                                  |       | (5,596          | )          | (5,862        | )          |
| Net loss                                                              |       | (5,694          | )          | (5,960        | )          |
| Net loss applicable to common shares                                  |       | (5,699          | )          | (5,960        | )          |
| Net loss per share – basic and diluted                           |       | $               | (0.34      | )             | $          | (0.32 | ) |
| Average number of common shares outstanding  – basic and diluted |       | 16,862          |       | 18,473        |       |

 

The difference in the netloss for the Company as reported and the pro forma net loss is the result ofthe following:

 

•                  The net loss of Refocus from January 1, 2003to the Merger Closing Date was $5,903. Refocus had no revenues and had no provision for income taxes duringthis period.

•                  It was assumed that there would be no accrualof dividends or accretion of discount on the Series B preferred stock ofOcular, as the Series B preferred stock would be converted to common stock aspart of the merger as actually occurred on the Merger Closing Date.

•                  There would be additional expenses for legal,audit, public relations and other expenses related to being a publiccompany.  The Company estimated that anadditional $260,000 would have been incurred from January 1, 2003 to the MergerClosing Date.

 

**NOTE 3 –GOING CONCERN**

 

Since the merger betweenRefocus and Ocular in March 2003, the Company has been attempting to raiseadequate capital to be able to conduct its FDA trials for the treatment ofpresbyopia, continue its clinical trials in 

 

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Canada for the treatment ofocular hypertension and primary open angle glaucoma, apply to begin clinicaltrials for ocular hypertension and primary angle glaucoma in the United States,obtain CE Mark and other regulatory approvals to begin sales in Europe and inother international markets, and continue to improve the procedure, making itsimpler and with more consistent results.  Management has had to devote a significant amount of time to raisingcapital rather than to these matters. Management of the Company took certain steps in 2004 and 2003 to reducecash expenditures while pursuing additional financing.  Even with the $510,000 raised in October andNovember 2004 (see Note 7), the Company previously anticipated it would be outof funds by February 2005.  In January2005, a bridge loan of $500,000 was made by an investor who later funded a$7,001,000 private placement of preferred stock and warrants in March 2005 (seeNote 16).  Management of the Company believes, as a result of the March 2005private placement, that it has adequate funds on hand to pursue its currentlyanticipated business plan for the next twelve months.  There can be no assurances, however,that there will not be delays, complications or other unforeseen events,including increased costs, which prevent it from achieving its current businessplan over the next twelve months.

 

The Company cannot sell itsproducts in the United States until it receives approval from the FDA, andthere can be no assurance, even if the Company has adequate funding, that itwill 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 trail could causesubstantial delays in receiving approval. Delays may also arise from additional government regulation from futurelegislation, administrative actions or changes in FDA policies.  Therefore, the actual timing and amounts ofexpenditures required to obtain FDA approval cannot be predicted withcertainty, and the additional funding needed for these clinical trials may notbe available when needed.

 

Additional funding sourceswill be needed by March 2006 to continue with the Company’s business plan.  Assuming the Company receives permission tostart its Phase III trials from the FDA, and subject to customary closingconditions including the absence of a material adverse event, the Company has acommitment for $7,000,000 to be funded in March 2006 (see Note 16).  While the Company anticipates the reintroductionof the SSP in the European Union during 2005 or early 2006, assumingappropriate CE Mark approvals, it does not expect to generate any materialamount of revenues until 2007.  Theserevenues will provide a source of additional funding for the Company.  However, the additional funding in March 2006by Medcare and the anticipated revenues from international sales may notprovide adequate funds to continue the Company’s business plan for the next fewyears.  Therefore, the Company may stillrequire additional debt and/or equity financing to complete its business planin a timely manner.  There can be noassurances that additional financing can be obtained on reasonable terms or atall.

 

The Company’s continuationas a going concern is dependent upon its ability to obtain additional financingand, ultimately, to attain successful operations.  To attain successful operations, it mustsatisfactorily complete its FDA and other clinical trials and convince themedical community that the Company has a successful commercial product fortreating presbyopia, ocular hypertension and primary open angle glaucoma.  Until sufficient revenues are generated fromproduct sales, the Company will need to continue to seek additionalfunding.  If this funding is notavailable or the Company cannot successfully commercialize its products, theCompany may not be able to continue as a going concern.

 

The accompanying financialstatements have been prepared on a going concern basis, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business.  These financial statementsdo not include any adjustments to the recoverability and classification ofrecorded asset amounts or the amount and classification of liabilities thatmight be necessary should the Company be unable to continue as a going concern.

 

**NOTE 4 – PRIVATE EQUITY TRANSACTIONS**

 

In connection with the merger discussed in Note 2,and as a condition of that merger, Refocus completed a private placement ofshares of its common stock and warrants 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 (seeNote 15).

 

F-16

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The first tranche closed on the Merger Closing Dateand consisted of 2,875,000 units at $2.00 per unit.  Each unit wascomprised 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.  As a result, the investors in the first tranche of the privateplacement were issued 2,875,000 shares of Refocus common stock and warrants topurchase 1,437,500 shares of Refocus common stock.  In addition, 12,500 sharesof Refocus common stock, warrants to purchase 1,250,000 shares of Refocuscommon stock at an exercise price of $2.50 per share and warrants to purchase50,000 shares of Refocus common stock at an exercise price of $2.00 per sharewere issued to agents and others involved in the private placement.  The$2.50 warrants expire in three years, and the $2.00 warrants expire in fiveyears.

 

The warrants issued in connection with the initialtranche of the private placement were valued using the Black-Scholes option-pricingmodel.  The Company assumed an expected volatility rate of 59.8%, anexpected life of 2 years, a 1.38% risk-free interest rate and that no dividendswould be paid.  Based on these factors, the Company determined the valueof the $2.00 warrants to be $0.66, and the value of the $2.50 warrants to be$0.52, for each share of common stock that could be acquired, for a total valueof $1,430,500.

 

The Company paid certain agent and advisory fees andlegal, audit and other private placement costs from the proceeds received fromthe 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 |   |

 

The closing of the second tranche (and the fundingof investor funds in connection with the second tranche) was contingent oncertain events, one of which was the investment by CIBA of $1,250,000 in thesecond tranche.  As a result of theTransfer Agreement executed in January 2004, CIBA was relieved of itsobligation to make its second tranche investment.  Therefore, the investors in the first tranchecould no longer be compelled to fund the second tranche, and the second tranchewould never be funded.

 

The participants in the first tranche signed lock-upagreements that limited the amount of shares that could be sold eachmonth.  All remaining lock-up provisionsexpired March 6, 2005.

 

The Company conducted another private placement thatclosed December 23, 2003.  The Companysold 4,425,000 units at $.50 per unit. Each unit consisted of a share of common stock and a warrant to purchaseone-half share of common stock at an exercise price of $2.00 per share.  The warrants issued to these investors willexpire three years from the date of the closing.  The agent who conducted the private placementreceived a warrant to purchase 170,000 shares of common stock with the sameterms as the investors in the private placement.  The agent also had been previously issued awarrant to purchase 200,000 shares of common stock at an exercise price of $2.50per share that was to expire March 6, 2006. This warrant was cancelled and a new warrant for the same number ofshares and at the same exercise price was issued but with an expiration date ofDecember 23, 2006.  In addition, those investorswho participated in the March 2003 private placement, and who invested a dollaramount at least equal to their second tranche commitment, had their lock-upagreements 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.

