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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|          
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|          
|           |  | For the Quarterly Period Ended
    September 30, 2002                                       
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the Transition Period
    from           to           .                                 

Commission file number: 000-27212

Endocare, Inc.

(Exact Name of Registrant as Specified in Its
Charter)


|                         |  |                           
|------------------------ |  | --------------------------
|Delaware                 |  | 33-0618093                
|(State of Incorporation) |  | (I.R.S. Employer I.D. No.)

201 Technology Drive, Irvine, California
92618

(Address of Principal Executive Office,
Including Zip Code)


(949) 450-5400

(Registrants Telephone Number, Including
Area Code)


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

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

The number of shares of the Registrants
common stock, par value $.001 per share, outstanding at
May 31, 2004 was 24,007,482.



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ENDOCARE, INC. AND SUBSIDIARIES

FORM 10-Q, QUARTER ENDED
SEPTEMBER 30, 2002

TABLE OF CONTENTS

|                                                                                                       |  |      |    | 
|------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                       |  | Page
|                                                                                                       |  |     
|PART I 
    FINANCIAL INFORMATION                                                                     |  |      |    | 
|Item 1.  Condensed
    Consolidated Financial Statements                                               |  |      | 2  | 
|Condensed Consolidated
    Statements of Operations (Unaudited)                                        |  |      | 2  | 
|Condensed Consolidated
    Balance Sheets                                                              |  |      | 3  | 
|Condensed Consolidated
    Statements of Cash Flows (Unaudited)                                        |  |      | 4  | 
|Notes to Condensed
    Consolidated Financial Statements                                               |  |      | 5  | 
|Item
    2.  Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |      | 21 | 
|Item
    3.  Quantitative and Qualitative Disclosures About
    Market Risk                            |  |      | 37 | 
|Item 4.  Controls
    and Procedures                                                                   |  |      | 38 | 
|                                                                                                      
|PART II 
    OTHER INFORMATION                                                                        |  |      | 38 | 
|Item 1.  Legal
    Proceedings                                                                         |  |      | 38 | 
|Item 2.  Changes
    in Securities                                                                     |  |      | 40 | 
|Item 3.  Defaults
    Upon Senior Securities                                                           |  |      | 40 | 
|Item
    4.  Submission of Matters to a Vote of Security
    Holders                                   |  |      | 40 | 
|Item 5.  Other
    Information                                                                         |  |      | 40 | 
|Item 6.  Exhibits
    and Reports on Form 8-K                                                          |  |      | 40 | 
|SIGNATURE PAGE                                                                                         |  |      | 42 | 
|EXHIBIT INDEX                                                                                          |  |      | 43 | 
|EXHIBIT 31.1                                                                                          
|EXHIBIT 31.2                                                                                          
|EXHIBIT 32.1                                                                                          
|EXHIBIT 32.2                                                                                          



1



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##### Table of Contents



EXPLANATORY NOTE:We are filing this past due quarterly
report on Form 10-Q for the quarter ended
September 30, 2002 concurrently with our filing of past due
quarterly reports on Form 10-Q for the quarters ended
March 31, 2003, June 30, 2003 and September 30,
2003. Except as otherwise noted, this quarterly report on
Form 10-Q speaks as of the date of filing. Accordingly,
statements in this report on Form 10-Q containing the words
(i) now, currently,
present, to date, and words of similar
import, or (ii) believes, intends,
anticipates, expects,
estimates, should, could,
may, plans, planned, and
words of similar import, are used to refer to conditions
existing on the date of filing of this quarterly report on
Form 10-Q.




PART I  FINANCIAL
INFORMATION






|        |                                                
|------- | -----------------------------------------------
|Item 1. | Condensed Consolidated Financial
    Statements

ENDOCARE, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


(Unaudited)


|                        |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |            |            |  
|----------------------- | ----------------------------------- | -------------------------------------------------------------------------- | ---------- | ----------------- | ---------- | ---- | ---------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | - | ---------- | ---------- | ---------- | -
|                        |                                     |                                                                            |            |                  
|                        |                                     | Three Months Ended                                                         |            | Nine Months Ended
|                        |                                     | September 30,                                                              |            | September 30,    
|                        |                                     |                                                                            |            |                  
|                        |                                     | 2002                                                                       |            | 2001              |            | 2002 |            | 2001      
|                        |                                     |                                                                            |            |                   |            |      |            |           
|                        |                                     |                                                                            |            | (Restated)        |            |      |            | (Restated)
|Revenues                |                                     | $                                                                          | 8,381,793  |                   |            | $    | 3,783,075  |            |            | $ | 23,807,706  |            |            | $ | 9,522,511  |           
|Costs and expenses:     |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|                        | Cost of revenues                    |                                                                            |            | 4,525,786         |            |      |            | 1,580,084  |            |   |             | 12,018,692 |            |   |            | 4,377,149  |           
|                        | Research and development            |                                                                            |            | 489,890           |            |      |            | 526,029    |            |   |             | 2,051,744  |            |   |            | 1,907,343  |           
|                        | Selling, general and administrative |                                                                            |            | 8,408,328         |            |      |            | 4,397,892  |            |   |             | 24,075,011 |            |   |            | 11,891,740 |           
|                        |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|                        |                                     | Total costs and expenses                                                   |            |                   | 13,424,004 |      |            |            | 6,504,005  |   |             |            | 38,145,447 |   |            |            | 18,176,232 |  
|                        |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|Loss from operations    |                                     |                                                                            | (5,042,211 | )                 |            |      | (2,720,930 | )          |            |   | (14,337,741 | )          |            |   | (8,653,721 | )         
|Other income (expense): |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|                        | Interest income, net                |                                                                            |            | 317,314           |            |      |            | 46,996     |            |   |             | 934,511    |            |   |            | 12,004     |           
|                        | Loss on minority investment         |                                                                            |            |                  |            |      |            |           |            |   |             |           |            |   |            | (250,000   | )         
|                        |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|Net loss                |                                     | $                                                                          | (4,724,897 | )                 |            | $    | (2,673,934 | )          |            | $ | (13,403,230 | )          |            | $ | (8,891,717 | )         
|                        |                                     |                                                                            |            |                   |            |      |            |            |            |   |             |            |            |   |            |           
|                        |                                     | Net loss per share of common stock, basic and
    diluted                  |            | $                 | (.19       | )    |            | $          | (.16       | ) |             | $          | (.57       | ) |            | $          | (.56       | )
|                        |                                     | Weighted average shares of common stock
    outstanding, basic and diluted |            |                   | 24,279,000 |      |            |            | 16,920,505 |   |             |            | 23,695,667 |   |            |            | 15,892,333 |  