 

The warrants issued in connection with this privateplacement were valued using the Black-Scholes option-pricing model.  TheCompany assumed an expected volatility rate of 111.3%, an expected life of 3years, a 2.40% risk-free interest rate and that no dividends would bepaid.  Based on these factors, the Company determined the value of the$2.00 warrants to be $0.18, and the value of the $2.50 warrant to be $0.16, foreach share of common stock that could be acquired, for a total value of$460,850.  The warrant that had beenpreviously issued to the agent in the March 2003 private placement that was cancelledhad a value of $104,000.

 

F-17

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The Company paid certain agent fees and legal, auditand other private placement costs from the proceeds received from the offeringas 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 the agent                                |   | (7,213   | )         |
| Expenses incurred by the Company                              |   | (4,915   | )         |
| Cash received from the offering                               |   | $        | 1,946,152 |   |

 

The Company also completed aprivate placement of $510,000 in convertible debt in October and November 2004(see Note 7) and a private placement of preferred stock for $7,000,000 in March2005 (see Note 16).

 

**NOTE 5 – CIBA AGREEMENTS**

 

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 an exclusiveworldwide license to market, distribute and sell the PSI, the PresVIEW IncisionSystem and related products.  The CIBAAgreement was subject to a number of terms and conditions, which included arequirement for CIBA to purchase equity interests in Ocular.  The Company’s products were to be marketedunder 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 if it wished to maintain its rights to an exclusive license of thePSI, the PresVIEW Incision System and related products.  CIBA paid the Company $2,000,000 as anadvance royalty, which is shown in the consolidated balance sheet at December31, 2003 as the “CIBA obligation”.  CIBApurchased 625,000 shares of Refocus common stock and a warrant to purchase312,500 shares of Refocus common stock in the first tranche of the March 2003private placement (see Note 4) 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 private placement.  CIBA had agreed to assume responsibility forthe legal defense of the Company’s worldwide PresVIEW patent portfolio againstpatent infringement.  CIBA also assumedresponsibility for the manufacturing, distribution and marketing of theCompany’s products at their expense.

 

At the time the CIBA Agreement was executed in March 2002, the Companyhad invented and produced a prototype of the PresVIEW Incision System.  In preparation for future marketing, theCompany and CIBA decided to make further enhancements and improvements to theincision 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.

 

CIBA’s surgical business unit marketed avariety of ophthalmic products and was primarily responsible for performing theCIBA Agreement.  In August 2003, CIBAannounced that it was seeking strategic alternatives for its surgical businessunit, including the sale of that unit. On December 29, 2003, CIBA informed management of the Company that itwas 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.  As a result, the Company begannegotiations with CIBA for the transfer of CIBA’s rights under the CIBAAgreement back to the Company and the termination of the license.

 

On January 30, 2004, the Company entered intothe 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, includingits obligation to purchase $1,250,000 of common stock and warrants in a secondtranche of the March 2003 private placement 

 

F-18

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and its commitments associated with manufacturing, marketing,distribution and regulatory matters. Under the Transfer Agreement, CIBA agreed to provide the Company withcertain transition services during 2004. As consideration for the acquisition of CIBA’s license rights, theforgiveness of the $2,000,000 in prepaid royalties the Company received underthe CIBA Agreement and the transition services to be performed by CIBA underthe Transfer Agreement, the Company agreed to pay CIBA an aggregate of$3,000,000 in twelve quarterly installments commencing in the first calendarquarter of 2006 (see the change in terms discussed below).  The Company, however, was entitled to prepayand extinguish the payment obligations by paying an aggregate amount of$2,000,000 to CIBA prior to January 1, 2006.

 

The $3,000,000 obligation had a present valueof approximately $1,612,000 at January 30, 2004, using an 18% discount rate,which estimated rate was based on interest rates available to companies withsimilar credit risk.  However, since theobligation can be extinguished by the payment of $2,000,000 prior to January 1,2006, the carrying value of the obligation will be the greater of its presentvalue or $2,000,000 until that date. Afterwards, the obligation will be carried at its present value.   Since the current value of the obligationwas the same as the unearned portion of the advance royalty payment forgiven atJanuary 30, 2004, no gain or loss was recognized at the date of the TransferAgreement.

 

Under the Transfer Agreement, CIBA returnedthe warrant to purchase 312,500 shares of Refocus common stock that it acquiredin the March 2003 private placement. While it retained the 625,000 shares of common stock acquired at thesame time, these shares are subject to certain restrictions on theirtransfer.  CIBA also agreed to certainrestrictions on their ability to solicit proxies for a two-year period.

 

CIBA’s transition services included thecontinuation of manufacturing processes to result in the delivery to theCompany of all existing PSI inventory. Prior to the CIBA Agreement executed in March 2002, the Companymanufactured a significant quantity of the PSI for future use.  The Company no longer has those manufacturingarrangements in place because CIBA assumed responsibility for manufacturingunder the CIBA Agreement.  Due to thesufficient quantity of PSIs on hand, CIBA did not establish an injectionmolding manufacturing arrangement during the term of the CIBA Agreement.  CIBA did, however, inspect and repackage theCompany’s PSI inventory for expected marketing by CIBA.  The Company believes that it has adequateinventory of the PSI for the Company’s expected requirements over at least thenext 12 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 the Company had formerly attained on the PSI no longerapplied.  The Company is now trying toregain its CE Mark certification and expects to complete that project during2005.

 

Therefore, the Company believes that the TransferAgreement had a material adverse impact on its financial condition.  It reduced future potential revenues fromminimum royalty and milestone payments, it moved the anticipated European saleslaunch farther into the future, and it increased the Company’s expensessubstantially for functions previously performed by CIBA when the Company’sfunds available to pay for these increased expenses were limited.  However, we believe the Transfer Agreementwas in the long-term best interest of the shareholders.

 

In February 2005, the Company and CIBA entered into the First Amendmentto License Transfer and Transition Services Agreement (the “Amendment”).  Under the Amendment, the Company is no longerobligated to pay to CIBA $3,000,000 on an installment basis.  Instead, under the Amendment, the Companywill pay to CIBA a 4% royalty on net sales from February 2005 until the earlierof December 31, 2009 or the date that CIBA shall have collected $3,250,000 inroyalties.  If the aggregate amount ofroyalties paid to CIBA is less than $3,250,000 by December 31, 2009, then on orbefore February 15, 2010, the Company will pay the difference to CIBA.  However, the Company still has the right toterminate its obligation by the payment of $2,000,000 before January 1, 2006.  Therefore, the Company will record theliability at the present value of the estimated payments to be made under theroyalty agreement based on projected sales; however, until January 1, 2006, theliability cannot be less than $2,000,000.

 

F-19

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**NOTE 6 –SEPARATION AND CONSULTING AGREEMENT**

 

On February 25, 2003, Dr.Ronald A. Schachar, the Company’s founder and former Chief Scientist, and theCompany entered into a Severance, Release and Consulting Agreement (the“Consulting Agreement”).  In accordancewith the Consulting Agreement, Dr. Schachar resigned as an officer, directorand employee of the Company at the Merger Closing Date.  The Company agreed to retain Dr. Schachar asa consultant for the term of the consulting agreement, which is from March 6,2003 to a period that ends when all amounts due Dr. Schachar under theConsulting Agreement have been paid (a maximum of five years).  He agreed not to compete with the Companyduring that time.  Dr. Schachar was toassist the Company in conducting research and development on its products forthe treatment of ARMD for the initial two years of the Consulting Agreement andassist in the maintenance of its patent portfolio and other matters for theentire term of the Consulting Agreement.

 

Subject to certainconditions, Dr. Schachar will be paid $1,750,000 over the consulting period, ofwhich $950,000 was paid in the first two years ($550,000 for the year beginningMarch 2003 and $400,000 for the year beginning March 2004).  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.

 

As security for the paymentof his consulting fees, the Company granted Dr. Schachar a non-exclusive securityinterest in its patent rights relating to the ARMD device and the SEVFL.  Dr. Schachar also received an assignment ofthe Company’s patents for the ARMD device outside the United States, which isrevocable under certain conditions.  Thecapitalized value of these assigned patents was $120,355.

 

The Company determined thatthe present value of the future cash payments for the $1,750,000 base paymentunder the Consulting Agreement plus the $24,000 in supplemental payments underthe Consulting Agreement was $1,437,270. The present value calculation assumed a 12% interest rate and paymentsof $400,000 per year in the third and fourth years so that all payments wouldhave been made at the end of four years.

 

Therefore, the total cost ofthe Consulting Agreement to the Company was the present value of future cashpayments plus the $120,355 capitalized value of the ARMD patents assigned toDr. Schachar, or $1,557,625.  Thesepayments were allocated to prepaid consulting payments related to the Company’soutstanding patents, to prepaid research and development consulting for thetreatment of ARMD, to a non-compete agreement and, finally, to severance costsas 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 |   |

 

The amount allocated to thenon-compete agreement and prepaid consulting are being expensed over fouryears.  The amount allocated to researchand development was to be expensed over two years; however, the Companydetermined in 2004 that it would not continue to pursue development of the ARMDdevice and wrote off the remaining balance of this prepaid asset (see Note1).  The balance of the obligation underthe Consulting Agreement at December 31, 2004 was $775,730, based on thepresent value of the remaining amounts due, with $266,695 classified as acurrent liability and $509,035 as a long-term liability.  For the years ended December 31, 2004 and2003, there were charges totaling $401,335 and $831,650, respectively, inconnection with the Consulting Agreement.

 

**NOTE 7 –CONVERTIBLE DEBT**

 

On October 8, 2004, the Company entered intoa loan agreement pursuant to which it issued $500,000 aggregate principalamount of its convertible promissory notes (the “Notes”) in a privateplacement.  The Company 

 

F-20

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subsequently issued an additional $10,000 in Notes in November2004.  The Company also issued warrantsto purchase 510,000 shares of the Company’s common stock at $0.22 per share(the “Warrants”) to these investors, each investor receiving a warrant topurchase the number of shares of the Company’s common stock equal to eachdollar of the Notes they purchased.  TheWarrants expire in five years.  The loanproceeds were used for working capital and general corporate purposes as wellas to fund other actions that were necessary to secure additional financing.

 

Of the $510,000 in gross proceeds received bythe Company, $250,000 was contributed by Verus International Group Ltd. (“VerusInternational”) or its designees (see Note 15).

 

The Notes bear interest at a rate of 12% perannum.  Unless the Notes are convertedinto the Company’s common stock in accordance with their terms (see discussionbelow), the principal amount and all accrued and unpaid interest due under theNotes is payable in one lump sum on or before April 8, 2005.

 

The Company estimated thevalue of the Warrants to be $72,200, using the Black-Scholes option-pricingmodel with an expected life of approximately 3 years, an expected volatilityrate of 114.1%, a 2.82% risk-free interest rate and that no dividends would bepaid.  The value of the Warrants wasrecorded as a discount on the Notes, which results in a discounted interestrate on the Notes of approximately 47% to maturity.

 

The Notes issued to investors, other than Verus International and itsdesignees, would automatically convert into the Company’s common stock if,among other things, on or prior to the maturity date of the Notes, the Companyconsummated a financing that was in the form of equity securities of theCompany aggregating at least $2,000,000 in new funds, where the proceeds of thefinancing were to be used for general working capital purposes.  The Company completed a financing that metthe criteria for automatic conversion in March 2005 (see Note 16). The conversionrate of the Notes was based on the equivalent price paid for the Company’scommon stock in the financing that triggered the automatic conversion.  A total of 1,088,795 shares of the Company’scommon stock were issued in lieu of the $260,000 in Notes plus accrued interestof $12,201 on March 1, 2005.  At December31, 2004, the amount of these Notes plus accrued interest is shown in long-termliabilities on the consolidated balance sheet.

 

The Notes issued to Verus International and its designees wouldautomatically convert into the Company’s common stock if, and only if, amongother things, on or prior to the maturity date of the Notes, a financing wasnot consummated that was in the form of equity securities of the Companyaggregating at least $3,000,000, where the proceeds of the financing were to beused for general working capital purposes. As a result of the financing that occurred on March 1, 2005, the Notesissued to Verus International and its designees will not be automatically converted.  These Notes, including accrued interest of$13,099, were repaid on March 17, 2005. At December 31, 2004, the amount of these Notes is shown as a currentliability.

 

The conversion price of the Notes that were automatically converted onMarch 1, 2005 was set at the equivalent common stock purchase price in thefinancing that triggered the conversion, or $0.25 per share.  The exercise price of the warrants issuedwith the Notes was set at $0.22 per share also as a result of the financing.

 

In accordance with their employment agreements, the Company’s ChiefExecutive Officer and Chief Financial Officer were issued stock options equalto 3.5% of the 510,000 shares of common stock of the Company that may beacquired under the Warrants.  The stockoptions for 17,850 shares of common stock were issued in 2004 at an exerciseprice of $0.60 per share.  These sameindividuals are entitled, under their employment agreements, to additionaloptions based on the 1,088,795 shares of common stock issued on the conversionof the Notes in 2005.  The final terms ofthese 2005 options are still to be determined by the Compensation Committee ofthe Board of Directors.

 

**NOTE 8 –PREFERRED STOCK, COMMON STOCK AND WARRANTS**

 

Ocular had designated4,500,000 shares of $.001 par value preferred stock as Series B and 65,000shares of $.001 par value preferred stock as Series C.

 

Between April 1998 and April2000, Ocular had issued 2,443,815 shares of Series B preferred stock.  Each share was convertible into 2.52 sharesof common stock of Ocular at the option of the holder or automatically based

 

F-21

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on the closing of a publicoffering.  Each share earned dividends atan annual rate of 12% of their stated value. Dividends were accrued but were deferred until October 31, 2002.  In the event of liquidation, the Series B preferredstockholders were entitled to $2.046 (the “stated value”) per share plus unpaiddividends prior to any distribution to the Series C preferred or commonstockholders.  The Series B preferredstock was redeemable at the option of the holders after May 1, 2005.

 

Effective July 15, 2002,Ocular reached an agreement with the Series B preferred stockholders wherebyOcular issued 2,012,344 shares of Series B preferred stock in lieu of accrueddividends and in lieu of any future dividends on the Series B preferredstock.  The shares were valued at statedvalue and the value of the shares issued over the amount of dividends accruedof $2,454,867 was accounted for as additional dividends on the Series B preferredstock.  No future dividends were accruedafter that date.  The agreement changedthe automatic conversion feature by adding a provision that if Ocular completeda sale of common stock where the aggregate gross proceeds were at least$5,000,000, the Series B stock would automatically be converted.  This provision was triggered as of the MergerClosing Date.