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

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ENDOCARE, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE
SHEETS


|                                         |                                                                                                                       |                                            |           |              |             |  |   |             |            | 
|---------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | --------- | ------------ | ----------- |  | - | ----------- | ---------- | 
|                                         |                                                                                                                       | September 30,                              |           | December 31,
|                                         |                                                                                                                       | 2002                                       |           | 2001        
|                                         |                                                                                                                       |                                            |           |             
|                                         |                                                                                                                       | (Unaudited)                                |           |             
|ASSETS                                  
|Current assets:                          |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         | Cash and cash equivalents                                                                                             |                                            | $         | 23,779,675   |             |  | $ | 81,886,801  |           
|                                         | Available-for-sale securities                                                                                         |                                            |           | 20,200,893   |             |  |   |            |           
|                                         | Accounts receivable, net                                                                                              |                                            |           | 8,068,301    |             |  |   | 4,832,963   |           
|                                         | Inventories                                                                                                           |                                            |           | 5,061,434    |             |  |   | 2,129,797   |           
|                                         | Prepaid expenses and other current assets                                                                             |                                            |           | 824,190      |             |  |   | 362,951     |           
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         |                                                                                                                       | Total current assets                       |           |              | 57,934,493  |  |   |             | 89,212,512 | 
|                                         | Property and equipment, net                                                                                           |                                            |           | 8,017,831    |             |  |   | 1,749,126   |           
|                                         | Goodwill                                                                                                              |                                            |           | 35,081,479   |             |  |   |            |           
|                                         | Intangibles, net                                                                                                      |                                            |           | 16,127,822   |             |  |   | 656,374     |           
|                                         | Investments and other assets                                                                                          |                                            |           | 3,784,835    |             |  |   | 3,475,594   |           
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         |                                                                                                                       | Total assets                               |           | $            | 120,946,460 |  |   | $           | 95,093,606 | 
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         | Accounts payable                                                                                                      |                                            | $         | 4,414,364    |             |  | $ | 1,807,500   |           
|                                         | Accrued compensation                                                                                                  |                                            |           | 2,394,333    |             |  |   | 1,020,462   |           
|                                         | Other accrued liabilities                                                                                             |                                            |           | 6,213,717    |             |  |   | 1,385,078   |           
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         |                                                                                                                       | Total current liabilities                  |           |              | 13,022,414  |  |   |             | 4,213,040  | 
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|Minority interests                       |                                                                                                                       |                                            | 1,281,287 |              |             |  |  |            
|Commitments and contingencies            |                                                                                                                       |                                            |           |              |             |  |   |            
|Stockholders equity                     |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         | Preferred stock, $.001 par value;
    1,000,000 shares authorized; none issued and outstanding                        |                                            |           |             |             |  |   |            |           
|                                         | Common stock, $.001 par value;
    50,000,000 shares authorized; 24,280,620 and 22,051,826
    issued and outstanding |                                            |           | 24,329       |             |  |   | 22,079      |           
|                                         | Additional paid-in capital                                                                                            |                                            |           | 169,534,717  |             |  |   | 138,337,026 |           
|                                         | Accumulated deficit                                                                                                   |                                            |           | (60,429,377  | )           |  |   | (46,945,837 | )         
|                                         | Receivable from stockholder                                                                                           |                                            |           | (278,542     | )           |  |   | (471,292    | )         
|                                         | Accumulated other comprehensive income, net of tax                                                                    |                                            |           | 17,590       |             |  |   |            |           
|                                         | Deferred compensation                                                                                                 |                                            |           | (154,327     | )           |  |   |            |           
|                                         | Treasury stock at cost, 201,200 and 27,000 shares                                                                     |                                            |           | (2,071,631   | )           |  |   | (61,410     | )         
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         |                                                                                                                       | Total stockholders equity                 |           |              | 106,642,759 |  |   |             | 90,880,566 | 
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            
|                                         |                                                                                                                       | Total liabilities and stockholders equity |           | $            | 120,946,460 |  |   | $           | 95,093,606 | 
|                                         |                                                                                                                       |                                            |           |              |             |  |   |            

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

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ENDOCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS

(Unaudited)


|                                                        |                                                                                                                            |                   |             |             |   |   |            |            |  
|------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ----------------- | ----------- | ----------- | - | - | ---------- | ---------- | -
|                                                        |                                                                                                                            |                  
|                                                        |                                                                                                                            | Nine Months Ended
|                                                        |                                                                                                                            | September 30,    
|                                                        |                                                                                                                            |                  
|                                                        |                                                                                                                            | 2002              |             | 2001       
|                                                        |                                                                                                                            |                   |             |            
|                                                        |                                                                                                                            |                   |             | (Restated) 
|Net cash used in operating activities                   |                                                                                                                            |                   | (11,851,408 | )           |   |   | (8,839,344 | )         
|Cash flows from investing activities:                   |                                                                                                                            |                   |             |             |   |   |            |           
|                                                        | Acquisitions, net of cash acquired                                                                                         |                   |             | (24,092,497 | ) |   |            |           |  
|                                                        | Purchases of property and equipment                                                                                        |                   |             | (1,815,754  | ) |   |            | (544,742   | )
|                                                        | Intangibles                                                                                                                |                   |             |            |   |   |            | (50,000    | )
|                                                        | Loan made to investee                                                                                                      |                   |             |            |   |   |            | (250,000   | )
|                                                        | Repayment of loan made to investee                                                                                         |                   |             |            |   |   |            | 250,000    |  
|                                                        | Purchases of available-for-sale securities                                                                                 |                   |             | (20,183,303 | ) |   |            |           |  
|                                                        | Other assets                                                                                                               |                   |             | (119,443    | ) |   |            |           |  
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Net cash used in investing activities                   |                                                                                                                            |                   | (46,210,997 | )           |   |   | (594,742   | )         
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Cash flows from financing activities:                   |                                                                                                                            |                   |             |             |   |   |            |           
|                                                        | Payments on credit facility and note payable                                                                               |                   |             |            |   |   |            | (1,032,603 | )
|                                                        | Stock options and warrants exercised                                                                                       |                   |             | 1,965,500   |   |   |            | 1,772,528  |  
|                                                        | Repurchase of treasury stock                                                                                               |                   |             | (2,010,221  | ) |   |            |           |  
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Net cash (used in) provided by financing
    activities |                                                                                                                            |                   | (44,721     | )           |   |   | 739,925    |           
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Net decrease in cash and cash equivalents               |                                                                                                                            |                   | (58,107,126 | )           |   |   | (8,694,161 | )         
|Cash and cash equivalents, beginning of period          |                                                                                                                            |                   | 81,886,801  |             |   |   | 22,016,448 |           
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Cash and cash equivalents, end of period                |                                                                                                                            | $                 | 23,779,675  |             |   | $ | 13,322,287 |           
|                                                        |                                                                                                                            |                   |             |             |   |   |            |           
|Non-cash activities:                                    |                                                                                                                            |                   |             |             |   |   |            |           
|                                                        | Convertible debentures and accrued interest
    converted to common stock, net of unamortized deferred financing
    costs |                   | $           |            |   |   | $          | 7,241,641  |  
|                                                        | Transfer of inventory to property and equipment
    for placement at customer sites                                        |                   |             | 1,872,571   |   |   |            | 35,280     |  
|                                                        | Common stock exchanged for investment in USMD                                                                              |                   |             |            |   |   |            | 2,837,293  |  
|                                                        | Common stock issued and options assumed in the
    acquisition of Timm Medical                                             |                   |             | 25,741,128  |   |   |            |           |  
|                                                        | Common stock issued for patents and
    covenant-not-to-compete                                                            |                   |             | 3,257,139   |   |   |            | 150,000    |  
|                                                        | Change in unrealized gain on available-for-sale
    securities                                                             |                   |             | 17,590      |   |   |            |           |  