 

Ocular had an agreement withan entity, RAS Service LP (“Service LP”), owned by the Series B preferredstockholders and certain then current employees of Ocular.  The agreement was cancelled in July 2002, andOcular issued 25,237 shares of Ocular Series B preferred stock to Service LP inlieu 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-incapital.  These shares were alsoautomatically converted to Ocular common stock on the Merger Closing Date.

 

The Series C preferred stockwas convertible into 21 shares of Ocular’s common stock at any time and wouldautomatically convert upon certain events, one of which was the conversion of amajority of the Series B preferred stock into Ocular common stock.  In the event of liquidation, the Series Cpreferred stock would be entitled to received $100 per share after thedistribution to holders of the Series B preferred stock but before commonstockholders.  These shares were automaticallyconverted to Ocular common stock on the Merger Closing Date as a result of theconversion of the Series B preferred stock.

 

On the Merger Closing Date,there was a 2.14-to-1 reverse split of Ocular’s common stock 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 reverse split).  Therefore, with the 6,450,878 shares ofOcular common stock outstanding prior to the conversion of the preferred stockand after the 2.14-to-1 reverse split, there were a total of 11,940,144 sharesof common stock outstanding at the Merger Closing Date (see Note 2).  These shares were exchanged by thestockholders of Ocular for shares of Refocus on March 6, 2003 as part of themerger of Ocular into a wholly-owned subsidiary of Refocus.

 

The Company had 60,000,000 shares of $.0001 par value common stockauthorized as of December 31, 2003.  On July9, 2004, the Company’s Board of Directors approved an amendment to theCompany’s certificate of incorporation to increase the number of authorizedshares of common stock from 60,000,000 to 120,000,000 shares, subject to theadoption of the amendment by the stockholders of the Company.  The stockholders approved the increase in theauthorized shares, and, on October 12, 2004, the Company filed the amendment toits certificate of incorporation with the State of Delaware.  The number of shares of common stockoutstanding at December 31, 2004 was 23,542,770.

 

The Company has 10,000,000shares of $.0001 par value preferred stock authorized.  There were no shares of preferred stockissued or outstanding at December 31, 2004 and 2003.  The Company did issue shares of preferredstock on March 1, 2005 (see Note 16).

 

In May 2003, in connectionwith a consulting contract with an investment banker, in addition to themonthly retainer, the Company issued to the investment banker a warrant topurchase 200,000 shares of the Company’s common stock.  The Company also issued in May 2003 a warrantto purchase 200,000 shares of the Company’s common stock to an agent for aprivate placement that was never completed. Both warrants have an exercise price of $2.50 per share and expire March6, 2006.  The Company estimated the valueof these warrants to be $260,000, using the

 

F-22

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Black-Scholes option-pricingmodel with an expected life of approximately 1.8 years, an expected volatilityrate of 60%, a 1.31% risk-free interest rate and that no dividends would bepaid.  The value of both the warrants wascharged to expense.

 

In August 2004, the Companyissued a warrant to purchase 300,000 shares of the Company’s common stock to anagent for a potential private placement offering, which offering was nevercompleted.  The warrant has an exerciseprice of $0.25 per share and expires August 19, 2009.  The Company estimated the value of thewarrant to be $30,000 using the Black-Scholes option-pricing model with anexpected life of 4 years, an expected volatility rate of 112.7%, a 3.54%risk-free interest rate and that no dividends would be paid.  The value of the warrant was charged to expense.

 

The following table liststhe exercise price, expiration date and the number of shares of common stockthat could be purchased by the exercise of the Company’s outstanding warrantsfor the year ended December 31, 2004:

 
| ** **          | ** ** | ** **          | ** **        | **Number of common shares issuable on exercise** | ** ** |
|---------------------|------------|---------------------|-------------------|--------------------------------------------------|------------|
| **Exercise  Price** | ** ** | **Expiration Date** | ** **        | **Balance Beginning  of Year**                   | ** ** | **Additions** | ** ** | **Cancelled or  Forfeited** | ** ** | **Balance End  of Year** | ** ** |
| $                   | 0.22       |                | October 8, 2009   |                                             | —     |   | 510,000 |   | — |   | 510,000 |   |
| $                   | 0.25       |                | August 19, 2009   |                                             | —     |   | 300,000 |   | — |   | 300,000 |   |
| $                   | 2.00       |                | December 23, 2006 |                                             | 2,382,500  |   | — |   | — |   | 2,382,500 |   |
| $                   | 2.00       |                | March 6, 2008     |                                             | 50,000     |   | — |   | — |   | 50,000 |   |
| $                   | 2.50       |                | March 6, 2006     |                                             | 2,887,500  |   | — |   | (362,500 | ) | 2,525,000 |   |
| $                   | 2.50       |                | December 23, 2006 |                                             | 200,000    |   | — |   | — |   | 200,000 |   |
|                |       | Total               |              | 5,520,000                                        |       | 810,000 |   | (362,500 | ) | 5,967,500 |   |

 

Warrants for the purchase of200,000 shares of common stock with an exercise price of $2.50 per share thatexpire March 6, 2006 cannot be exercised unless the second tranche of the March2003 private placement is funded.  Sincethe second tranche will not be funded (see Note 4), these warrants will neverbe exercised.

 

 The Company has reserved 5,967,500 shares ofcommon stock for issuance upon the exercise of outstanding warrants.  The Company has also reserved 4,203,170shares of common stock for grant or issuance under the Amended and RestatedStock Option Plan discussed below.

 

**NOTE 9 –STOCK OPTIONS**

 

OnFebruary 25, 2003, Ocular’s Board of Directors adopted the Amended and RestatedPresby Corp 1997 Stock Option Plan (the “Plan”).  Shareholders of Ocular approved the Plan onMarch 4, 2003.  Refocus assumed this Planon the Merger Closing Date.  The Planprovides for the issuance of incentive stock options and non-qualified stockoptions to key employees, directors and independent contractors of the Company.  The exercise price for each incentive stockoption granted under the Plan may not be less than the market value of thecommon stock on the date of the grant. The exercise price for non-qualified stock options granted under thePlan are set by the Board but are, generally, set at the market value of thecommon stock at the grant date.  Unlessotherwise determined by the Board, incentive and non-qualified stock optionsgranted under the Plan have a maximum duration of ten and fifteen years,respectively.  The vesting periods for theseoptions vary, but they are generally for periods of three years or less.  As a result of the March 2005 financing (seeNote 16), there was a change in control as defined in the Plan, which resultedin all outstanding non-vested options becoming vested on March 1, 2005.  The charge for stock-based employeecompensation as a result of all options vesting will be approximately $169,000in the first quarter of fiscal year 2005.

 

Thetotal number of shares of common stock available for new grants under the Planafter March 4, 2003, is 4,100,000 shares. There were options to purchase 161,851 shares of common stockoutstanding prior to the amendment and restatement of the Plan.  Options to purchase 2,464,742 shares ofcommon stock are still available for grant under the Plan at December 31, 2004.

 

F-23

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See Note 1 forthe calculation of the weighted average fair value of options issued for thethree years ended December 31, 2004, as well as the weighted average factorsused to calculate those values.

 

Thefollowing table summarizes the information with respect to stock options forthe years ended December 31, 2004, 2003 and 2002, respectively:

 
| ** **                     | ** ** | **2004**   | ** ** | **2003**                               | ** ** | **2002**   | ** ** |
|--------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                     | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of year |       | 1,111,051  |       | $                                      | 1.787      |       | 161,851    |   | $ | 0.104 |   | 189,922 |   | $ | 0.098 |   |
| Granted                        |       | 967,850    |       | $                                      | 0.551      |       | 1,067,635  |   | $ | 1.986 |   | 7,010 |   | $ | 0.193 |   |
| Exercised                      |       | (13,295    | )          | $                                      | 0.092      |       | (19,136    | ) | $ | 0.092 |   | — |   | — |   |
| Canceled or expired            |       | (327,178   | )          | $                                      | 1.775      |       | (99,299    | ) | $ | 1.509 |   | (35,081 | ) | $ | 0.092 |   |
| Outstanding, end of year       |       | 1,738,428  |       | $                                      | 1.114      |       | 1,111,051  |   | $ | 1.787 |   | 161,851 |   | $ | 0.104 |   |
|                           |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Exercisable                    |       | 960,807    |       |                                   |       | 323,648    |       |   |   | 143,159 |   |   |   |

 

Thefollowing table summarizes information for options outstanding and exercisableat December 31, 2004:

 
| ** **               | ** ** | **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-$ 0.60 |       | 1,021,020               |       | 4.4 years                                              |       | $ | 0.502 |   | 360,652 |   | $ | 0.410 |   |
| $1.98 - $2.31            |       | 717,408                 |       | 4.2 years                                              |       | $ | 1.985 |   | 600,155 |   | $ | 1.986 |   |
|                     |       | 1,738,428               |       | 4.3 years                                              |       | $ | 1.114 |   | 960,807 |   | $ | 1.395 |   |

 

F-24

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**NOTE 10– SUPPLEMENTAL CASH FLOW AND BALANCE SHEET INFORMATION**

 

The following supplementalcash flow information is provided for interest and income taxes paid and fornon-cash transactions for the years ended December 31:

 
| ** **                                                                                                        | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Interest paid                                                                                                     |       | $         | —     |      | $          | 667       |       | $ | — |   |
| Income taxes paid                                                                                                 |       | —    |       | —    |       | —    |       |
| Non-cash transactions:                                                                                            |       |      |       |      |       |      |       |
| Value of common stock issued in lieu of  cash to directors                                                        |       | 102,776   |       | —    |       | —    |       |
| CIBA obligation related to an advance  royalty payment exchanged for future payments under the Transfer Agreement |       | 2,000,000 |       | —    |       | —    |       |
| Accretion of discount on Series B preferred  stock                                                                |       | —    |       | 4,306     |       | 23,482    |       |
| Accrual of dividends on Series B preferred  stock                                                                 |       | —    |       | —    |       | 322,195   |       |
| 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 warrants issued to agents or  investment bankers                                                         |       | 30,000    |       | 260,000   |       | —    |       |
| Value of Refocus common stock issued to  advisor                                                                  |       | —    |       | 21,750    |       | —    |       |
| Value of warrants issued to convertible  note holders                                                             |       | 72,200    |       | —    |       | —    |       |
|                                                                                                                   |            |           |            |           |            |           |            |  |  |  |

 

The following supplementalbalance sheet information is provided for prepaid expenses, other long-termassets and accrued expenses:

 
| ** **                                                     | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Prepaid expenses:                                              |       |                   |       |                   |       |
| Prepaid insurance                                              |       | $                      | 66,767     |                   | $          | 62,826 |   |
| Prepaid consulting expenses                                    |       | 61,668                 |       | 61,668                 |       |
| Prepaid research and development costs                         |       | —                 |       | 28,779                 |       |
| Prepaid FDA trial costs                                        |       | 10,572                 |       | 75,007                 |       |
| Other prepaid expenses                                         |       | 2,142                  |       | 2,184                  |       |
| Total                                                          |       | $                      | 141,149    |                   | $          | 230,464 |   |
|                                                           |       |                   |       |                   |       |
| Other long-term assets:                                        |       |                   |       |                   |       |
| Prepaid consulting expenses                                    |       | $                      | 71,947     |                   | $          | 133,615 |   |
| Prepaid research and development costs                         |       | —                 |       | 4,797                  |       |
| Total                                                          |       | $                      | 71,947     |                   | $          | 138,412 |   |
|                                                           |       |                   |       |                   |       |
| Accrued expenses:                                              |       |                   |       |                   |       |
| Accrued salaries, wages and benefits                           |       | $                      | 1,405      |                   | $          | 36,228 |   |
| Liability for possible replacement of  product already shipped |       | 50,000                 |       | 50,000                 |       |
| Audit fee accrual                                              |       | 52,000                 |       | 30,000                 |       |
| Accrued interest expense                                       |       | 12,157                 |       | 7,305                  |       |
| Director fees                                                  |       | 68,500                 |       | 131,500                |       |
| Accrued taxes                                                  |       | 4,687                  |       | 9,779                  |       |
| Other                                                          |       | 14,350                 |       | 12,500                 |       |
| Total                                                          |       | $                      | 203,099    |                   | $          | 277,312 |   |

 

F-25

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**NOTE 11– COMMITMENTS AND CONTINGENCIES**

 

The Company leases afacility in Dallas, Texas and, until September 2003, a facility in Denison,Texas.  Total lease expense for the yearsended December 31, 2004, 2003 and 2002 were approximately $18,000, $48,000 and$204,000, respectively.  There are noleases with remaining terms of one year or more at December 31, 2004.

 

The Company is involved invarious legal proceedings arising in the normal course of business.  These proceedings, for the most part, involvepatent litigation.  Management believesthe outcome of these matters will not materially affect the financialcondition, results of operations or cash flows of the Company.  The primary matters related to our patentsthat are being contested are discussed below.

 

On March 4, 2005, the Company was served with a lawsuit filed onFebruary 24, 2005, in the United States District Court, Central District ofCalifornia, Case No. CV05 1415WMB, by Biolase Technology, Inc., (“Biolase”).  In the complaint, Biolase is seeking adeclaratory judgment that the Company’s patent titled “Treatment of Presbyopiaand Other Eye Disorders” is invalid, unenforceable and not infringed upon byBiolase.  This patent relates to the methodsfor the treatment of presbyopia by weakening of the sclera.

 

In the fourth quarter of 2004, the Company was contacted by Biolaseregarding a potential license of our patent that is the subject of thislawsuit.  Consistent with our statedintent to pursue all alternative sources of financing, the Company entered intonegotiations for a license, but continued its negotiations for alternativesources of financing.  The negotiationswith Biolase did not conclude in any license being granted to Biolase, butinstead the Company finalized its March 2005 private placement (see Note 16).

 

The Company believes that the claims asserted by Biolase lack bothprocedural and substantive merit.  Althoughthe Company is unable to predict the ultimate outcome of this matter, itbelieves that the patent rights are valid and enforceable.  Accordingly, the Company intends to vigorouslydefend this patent against this declaratory relief action.