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

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ENDOCARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS



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

Endocare, Inc. (Endocare or the
Company) is a medical device company focused on
developing, manufacturing and selling cryosurgical products with
the potential to improve the treatment of cancer and other
tumors. In addition, through its wholly-owned subsidiary, Timm
Medical Technologies, Inc. (Timm Medical), the
Company offers vacuum therapy systems for non-pharmaceutical
treatment of erectile dysfunction. The Company was formed in
1990 as a research and development division of Medstone
International, Inc., a manufacturer of shockwave lithotripsy
equipment for the treatment of kidney stones. The Company was
incorporated under the laws of the state of Delaware in 1994 and
became an independent, publicly-owned corporation upon
Medstones distribution of the Companys stock to the
existing stockholders on January 1, 1996.

Following the rules and regulations of the
Securities and Exchange Commission (the SEC), the
Company has omitted footnote disclosures in this report that
would substantially duplicate the disclosures contained in the
Companys annual audited financial statements. The
accompanying unaudited condensed consolidated financial
statements should be read together with the consolidated
financial statements and the notes thereto included in the
Companys December 31, 2002 and 2003 Annual Reports on
Form 10-K, filed with the SEC on December 3, 2003 and
March 15, 2004, respectively.

Additionally, the condensed consolidated
financial statements for the quarter ended September 30,
2001 contained in this report reflect various restatement
adjustments made as a result of a review by management of
historical financial statements previously filed with the SEC,
including the report filed for that period. For a further
description of the nature and status of these adjustments see
Note 4 below, Item 2 
Managements Discussion and Analysis of Financial Condition
and Results of Operations and Note 3 to our
consolidated financial statements contained in the
Companys Annual Report on Form 10-K for the year
ended December 31, 2002 filed with the SEC on
December 3, 2003.

The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with
U.S. generally accepted accounting principles for interim
financial information and reflect all adjustments, consisting
solely of normal recurring accruals, needed to present fairly
the financial results for these interim periods. The condensed
consolidated results of operations presented for the interim
periods are not necessarily indicative of the results for a full
year.

All intercompany transactions and accounts have
been eliminated in consolidation.



|   |                                           
|-- | ------------------------------------------
|2. | Recent Operating Results and
    Liquidity

The Companys operating results for the nine
months ended September 30, 2002 reflect sales and gross
profits, as well as operating expenses, associated with certain
non-core product lines divested during 2003. While these
divestitures have allowed the Company to better concentrate on
its core businesses, they have also eliminated some sources of
revenue and gross profit for the Company going forward. In
addition, while the Company lowered certain operating costs in
2003 by consolidating functions at its Irvine, California
headquarters that were formerly performed by its subsidiaries,
the Company has also incurred significant one-time charges
associated with ongoing investigations related to its historical
accounting and financial reporting. These costs amounted to
approximately $20.2 million from the fourth quarter of 2002
through the first quarter of 2004 (including executive severance
charges of $3.2 million in the third quarter of 2003). In
addition to charges for executive severance payments, these
non-recurring expenses have included legal fees and settlements,
audit fees and accounting support fees.

Since inception, the Company has incurred losses
from operations and has reported negative cash flows. As of
September 30, 2002, the Company had an accumulated deficit
of $60.4 million and cash and available-for-sale securities
of $44.0 million. For all periods since September 30,
2002, the Company has continued to incur operating losses. As
discussed above, commencing in the fourth quarter of 2002, the

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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Company incurred, and continues to incur,
significant costs in connection with internal and regulatory
investigations into its historical accounting and financial
reporting. The Company also faces potentially large costs
related to directors and officers liability
insurance, delinquent state and local tax obligations, as well
as additional expenditures needed to bring the Company into
compliance with SEC rules and regulations, including with
Section 404 of the Sarbanes-Oxley Act of 2002, and efforts
to regain listing on a national exchange or market.

There may also be material cash payments required
in connection with resolving a class action and a derivative law
suit (see Note 7). The Company may be required to pay
judgments or settlements and to incur expenses in defending
against these claims that could exceed the Companys
directors and officers liability insurance coverage.
Regulators may fine the Company when the investigations are
complete.

The Company continued to experience growth in
cryosurgical probe and procedure revenues during 2003 and into
the first quarter of 2004. Costs and expenses have also grown
through this period. Management plans continued investment in
sales and marketing to increase market penetration and in
research and development to improve existing products and
develop new ones. The Company will continue to use cash reserves
to finance its cash flow deficit. If the Company is unable to
generate cash flows from operations, it may need to raise
additional capital to fund operations through the sale of equity
securities to public or private investors, debt or the sale or
licensing of its assets. Additional capital, if needed, might
not be available on terms acceptable to the Company, or at all.
If additional capital were raised through the issuance of equity
securities, the percentage of the Companys stock owned by
its then-current stockholders would be reduced.

The Company has no long-term debt and no other
material financial commitments other than those under operating
lease agreements and purchase commitments for raw materials used
in manufacturing its products.



|   |                               
|-- | ------------------------------
|3. | Goodwill and Intangible Assets

The excess of the purchase price over the fair
value of net assets acquired has been allocated to goodwill and
identifiable intangible assets. The Company had no reported
goodwill prior to January 1, 2002. The Company does not
amortize goodwill, which is consistent with the provisions of
Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and other Intangible
Assets, but goodwill is subject to impairment tests on an
annual basis or more frequently if impairment indicators exist.
Under the guidance of SFAS No. 142, the Company uses a
discounted cash flow methodology to assess the fair values of
its reporting units. Impairment is measured by comparing the
goodwill derived from the hypothetical purchase price allocation
to the carrying value of the goodwill balance. During the fourth
quarter of 2002, the Company recorded an impairment charge of
$18 million to reduce the carrying value of goodwill
acquired in the Timm Medical acquisition resulting from the
termination or abandonment of three of the acquired distribution
agreements for urological products following the acquisition.