 

In May 2000, the Company filed a patent infringement suit againstHoward N. Straub, D.O., the Colorado Eye Institute, Restorvision, Inc. andLensTec, in the United States District Court for the District of Colorado.  The Company alleged that Straub hadperformed, or arranged for the performance of, surgical procedures on UnitedStates citizens and in foreign countries in which unauthorized copies of the Company’spatented PSI were used.  The Company andour patent counsel believe that the copies of the PSI created by the defendantsare covered under existing patents issued to the Company.  In June 2002, the Court granted a motionjointly proposed by both parties that stayed the litigation for a period oftwelve months.  The Court has grantedadditional twelve month stays until June 2005. During this period, the United States Patent and Trademark Office willcontinue its investigation into the validity of Restorvision’s patent applications.

 

If the Patent Office issues a patent on Restorvision’s modification,the Company and our patent counsel believe that Restorvision would still berequired to obtain a license to our underlying patents prior to marketing theRestorvision modification in the United States and in many countries around theworld.

 

Until April 1, 2003, theCompany carried product liability insurance coverage with 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 assumed thisresponsibility under the Transfer Agreement, the Company has not increased theamount of product liability coverage because of the low volume of its products thatare being used; however, it did increase the limit per occurrence to $5,000,000at its latest renewal.

 

As a result of the Company’ssuspension of sales of the PSI in 2001, while the Company was developing thePresVIEW Incision System, and the continued suspension of sales as a result ofthe CIBA Agreement, pursuant to which CIBA was supposed to exclusively handlethe Company’s future sales and marketing, the Company encouraged customers notto perform the SSP using the PSI until the PresVIEW Incision System wasavailable, and the 

 

F-26

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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.

 

In 2003, the Company wasinformed by two of its former foreign distributors that they were seeking refundson 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.

 

Prior to 2003, 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.

 

As a result of the TransferAgreement, the Company will be responsible for all future marketing.  As part of future marketing programs in theUnited States or internationally, the Company may determine that it is in itsbest interest to provide some compensation in the form of product discounts orby other means to the surgeons who bought our kits, and did not get toparticipate in the FDA trials, or to foreign distributors of our products.  At this time, the Company is currently unableto determine the amount of possible compensation, if any, that it may agree topay in the future.

 

A supplier had indicated toOcular that it believed it had a firm order for 150 prototypes of the PresVIEWIncision System, which the Company disputed. The Company settled this claim for $15,000 during the year ended December31, 2003.  The charge for the settlementis included in “Research and development” in the consolidated statement ofoperations for the year ended December 31, 2003.

 

**NOTE 12– OTHER RELATED PARTY TRANSACTIONS**

 

The Company leased itsDenison, Texas facility under a monthly operating lease agreement with Dr.Schachar.  The lease was terminatedAugust 31, 2003.  Total rent expense forthe years ended December 31, 2003 and 2002 was $32,000 and $48,000,respectively.

 

Ocular leased its formerDallas, Texas facility from a substantial holder of its Series B preferredstock.  Due to the downsizing of itsstaff in conjunction with the business changes contemplated in the CIBAAgreement, Ocular negotiated a settlement with its former lessor to abandonthat lease for a smaller facility.  Underthe contract, lease payments to the lessor of approximately $98,000 for theperiod from January through December 2003 were still due.  Ocular negotiated a reduced lease payment of$48,000 to the lessor.  This amount waspaid by March 2003.

 

On February 26, 2003, theChief Executive Officer, three of the Company’s then current directors and othersloaned the Company $250,000 to provide working capital until the Merger ClosingDate.  The annual interest rate on theloan was 12%, and the loan was due on the Merger Closing Date.  All but $25,000 of the amounts repaid wereused to purchase Refocus common stock in the March 2003 private placement.  Interest paid on the loans was $667.

 

The Chief Executive Officerand relatives of his, the Chief Financial Officer and Controller as well as twoof the Company’s then current directors purchased $135,000 of the $510,000 ofNotes issued in 2004.  These investorsalso received Warrants to purchaser 135,000 shares of the Company’s commonstock.  See Note 7 for terms of the Notesand Warrants.  The Notes wereautomatically converted into 565,560 shares of common stock on March 1, 2005.

 

F-27

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**NOTE 13 – INCOME TAXES**

 

Noprovision for income taxes has been recognized for the three years ended December31, 2004 as the Company incurred net operating losses for income taxpurposes.  The Company did not record anyfederal income tax benefit for its losses because of the uncertainty ofrealizing its deferred tax assets.  TheCompany has adjusted the valuation allowance to maintain a full valuation allowanceagainst the net deferred tax assets.

 

Whilethe Company had generated substantial tax loss carryforwards in prior years,the ability to use these loss carryforwards has been substantially affected as aresult of an ownership change (as defined in the Internal Revenue Code of 1986,as amended) that occurred in connection with the merger of Ocular into asubsidiary of Refocus.  The Companybelieved that the use of loss carryforwards generated prior to the MergerClosing Date would be limited going forward. However, due to the private placement investment on March 1, 2005 (seeNote 16), the Company believes there has been another ownership change thatwill further limit its ability to use its loss carryforwards generated prior tothat date.

 

Deferredtax assets consist of the following:

 
| ** **                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **2004**                    | ** ** | **2003** | ** ** |
| Deferred tax assets:             |       |                        |       |   |   |
| Net operating loss carryforwards |       | $                           | 6,213,622  |   | $ | 4,943,152 |   |
| CIBA obligation                  |       | 634,667                     |       | 680,000 |   |
| Stock option compensation        |       | 404,790                     |       | 326,263 |   |
| Consulting Agreement             |       | 76,219                      |       | 86,990 |   |
| Fixed assets and other items     |       | 19,614                      |       | 20,235 |   |
| Total deferred tax assets        |       | 7,348,912                   |       | 6,056,640 |   |
| Valuation allowance              |       | (7,348,912                  | )          | (6,056,640 | ) |
| Recognized deferred tax assets   |       | $                           | —     |   | $ | — |   |

 

Theincrease in the deferred tax asset valuation allowance for the year endedDecember 31, 2004 was $1,292,272.

 

AtDecember 31, 2004, the Company had net operating loss carryforwards for incometax purposes of approximately $10,196,000 generated prior to the Merger ClosingDate and $8,079,000 since the Merger Closing Date.  These net operating loss carryforwards willexpire primarily between 2018 and 2024. However, the change in ownership the Company believes occurred on March1, 2005 will limit the Company’s use of its loss carryforwards.  Based on preliminary estimates, the Companybelieves that use of tax loss carryforwards will be limited to approximately$260,000 per year, or about $5,200,000 before the loss carryforwards expire,and that the remainder of the loss carryforwards will be lost.

 

Thedifference between the Company’s effective tax rate and the federal statutoryrate of 34% are as follows:

 
| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Income tax benefit at statutory rate   |       | (34.0                       | )%         | (34.0 | )% | (34.0 | )% |
| Losses of foreign subsidiary and other |       | 0.3                         |       | 0.2 |   | — |   |
| Valuation allowance                    |       | 33.7                        |       | 33.8 |   | 34.0 |   |
| Total income tax expense               |       | 0.0                         | %          | 0.0 | % | 0.0 | % |

 

**NOTE 14 – EMPLOYEE BENEFIT PLAN**

 

TheCompany had a retirement savings plan under Section 401(k) of the InternalRevenue Code covering substantially all employees.  The Company’s contributions to the plantotaled $0, $0, and $14,713 for the years ended December 31, 2004, 2003 and 2002,respectively.  The plan was terminatedAugust 30, 2004.

 

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**NOTE 15 – VERUS AGREEMENT**

 

In the event that at least $1,000,000 was not raisedin a private placement within six months of March 6, 2003, on terms no lessfavorable than in a private placement consummated in March 2003 (see Note 4),Verus Support Services, Inc. (“Verus”) subscribed to purchase that number ofunits at $2.00 per unit in order to satisfy the deficiency between the amountof additional capital successfully raised and $1,000,000 ( the “VerusAgreement”).  Since no funds werereceived from a private placement within the six-month period, Verus wasrequired to fund the entire $1,000,000. During 2003, the Company gave Verus an 120-day extension to January 6,2004 to satisfy their funding requirement in exchange for their forgiveness of$60,000 in consulting fees due them.

 

In January 2004, a disputearose as to the continuing obligation of Verus under the Verus Agreement.  Verus and the Company, as a means ofdeferring and ultimately resolving this dispute, entered into amendments to theVerus Agreement to further extend to August 31, 2004 Verus’ obligation underthe Verus Agreement.

 

Effective October 8, 2004, theCompany, Ocular, Verus, and Verus International entered into the Terminationand Settlement Agreement (the “Verus Termination Agreement”).  The Company entered into the Verus TerminationAgreement in exchange for the purchase by Verus International and its designeesof $250,000 aggregate principal amount of the Notes issued in a privateplacement consummated by the Company on October 8, 2004 (see Note 7).

 

Pursuant to the Verus Termination Agreement, the Company and Verusagreed to settle their dispute arising under the Verus Agreement.  The Verus Termination Agreement, upon itseffective date, cancelled and terminated the Verus Agreement and Verus’obligations under that agreement.  TheVerus Termination Agreement also cancelled and terminated an agreement betweenOcular and Verus pursuant to which Verus provided advisory services to Ocularand the Company.  In addition, the VerusTermination Agreement released each party from, and bars any party frompursuing, any claims under the Verus Agreement and the advisory agreement.

 

**NOTE 16 – SUBSEQUENT EVENTS**

 

On January 27, 2005, the Company entered into a secured bridge notewith Medcare Investment Fund III, Ltd. (“Medcare”) for $500,000 to provideworking capital for the Company while the Company tried to finalize negotiationsfor a private placement investment by Medcare. The note was secured by the Company’s United States presbyopia patentsand trademarks, was guaranteed by the Company’s subsidiaries, bore interest at8% and was to be repaid upon the earlier of the closing of an investment byMedcare or July 26, 2005.

 

On February 25, 2005, the Company and Medcare entered into a term sheet(the “Term Sheet”) outlining a proposed investment by Medcare in theCompany.  The Term Sheet contained bothbinding and non-binding terms.  Among thebinding terms was a provision that provided that if the Company failed to closea transaction on the terms outlined in the Term Sheet, and Medcare was ready,willing and able to consummate the transaction, the Company was required to payMedcare a fee of $2,000,000 in addition to Medcare’s expenses.

 

In anticipation of the investment transactiondiscussed below, on March 1, 2005, the Board of Directors of the Company, pursuantto the Certificate of Incorporation of the Company, exercised its authority toissue in one or more series up to 10,000,000 shares of the Company’s preferredstock.  On March 1, 2005, the Companyfiled a Certificate of Designation, Rights and Preferences (the “Certificate ofDesignation”) with the Secretary of State of the State of Delaware, whichbecame effective upon its filing.  TheCertificate of Designation established a Series A-1 Convertible Preferred Stock(“Series A-1 Shares”), consisting of 280,000 shares, a Series A-2 ConvertiblePreferred Stock (“Series A-2 Shares”), consisting of 280,000 shares, and aSeries A-3 Convertible Preferred Stock (“Series A-3 Shares”), consisting of200,000 shares (collectively, the “Series A Preferred Stock”).

 

On March 1, 2005, the Company and Medcare entered into a SecuritiesPurchase Agreement (the “Purchase Agreement”) that documented the transactionscontemplated in the Term Sheet.  Pursuantto the Purchase 

 

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Agreement, the Company issued and sold, and Medcare purchased, 280,000shares of Series A-1Shares for an aggregate purchase price of $7,000,000, or$25 per share, and a warrant to purchase 133,334 shares of Series A-3 Sharesfor a purchase price of $1,000.  Aportion of the funds received were used to repay the Medcare bridge loan,including accrued interest of $3,667, and to repay a portion of Notes issued inOctober and November 2004 (see Note 7). The remainder of the funds will be used for general working capital purposes.

 

The Series A-1 Shares are convertible into shares of the Company’scommon stock at an effective conversion price of $0.25 per share.  The Warrant has an exercise price of $30 pershare for each of the Series A-3 Shares and expires on February 28, 2007.  The Series A-3 Shares are convertible intoshares of the Company’s common stock at an effective conversion price of $0.30per share.  The conversion price of theSeries A-1 Shares and Series A-3 Shares, and the exercise price of the warrant,are subject to adjustment based on customary anti-dilution protection provisions.

 

Additionally, pursuant to the PurchaseAgreement, in the event that the Company receives authorization in writing fromthe FDA to commence its Phase III clinical trials for the treatment ofpresbyopia without any material limitations, Medcare has committed to purchase280,000 shares of Series A-2 Shares for an aggregate purchase price of$7,000,000, or $25 per share, subject to customary closing conditions includingthe absence of a material adverse event. The Series A-2 Shares will be convertible into shares of the Company’scommon stock at an effective conversion price of $0.25 per share.  Medcare, however, is under no obligation topurchase the Series A-2 Shares until March 1, 2006.  Medcare may accelerate the timing of the purchaseof the Series A-2 Shares at its discretion by waiving any of the conditions.

 

The holdersof the Series A Preferred Stock are not entitled to any preferentialdividends.  Holders of the Series A PreferredStock, however, are entitled to participate on an as-converted basis in anycash dividends declared and paid on the Company’s common stock.

 

Uponthe liquidation, dissolution or winding up of the Company, an acquisition ofthe Company that results in the sale of more than 50% of the outstanding votingpower of the Company, or the sale or exclusive license of all or substantiallyall of the assets of the Company, the holders of the Series A Preferred Stockwill be entitled to receive, out of the legally available funds and assets ofthe Company, before any payment is made to any shares of the Company’s commonstock or other junior stock, an amount per share equal to the greater of:

 

•                                          two times the Applicable Stated Value (asdescribed below) of the share of Series A Preferred Stock; or

 

•                                          the amount that the holder of that share ofSeries A Preferred Stock would have received had the holder converted thatshare into shares of the Company’s common stock immediately prior to theliquidation event.

 

If the legally availablefunds and assets of the Company are insufficient to pay the holders of sharesof the Series A Preferred Stock the full amount to which they are entitled, theholders of the shares of Series A Preferred Stock and the holders of capitalstock of the Company that is on a parity with the Series A Preferred Stock willshare ratably in any distribution of the remaining legally available funds andassets of the Company.

 

The Applicable Stated Valueof a share of Series A Preferred Stock means $25 with respect to the Series A-1Shares or Series A-2 Shares or $30 with respect to the Series A-3 Shares.

 

The Series A Preferred Stockshall, with respect to rights on liquidation, winding up, corporate reorganizationand dissolution rank senior to the shares of the Company’s common stock andother junior stock.  The Series A-1Shares, the Series A-2 Shares and the Series A-3 Shares rank on parity witheach other.