Intangible assets that are deemed to have finite
useful lives are recorded at cost and amortized using the
straight-line method over their estimated useful lives.
Estimated useful lives of such intangible assets are as follows:

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

Changes in circumstances (for example, changes in
laws or regulations to which the Company is subject,
technological advances or changes in the Companys
strategies) may result in changes to the useful lives from

6



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ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

initial estimates. Factors such as changes in the
planned use of intangibles may result from changes in customer
base, contractual agreements, or regulatory requirements and may
result in shorter useful lives. In such circumstances, the
Company will revise the useful life of the long-lived asset and
amortize the remaining net book value over the adjusted
remaining useful life. There were no changes in estimated useful
lives during 2002 and 2003.



|   |                                    
|-- | -----------------------------------
|4. | Restatement of Financial Statements

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

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

To address the matters discovered in the
investigations, the Company has implemented remedial actions,
including improved processes for and controls over all financial
transactions and the employees involved in them. These remedial
actions included the development and implementation of policies
and procedures governing sales personnel and sales orders, new
and more stringent credit approval practices, the adoption of
improved expense recognition and approval policies, improved
controls and documentation over the issuance of options and
warrants in financial transactions, and new internal financial
reporting procedures.

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



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

The Company discovered that its revenues had been
overstated relating to the sale of Cryocare Surgical System
units and cryoprobes because certain sales did not meet all
revenue recognition criteria required under Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial
Statements. The Company restated previously recognized
revenues related to certain Cryocare Surgical Systems and
cryoprobes transactions by

7



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

$432,000 and $986,000 for the quarter and nine
months ended September 30, 2001 respectively. These
adjustments primarily relate to the following:



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



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

The Company made certain adjustments to increase
cost of revenues, which totaled $291,000 and $641,000 for the
quarter and nine months ended September 30, 2001,
respectively. These adjustments primarily relate to the
following:



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

8



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c. Reclassification to cost of revenues
    certain research and development and quality assurance expenses
    related to routine manufacturing operations.



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

The Company made certain adjustments to increase
selling, general and administrative expenses, which totaled
$870,000 and $1,900,000 for the quarter and nine months ended
September 30, 2001, respectively, and to reduce research
and development costs by $240,000 and $685,000 for the quarter
and nine months ended September 30, 2001, respectively.
These adjustments primarily relate to the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. Failure to consistently accrue expenses
    in the periods when the obligations were incurred, including
    accrual of expenses in the period invoices were received rather
    than in the period the expenses were incurred; capitalization of
    legal, transactional and advertising expenses normally expensed;
    and establishing and recording unsupported general reserves.                                                                                                                                                                                                                                                     
|
| | b. Insufficient accrual of capital, sales
    and use taxes, and state and local taxes, which are assessed on
    a basis other than taxable income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | c. Incorrect recording of: (1) expenses
    associated with stock options and warrants issued as
    compensation to consultants; (2) the assets and related
    amortization where warrants were issued to acquire certain
    patents; and (3) the deferred financing costs and related
    amortization expense for warrants issued to lenders in
    connection with debt financings. Adjustments were recorded to
    expense the fair value of consultant stock options and warrants
    in the period services were provided, and capitalize and
    amortize the fair value of warrants issued to acquire patents
    and finance debt.
|
| | d. Forgiveness of an interest-bearing loan
    made to a Company executive (see Note 8) for the
    purchase of Company common stock. Adjustments were recorded to
    write-off the principal and interest over a 4-year period as
    compensation expense.                                                                                                                                                                                                                                                                                                                                                                                  
|
| | e. Reclassification from research and
    development to S,G&A of certain expenses related to
    collection of clinical data for marketing purposes, consulting
    and patent litigation. (see Cost of Revenues, paragraph c.
    above).                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | f. Incorrect capitalization of certain costs
    related to acquisition activities which should have been
    expensed as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | g. Absence of substantiation for the
    existence and/or carrying values of certain property and
    equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



| |                      
| | ---------------------
| | Other Income and Loss

The Company made certain adjustments to decrease
other income, net, which totaled $64,000 and $136,000 for the
quarter and nine months ended September 30, 2001,
respectively. These adjustments primarily relate to the
following:



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

The consolidated financial statements for the
three months and nine months ended September 30, 2002 and
2001, and notes thereto have been restated to include the items
described above.

9



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Consolidated Statements of
Operations

|                                                                            |  |               |            |               |  |               |            |               |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------------- |  | ------------- | ---------- | ------------- |  | ------------- | ---------- | ------------- |  | - | ---------- | - |  | - | ---------- | -
|                                                                            |  | As Previously |            |               |  | As Previously |            |              
|                                                                            |  | Reported      |            | Restated      |  | Reported      |            | Restated     
|                                                                            |  | Three Months  |            | Three Months  |  | Nine Months   |            | Nine Months  
|                                                                            |  | Ended         |            | Ended         |  | Ended         |            | Ended        
|                                                                            |  | September 30, |            | September 30, |  | September 30, |            | September 30,
|                                                                            |  | 2001          |            | 2001          |  | 2001          |            | 2001         
|                                                                            |  |               |            |               |  |               |            |              
|Revenues                                                                    |  | $             | 4,214,766  |               |  | $             | 3,783,075  |               |  | $ | 10,508,202 |   |  | $ | 9,522,511  |  
|Cost of revenues                                                            |  |               | 1,289,414  |               |  |               | 1,580,084  |               |  |   | 3,735,707  |   |  |   | 4,377,149  |  
|Research and development                                                    |  |               | 766,417    |               |  |               | 526,029    |               |  |   | 2,592,681  |   |  |   | 1,907,343  |  
|Selling, general and administrative                                         |  |               | 3,527,527  |               |  |               | 4,397,892  |               |  |   | 9,992,021  |   |  |   | 11,891,740 |  
|                                                                            |  |               |            |               |  |               |            |               |  |   |            |   |  |   |            |  
|Total costs and expenses                                                    |  |               | 5,583,358  |               |  |               | 6,504,005  |               |  |   | 16,320,409 |   |  |   | 18,176,232 |  
|                                                                            |  |               |            |               |  |               |            |               |  |   |            |   |  |   |            |  
|Loss from operations                                                        |  |               | (1,368,592 | )             |  |               | (2,720,930 | )             |  |   | (5,812,207 | ) |  |   | (8,653,721 | )
|Loss on minority investment                                                 |  |               |           |               |  |               |           |               |  |   |           |   |  |   | (250,000   | )
|Interest income, net                                                        |  |               | 110,546    |               |  |               | 46,996     |               |  |   | 148,087    |   |  |   | 12,004     |  
|                                                                            |  |               |            |               |  |               |            |               |  |   |            |   |  |   |            |  
|Net loss                                                                    |  |               | (1,258,046 | )             |  |               | (2,673,934 | )             |  |   | (5,664,120 | ) |  |   | (8,891,717 | )
|Net loss per share of common stock 
    basic and diluted                  |  |               | (.07       | )             |  |               | (.16       | )             |  |   | (.36       | ) |  |   | (.56       | )
|                                                                            |  |               |            |               |  |               |            |               |  |   |            |   |  |   |            |  
|Weighted average shares of common stock
    outstanding  basic and diluted |  |               | 16,921,000 |               |  |               | 16,921,000 |               |  |   | 15,892,000 |   |  |   | 15,892,000 |  