 

A share of Series APreferred Stock is convertible at the option of the holder of that share, atany time and from time to time, into 100 shares of the Company’s common stock,or an effective price of $0.25 per share of common stock for the Series A-1Shares and the Series A-2 Shares and $0.30 per share of common stock for theSeries A-3 Shares.  The Series A-1 Sharesissued March 1, 2005 can be converted into 28,000,000 shares of the Company’scommon stock.  If the Series A-2 Sharesare issued, those shares can also be converted into 28,000,000 shares of theCompany’s common stock.  The Series A-3Shares, assuming the full exercise of the warrant for those shares, can be 

 

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converted into 13,333,400 shares of theCompany’s common stock.  The conversionrate of a share of Series A Preferred Stock into shares of the Company’s commonstock is subject to adjustment, from time to time, for, among other reasons,stock splits, combinations, dividends and distributions.  The conversion rate is also subject to anupward adjustment if the Company issues common stock, or an option, warrant orother instrument convertible into common stock, whose exercise price is lessthan the effective price of the Series A Preferred Stock then outstanding.  Shares of Series A Preferred Stock will beautomatically converted into shares of the Company’s common stock at the theneffective conversion rate upon the closing of an underwritten public offeringof shares of the Company’s common stock that results in gross proceeds to theCompany of at least $45,000,000.

 

Theholders of the shares of Series A Preferred Stock will be entitled to vote onall matters required or permitted to be voted upon by the common stockholdersof the Company.  Each holder of a shareof Series A Preferred Stock is entitled to the number of votes equal to thelargest number of full shares of the Company’s common stock into which allshares of Series A Preferred Stock held by that holder could be converted.  Except as required by law on matters requiringclass voting, the holders of the Series A-1 Shares, the Series A-2 Shares, theSeries A-3 Shares and the Company’s common stock will vote together as a singleclass.  As a result, the holders of theSeries A-1 Shares control over 50% of the Company’s voting stock at March 1,2005 and, thus, control the Company.  Asnoted below, as of March 1, 2005, the directors appointed by Medcare havesignificant veto rights over many actions that require Board of Directors approval.  They also have control over many day-to-daymanagement functions as a result of their having to approve expense and capitalbudgets, major variances from the budget, compensation policies and otheritems.

 

For so long as 70,000 shares of the Series A-1 Shares remainoutstanding, the holders of the Series A Preferred Stock, as a single class,are entitled to elect one-half of the members of the Board of Directors (the “SeriesA Directors”), one of whom will be elected as the Vice-Chairman of the Board ofDirectors, and to designate at least one Series A Director to serve on each ofthe committees of the Board of Directors. The Vice-Chairman is to receive $50,000 annually in addition to fees normallypaid to directors of the Company.

 

In the Purchase Agreement, the Company represented and warranted to,and covenanted with, Medcare as to various matters.  Among those covenants was that for so long as70,000 Series A-1 Shares remain outstanding, without the prior approval of theBoard of Directors of the Company, including at least two-thirds of the SeriesA Directors, the Company will not:

 

•                                          declare or pay any dividends (other thandividends payable solely in shares of the Company’s common stock and dividendspayable to the Company or another subsidiary of the Company) on or declare ormake any other distribution, directly or indirectly, on account of any sharesof the Company’s common stock now or hereafter outstanding;

 

•                                          repurchase any outstanding shares of capitalstock (other than repurchases of capital stock from any subsidiary of theCompany or any employees of the Company whose employment has been terminatedfor any reason, not to exceed $100,000 in the aggregate);

 

•                                          approve or modify by 10% or more theaggregate amount of any annual or other operating or capital budget, or approveor modify by 50% or more any single line item of any such operating or capitalbudget;

 

•                                          increase the salary of any officer or pay anybonus to any officer, director or employee not contemplated in a budget orbonus plan approved by the Series A Directors;

 

•                                          retain, terminate or enter into any salary oremployment negotiation or employment agreement with any employee or any futureemployee;

 

•                                          incur indebtedness (other than tradepayables) in excess of $50,000 in the aggregate, or enter into contracts orleases which require payments in excess of $50,000 in the aggregate;

 

•                                          make or incur any single capital expenditurein excess of $50,000, or aggregate capital expenditures in excess of $100,000,per fiscal year;

 

•                                          award stock options, stock appreciationrights or similar employee benefits or determine vesting schedules, exerciseprices or similar features;

 

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•                                          make any material change in the nature of thebusiness or enter into any new line of business, joint venture or similararrangement;

 

•                                          pledge its assets or guarantee theobligations of any other individual or entity;

 

•                                          recommend amendment of the Company’s existingrestricted stock and stock option plan or approval of any new equity incentiveplan; or

 

•                                          form or acquire any subsidiary, joint ventureor similar business entity.

 

Inaddition to any other vote or consent required, for so long as 70,000 shares ofSeries A-1 Shares remain outstanding, without the prior vote or approval of 75%of the then outstanding Series A Preferred Stock, the Company shall not:

 

•                                          amend its Certificate of Incorporation andBylaws in any manner that would alter or change any of the rights, preferences,privileges or restrictions of the Series A Preferred Stock;

 

•                                          reclassify any outstanding securities intosecurities having rights, preferences or privileges senior to, or on a paritywith, the Series A Preferred Stock;

 

•                                          authorize or issue any additional Series APreferred Stock or any other stock having rights or preferences senior to, oron a parity with, the Series A Preferred Stock, except for authorizations forissuances solely to the holders of Series A Preferred Stock;

 

•                                          merge or consolidate with or into anycorporation if such merger or consolidation would result in the stockholders ofthe Company immediately prior to such merger or consolidation holding (byvirtue of securities issued as consideration in such transaction or otherwise)less than a majority of the voting power of the stock of the survivingcorporation immediately after such merger or consolidation;

 

•                                          sell all or substantially all its assets in asingle transaction or series of related transactions;

 

•                                          license all or substantially all of itsintellectual property in a single transaction or series of related transactions;

 

•                                          liquidate or dissolve; or

 

•                                          alter any rights of the Series A Directors orthe holders of the Series A Preferred Stock or change the size of the Board ofDirectors.

 

As part of the Purchase Agreement, the Boardof Directors also amended the Bylaws of the Company to permit any Series ADirector to call a special meeting of the Board of Directors, to permit anySeries A Director or the holders of 51% of the outstanding Series A PreferredStock, as a single class, to call a special meeting of the stockholders, and torequire the Board of Directors to meet bi-monthly until March 1, 2006, and atleast quarterly after that date.

 

In connectionwith, and as condition to, entering into the Purchase Agreement, the Companyand Medcare entered into an Investors’ Rights Agreement.  The Investors’ Rights Agreement grantsMedcare certain demand, piggy-back and shelf registration rights and sets forththe procedures pursuant to which such rights may be exercised andeffected.  The Investors’ RightsAgreement also grants Medcare preemptive rights to purchase any or all of thesecurities of the Company that the Company proposes to issue on the same termsand conditions as the proposed issuance by the Company.

 

In accordancewith their employment agreements, the Company’s Chief Executive Officer andChief Financial Office are entitled to options equal to 3.5% of the equivalentnumber of shares of common stock issued in this financing, assuming conversionof the Series A-1 Shares and the Warrant, up to $5,540,000 of the $7,000,00 infinancing.  The final terms of these 2005options are still to be determined by the Compensation Committee of the Boardof Directors.

 

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