|   |             
|-- | ------------
|5. | Acquisitions



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

On February 21, 2002, the Company entered
into an agreement and plan of reorganization to acquire Timm
Medical for total consideration of $37,350,000 (including
$838,000 in legal, accounting and other acquisition-related
costs). In connection with the merger, all outstanding shares of
the capital stock of Timm Medical were exchanged for $10,770,000
in cash and 1,620,530 shares of the Companys common
stock valued at $23,806,000 (of which 63,412 shares were
held in escrow, all of which have now been released).

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

10



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

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

Factors contributing to the origination of
goodwill include the enhancement of the product line and
projected growth in urology sales through collaborative
distribution agreements with other medical device companies and
the sales force which the Company believed would be valuable
assets as the Company divested non-core product lines and
redeployed existing resources in the area of cancer treatment.
Intangible assets relating to developed technology and trade
name are amortized over estimated useful lives of 15 years.

Net cash paid in the acquisition is as follows:

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

Subsequent to the acquisition date, the Company
decided to divest certain non-core product lines, including the
Dura II penile implants line sold in April 2003, and the
urinary incontinence and urodynamics lines sold in October 2003
(see Note 6).



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

On September 30, 2002, the Company completed
the acquisition of certain general and limited equity interests
in the mobile prostate and benign prostatic hyperplasia
(BPH) treatment businesses (Mobile Prostate
Treatment Businesses) from a group of affiliated companies
collectively known as USMD. Under the terms of the original
agreement, the Company agreed to forgive $7.7 million,
consisting of a $6.8 million loan and a $900,000 earnest
money deposit, if the Mobile Prostate Treatment Businesses
achieved $12 million in gross revenues during the period
from October 1, 2002 to December 31, 2005 (the
Forgiveness Period). At the time of the acquisition,
the Company assumed the loans would be forgiven and, therefore,
included them in the total purchase consideration of $11,734,000.

In February, 2004, the purchase agreement was
amended to extend the Forgiveness Period to December 31,
2008. In addition, effective January 1, 2004, the Company
reduced the service fee it pays to one of the partnerships for
the use of their Cryocare Surgical Systems from $2,500 to
$2,000 per procedure, representing an adjustment to a
market rate. As a result, the reduction in service fee does not
require a reallocation of goodwill.

11



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In late 2003 and early 2004, the Company
initiated the dissolution of five of the 13 partnerships
acquired from USMD, two of which were engaged in BPH treatment
and three of which were engaged in cryosurgical procedures for
prostate cancer (see Note 6).

The total purchase price was allocated to the
tangible and intangible assets acquired based on their
respective fair value as follows:

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

The goodwill is primarily related to the
distribution network provided by the Mobile Prostate Treatment
Businesses, which allows the Company to further penetrate
desired markets. The tangible assets acquired include
11 Cryocare Surgical Systems previously purchased from the
Company by USMD and resold to the partnerships. These systems
were recorded at their fair value of $2,109,000 on the
acquisition date, which approximated the carrying value recorded
by USMD, and are depreciated over their remaining useful lives
not to exceed three years. The covenant-not-to-compete is
amortized over three years.

Net cash paid in the acquisition is as follows:

|                                               |  |   |            |  
|---------------------------------------------- |  | - | ---------- | -
|Total purchase consideration and related costs |  | $ | 11,734,000 |  
|Cash acquired                                  |  |   | (396,000   | )
|                                               |  |   |            |  
|Net cash paid                                  |  | $ | 11,338,000 |  
|                                               |  |   |            |  

Endocare is the general partner or member in each
of the Mobile Prostate Treatment Businesses and generally holds
over 20% in combined general and limited equity interests. The
Company has sole responsibility for the management of the Mobile
Prostate Treatment Businesses and exercises exclusive control
over their operations. Other equity holders have limited
participation rights, which are protective in nature. As such,
the Mobile Prostate Treatment Businesses have been consolidated
with the Companys operations since September 30, 2002.



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

The following table presents pro forma results of
operations for the nine month periods ended September 30,
2002 and 2001, assuming the Timm Medical and Mobile Prostate
Treatment Business acquisitions occurred as of January 1,
2001:

|                                                           |  |                   |             |      |  |   |             |  
|---------------------------------------------------------- |  | ----------------- | ----------- | ---- |  | - | ----------- | -
|                                                           |  |                  
|                                                           |  | Nine Months Ended
|                                                           |  | September 30,    
|                                                           |  |                  
|                                                           |  | 2002              |             | 2001
|                                                           |  |                   |             |     
|Net revenues                                               |  | $                 | 26,097,000  |      |  | $ | 21,198,000  |  
|                                                           |  |                   |             |      |  |   |             |  
|Net loss                                                   |  |                   | (15,191,000 | )    |  |   | (10,698,000 | )
|                                                           |  |                   |             |      |  |   |             |  
|Net loss per share, basic and diluted                      |  |                   | (0.63       | )    |  |   | (0.61       | )
|                                                           |  |                   |             |      |  |   |             |  
|Weighted average shares outstanding, basic and
    diluted |  |                   | 23,927,000  |      |  |   | 17,510,000  |  
|                                                           |  |                   |             |      |  |   |             |  

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

12



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

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

On May 28, 2002, pursuant to an asset
purchase agreement, the Company agreed to acquire the
cryosurgical assets of Cryomedical Sciences, Inc., now known as
BioLife Solutions, Inc. (BioLife), consisting
primarily of a portfolio of patents, for $2,200,000 in cash and
120,022 shares of the Companys common stock valued at
$1,847,000. This transaction was accounted for under the
purchase method of accounting. The total purchase consideration
of $4,119,000 (including $72,000 in acquisition-related costs)
was allocated to the patents since other assets acquired had de
minimis value. Pursuant to a Registration Rights Agreement, the
Company was required to file a registration statement with the
SEC to register the shares issued to BioLife. In November 2002,
BioLife filed suit against the Company for failing to register
the shares in a timely manner, seeking damages for breach of
contract (see Note 7).

In February 2002, the Company entered into an
asset purchase agreement with a cryosurgeon inventor of certain
technologies related to the Companys business to acquire
certain patents and a covenant-not-to-compete for
100,000 shares of the Companys common stock valued at
$1,410,000. Of this amount, $1,058,000 (75,000 shares) was
allocated to the patent and is amortized over 15 years and
the remaining $352,000 (25,000 shares) was allocated to the
covenant-not-to-compete and is amortized over five years. The
agreement also requires the seller to provide certain consulting
services over 15 years for the consideration received. No
consideration was allocated to the consulting agreement since
the value of such services could not be accurately determined.
In January 2003, the Company extended a $344,000 loan to the
seller to finance tax payments related to the gain on the sale
(see Note 8).



|   |                                              
|-- | ---------------------------------------------
|6. | Dispositions and Restructuring
    Activities

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



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

On April 7, 2003, Timm Medical sold certain
assets related to the Dura II positionable urological
prostheses product line to American Medical Systems, Inc. for
approximately $2.15 million in cash. Assets sold include
developed technology, intellectual property, customer lists,
production equipment and Dura II inventory. The sale
resulted in a loss of $35,000 in the second quarter of 2003.



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

On April 14, 2003, the Company sold its
cardiac-related product manufacturing operations and licensed
the related intellectual property to CryoCath Technologies, Inc.
(CryoCath) for $10 million and a nine-year
descending royalty based on net sales of products incorporating
the licensed technology. Upon consummation of the sale, the
Company terminated its pre-existing distribution agreement with
CryoCath. CryoCath was the

13



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

exclusive distributor for cryoprobes and consoles
in connection with the SurgiFrost system, a cryoablation system
designed to treat cardiac arrhythmias. Since the technology was
internally developed and the tangible assets sold had
de minimus value, the sale resulted in a 2003 second
quarter gain of $10 million. The $10 million was
collected in four installments, three in 2003 and one in the
first quarter of 2004. The royalty stream decreases from 10% to
3% of net sales from the SurgiFrost system during the period
from 2004 to 2012. The first royalty payment of $131,000 was
collected and recorded in the first quarter of 2004, based on
CryoCath revenues for that period.



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

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



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

On October 15, 2003, Timm Medical agreed to
sell the manufacturing assets related to its urodynamics and
urinary incontinence product lines to SRS Medical Corp.
(SRS) for a $2,694,000 note. The note bears interest
at 7.5% and is secured by the assets sold, which consist of
certain patents, trademarks, inventory, customer lists and
technical know-how. Under the terms of the original agreement,
quarterly payments were to begin on March 31, 2004, equal
to the higher of (a) minimum quarterly payments as defined
or (b) 15% of the net revenues related to the urinary
incontinence assets acquired and 15% of the net revenues related
to SRS existing urodynamics business, including the
urodynamics assets acquired. These minimum quarterly payments
were to commence at $112,500 for the quarter ended
March 31, 2004, and increase to $298,406 for the quarter
ended March 31, 2007. Amounts which remain outstanding at
March 31, 2007 were to be payable at $250,000 per
quarter thereafter until fully paid. The carrying values of the
urodynamics and urinary incontinence related assets were
$1,314,000 on the date of sale. Management concluded that
collection of the note from SRS was not reasonably assured. As a
result, a loss of $1,314,000 was recorded in the fourth quarter
of 2003 equal to the carrying value of the assets sold.
Collections on the note, if any, will be reported as gain in the
period received. In March 2004, the Company agreed to amend the
purchase agreement to reduce the minimum quarterly payments to
$45,000, increasing to $60,000 for the quarter ended
December 31, 2005. Amounts which remain outstanding at
December 31, 2005 will be payable at $60,000 per
quarter until the outstanding principal and accrued interest are
paid in full.



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

In late 2003 and early 2004, the Company
initiated the dissolution of five of the 13 partnerships
acquired from USMD, two of which were engaged in BPH treatment
and three of which were engaged in cryosurgical procedures for
prostate cancer. The BPH partnerships discontinued operations
beginning in the first quarter of 2003 due to significant
reduction in payor reimbursements and the Companys desire
to exit the non-core BPH business. The Company elected to
terminate the cryosurgical partnerships due to decisions by
certain of the limited partner physicians to withdraw from these
partnerships. After the dissolution, the Cryocare Surgical

14



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Systems held by these partnerships were
redeployed to other markets as placement units. The assets held
by the BPH partnerships will be liquidated.



|   |                              
|-- | -----------------------------
|7. | Commitments and Contingencies



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

The Company entered into a Separation Agreement
and a one-year Consulting Agreement with the Companys
former Chief Executive Officer and Chairman of the Board (the
former CEO), each effective as of July 31,
2003. Under the Separation Agreement, the former CEO was
entitled to receive a $375,000 severance payment and a $375,000
upfront payment for a one-year covenant-not-to-compete and an
agreement to provide consulting services. The Company recorded a
charge of $775,500 in the third quarter of 2003 for the
severance and related benefits. The total severance payment was
deposited into an escrow account held by the Company and
released to the former CEO in March 2004.



| |                                   
| | ----------------------------------
| | Former Chief Financial
    Officer

The Company entered into an employment agreement,
dated March 3, 2003 (the Employment Agreement),
with the Companys former Chief Financial Officer
(former CFO). Under the Employment Agreement, upon
any Qualified Termination (as defined) the former CFO was
entitled to receive a cash payment of $616,000, continued
participation in the Companys benefit plans for
24 months, a $50,000 relocation allowance and an additional
payment to cover the tax liabilities relating to the allowance.
In addition, the Employment Agreement also provided that all of
the former CFOs options to purchase outstanding common
stock (385,000 shares) would be cancelled and replaced by
immediately exercisable options to be granted between
September 4, 2003 and November 3, 2003. Effective
July 31, 2003, the Company terminated the former CFOs
employment other than for cause. The Company recorded a charge
of $731,000 in the third quarter of 2003 for the severance and
related benefits due under the Employment Agreement. In
addition, the Company recorded a third quarter charge for
$1,715,000 for the fair value of the 385,000 replacement options
issued to the former CFO on October 30, 2003 determined
using the Black-Scholes option-pricing model. The total
severance payments due of $616,000 were deposited into an escrow
account held by the Company. In March 2004, all amounts due to
the former CFO under the Employment Agreement were released from
the escrow account.



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

Effective July 17, 2002, the Company adopted
the 2002 Executive Separation Benefits Plan (Separation
Plan) to provide separation benefits to certain designated
employees upon or following a change in control, as defined. In
February 2004, the Board of Directors voted to terminate the
Separation Plan effective July 18, 2004. In February 2004,
the Board of Directors voted to terminate the Separation Plan
effective July 18, 2004. On February 13, 2004, Craig
T. Davenport (Chairman and Chief Executive Officer), William J.
Nydam (President and Chief Operating Officer) and Katherine
Greenberg (Chief Financial Officer) were added as Eligible
Employees as defined in the Separation Plan.



| |              
| | -------------
| | Legal Matters

The Company is a party to lawsuits in the normal
course of its business. Litigation and governmental
investigation can be expensive and disruptive to normal business
operations. Moreover, the results of complex legal proceedings
are difficult to predict. The Company can provide no assurance
that significant judgments or settlements in connection with the
legal proceedings described below will not have a material
adverse effect on the Companys business, financial
condition, results of operations and cash flows. (See
Part I, Item 2  Managements
Discussion and Analysis of Financial Condition and Results of
Operations and Part II,

15



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Item 1  Legal Proceedings.)
Other than as described below, the Company is not a party to any
material legal proceedings.

In November 2002, the Company was named as a
defendant, together with certain former officers, one of whom is
also a former board member, in a class-action lawsuit filed in
the United States District Court for the Central District of
California. On February 2, 2003, the court issued an order
consolidating this action with various other similar complaints
and ordering plaintiffs to file a consolidated complaint, which
was filed on October 31, 2003. The consolidated complaint
asserts two claims for relief, alleging that the defendants
violated sections of the Securities Exchange Act of 1934 by
purportedly issuing false and misleading statements regarding
the Companys revenues and expenses in press releases and
SEC filings. Plaintiffs seek class certification and unspecified
damages from the Company, as well as forfeiture and
reimbursement of bonus compensation received by two of the
individual defendants. On April 26, 2004, the court issued
an order denying the Companys motion to dismiss the
consolidated complaint. The Company intends to defend the case
vigorously, but cannot assure you that it will be resolved in
the Companys favor.

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

On December 6, 2002, Frederick Venables
filed a purported derivative action against the Company and
certain former officers and certain current and former board
members in the California Superior Court for the County of
Orange alleging breach of fiduciary duty, abuse of control,
gross mismanagement, waste of corporate assets and unjust
enrichment. On April 23, 2004, the parties filed a
stipulation agreeing to a conditional stay of the action for
270 days, continuing the deadline to respond to the
complaint until after expiration of the stay. The complaint
seeks unspecified monetary damages, equitable relief and
injunctive relief based upon allegations that the defendants
issued false and misleading statements regarding the
Companys revenues and expenses in press releases and SEC
filings. The Company intends to defend the case vigorously, but
cannot assure you that it will be resolved in the Companys
favor.

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

16



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Department of Justice (DOJ) is
currently conducting an investigation into allegations that the
Company and certain of its current and former officers and
directors intentionally issued or caused to be issued false and
misleading statements regarding the Companys revenues and
expenses in SEC filings. The Company is cooperating fully with
this investigation. The Company cannot assure you that this
matter will be resolved in its favor.

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

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



|   |                           
|-- | --------------------------
|8. | Related Party Transactions



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

In November 1999, the Company received a full
recourse promissory note for $1,028,125 in connection with the
sale of 175,000 common shares at fair value to the
Companys then-Senior Vice President, Sales and Marketing.
The four-year note bore interest at 5.99% per annum,
payable annually, and was recorded as a reduction in
stockholders equity. The Company agreed to forgive the
principal on the note ratably over four years subject to
performance of certain objectives that were to be mutually
agreed upon by the borrower and the Company and subject to the
borrower remaining an employee of the Company. The outstanding
principal balance at September 30, 2002 and
December 31, 2001 totaled $278,542 and $471,292,
respectively. The Company forgave $64,250 and $192,750,
respectively, for the three months and nine months ended
September 30, 2002, which was recorded as compensation
expense (included in selling, general and administrative
expense). As of September 30, 2003, the full value of the
note had been written off.

In January 2003, the Company extended a $344,000
non-recourse loan to an individual who is a shareholder and
consultant. The Company previously entered into an asset
purchase agreement with the shareholder in February 2002 to
acquire certain patents and a covenant-not-to-compete. The
Company extended the loan to the shareholder to assist with the
payment of federal income taxes arising from the 2002 purchase
transaction. The loan is secured by the shares issued, bears
interest at 1.8% and is due at the earlier of January 2005 or
30 days after the borrower ceases to be a consultant to the
Company (see Note 5).



|   |                                   
|-- | ----------------------------------
|9. | Collaborative and Other Agreements



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

In October 1999, the Company entered into a
strategic alliance with Sanarus Medical, Inc.
(Sanarus), a privately held medical device company.
The Company received 200,041 Series A voting convertible
Preferred Shares or 6.8% of the total outstanding voting
securities at the investment date in exchange for $300,000. The
Company also received a warrant to acquire 3,166,000 common
shares (approximately 52.0% of Sanarus voting stock on an
as-converted, fully-diluted basis at that time) for
$.01 per share in consideration for entering into a
manufacturing, supply and license agreement (the 1999
Agreement). The 1999

17



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Agreement provided Sanarus an exclusive,
royalty-free, worldwide non-sublicensable right to develop,
manufacture and sell products using cryoablation technology
developed by Endocare for use in the field of gynecology and
breast diseases. The 1999 Agreement expires at the earlier of
the 30th anniversary, expiration of the patents underlying
the licensed technology or a change in control event (as
defined) at Sanarus. The warrant is exercisable at any time
through October 12, 2009.

In June 2001, the Company and Sanarus entered
into a license agreement (the 2001 Agreement)
amending the terms and conditions of the 1999 Agreement to
provide for, among other things: (i) the termination of
Sanarus exclusive, royalty-free, worldwide
non-sublicensable right under the 1999 Agreement;
(ii) Sanarus grant to Endocare of an exclusive (even
as to Sanarus), worldwide, irrevocable, fully paid-up right to
develop, manufacture and sell products using certain Sanarus
technology for use in the diagnosis, prevention and treatment of
prostrate, kidney and liver diseases, disorders and conditions;
and (iii) Endocares grant to Sanarus of an exclusive
(even as to Endocare), worldwide, irrevocable, fully paid-up
right to develop, manufacture and sell products using certain
Endocare technology for use in the diagnosis, prevention and
treatment of gynecological and breast diseases, disorders and
conditions.

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

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

Total investment in Sanarus of $300,000 and
$917,000 at December 31, 2002 and 2003, respectively, is
included in investments and other assets. The investment is
recorded at cost since the Company does not have significant
influence over the operations of Sanarus.



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

On June 30, 2001, the Company issued
213,010 shares of its common stock with a fair value of
$2,837,293 as consideration for a membership interest in
U.S. Medical Development, Inc., formerly
U.S. Therapies, LLC, in the form of 1,134,922 Class A
units. The investment represents approximately 9% of the total
issued and outstanding Class A Units of U.S. Medical
Development, Inc. and approximately 5% of the Class A Units
on a fully diluted basis. U.S. Medical Development, Inc. is
a privately held national urology services company based in
Dallas, Texas, representing more than 150 urologists across
the nation. In a related distributor agreement,
U.S.M.D., Ltd., formerly U.S. Medical Devices, Ltd., a
subsidiary of U.S. Medical Development, Inc, was appointed
a distributor and given exclusive sales rights to the
Companys Cryocare Surgical System and associated
disposable products in 16 states. U.S.M.D., Ltd. also had
the exclusive right to distribute the Cryocare Surgical System
to HealthTronics Surgical Services, Inc. and its affiliates, a
company that provides urologic and orthopedic services to
patients in 35 states through physician partnerships. The
investment in U.S. Medical Development, Inc. is included in
investments and other assets and is carried using

18



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the cost method of accounting as the Company does
not have significant influence over the operations of
U.S. Medical Development, Inc. The Company has recorded
sales of Cryocare Surgical Systems and cryoprobes to
U.S.M.D., Ltd. totaling $4,105,000 and $2,257,000 in 2001
and 2002, respectively. The distributor agreement was terminated
upon the Companys acquisition of certain Mobile Prostate
Treatment Businesses from USMD on September 30, 2002.

The Company recorded an other-than-temporary loss
of $2,327,000 in its investment in U.S. Medical
Development, Inc. during the fourth quarter of 2002, reducing
the carrying value of the investment to $510,000.



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

In September 2001, the Company entered into a
strategic alliance with CryoCath pursuant to an exclusive global
market access and supply agreement whereby CryoCath and the
Company would co-develop a new, advanced line of surgical probe
systems to treat cardiac arrhythmias. CryoCath would purchase
the newly developed systems from Endocare and market them on a
global basis under the CryoCath trademark, SurgiFrost. CryoCath
paid the Company $125,000 in license fees upon execution of the
agreement. Additional fees were due upon the availability of a
malleable cryoprobe and for the sale of a fixed number of
cryo-consoles. However, these amounts were never received since
the performance targets had not been met. The agreement also
provided volume purchase discounts to CryoCath to be determined
annually on a retrospective basis. The agreement had an initial
term of five years and with renewals for two additional
three-year periods if certain conditions were met. As discussed
in Note 5, the distribution agreement was terminated in
April 2003 upon the sale of the cardiac product line and related
assets to CryoCath. Purchase discounts due to CryoCath of
$433,000 at September 30, 2002 (included in other accrued
liabilities) were settled as part of the sale of the cardiac
product line to CryoCath in April 2003.



|    |                  
|--- | -----------------
|10. | Other Investments

Material equity investments in companies acquired
through collaboration agreements include the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. 833,333 common shares (approximately 14%
    interest) in Medical Resource Management, Inc.
    (MRM), a publicly traded company that provides
    mobile surgical equipment rental, certified technician training
    and support services to hospitals and medical facilities on a
    fee per procedure basis (acquired September 2000 for cash of
    $250,000). MRM specializes in laser surgery, cryosurgery,
    brachytherapy and other capital-intensive medical equipment. In
    June 2001, Emergent Group, Inc. acquired the outstanding stock
    of MRM in a share exchange. The Company wrote off the $250,000
    carrying value of this investment as a loss on minority
    investment in the second quarter of 2001 since the shares
    received in exchange have de-minimus value.
|
| | b. 33,945 common shares in Matritech, Inc.,
    a publicly traded company that develops proteomics-based
    diagnostic products for early detection of cancer (acquired
    February 2001 for cash of $150,000). Timm Medical was the
    exclusive United States distributor of bladder cancer diagnostic
    test kits manufactured by Matritech, Inc. The distribution
    agreement was terminated in June 2002. Purchases from Matritech,
    Inc. were immaterial. The carrying value of the investment at
    September 30, 2002 was $72,000.                                                                                                                                                                                                                                                       



|    |             
|--- | ------------
|11. | Income Taxes

The Company reported no income tax expense for
each of the nine months ended September 30, 2002 and 2001
due to its operating losses. The continuing operating losses
resulted in an increase in the valuation allowance of
$5.4 million and $3.6 million during the nine months
ended September 30, 2002 and 2001,

19



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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

respectively. Due to the Companys history
of operating losses, management cannot conclude that it is more
likely than not that the Companys deferred tax asset will
be realized through future earnings. Accordingly, valuation
allowances were recorded to fully reserve the Companys
deferred tax assets as of September 30, 2002 and 2001.



|    |                  
|--- | -----------------
|12. | Subsequent Events

During the first quarter ended March 31,
2004, the Company retired 326,222 of its common shares held in
treasury, including 120,022 shares re-purchased from
BioLife for $503,729 in February 2004 in connection with the
settlement of its litigation with this company.

Through its acquisition of Timm Medical in
February 2002, the Company obtained offices, manufacturing and
research facilities for its erectile dysfunction products in a
28,066 square foot building in Eden Prairie, Minnesota.
This lease expired on April 30, 2004. Due to the net
downsizing of its Minnesota operations and divestiture of
several product lines acquired in the purchase of Timm Medical,
the Company decided not to renew its existing lease and instead
negotiated a lease for a smaller facility. In May 2004, the
Company agreed to enter into a new lease on 8,919 square
feet in the existing facility to house its Minnesota operations.
The monthly rental payment during the term of the lease will
range from $0.61 to $0.67 per square foot, excluding common
area maintenance costs. The aggregate rental obligation over the
term of the lease will be approximately $343,000. The lease for
this office and warehouse facility expires in 2009.

20



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##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion and analysis should
be read in conjunction with the unaudited condensed consolidated
financial statements and notes thereto included in
Part I  Item 1 of this report, and the
audited consolidated financial statements, and notes thereto,
and Managements Discussion and Analysis of Financial
Condition and Results of Operations contained in the Annual
Reports on Form 10-K for the fiscal years ended
December 31, 2003 and 2002.

This discussion contains forward-looking
statements based on our current expectations. There are various
factors  many beyond our control  that
could cause our actual results or the occurrence or timing of
expected events to differ materially from those anticipated in
these forward-looking statements. Some of these factors are
described below and other factors are described elsewhere in
this Quarterly Report on Form 10-Q. In addition, there are
factors not described in this Quarterly Report on Form 10-Q
that could cause our actual results or the occurrence or timing
of expected events to differ materially from those anticipated
in these forward-looking statements. All forward-looking
statements included in this Quarterly Report on Form 10-Q
are based on information available to us as of the date hereof,
and we assume no obligation to update any such forward-looking
statements.

Overview

We are a medical device company focused on
developing, manufacturing and selling cryosurgical products with
the potential to improve the treatment of cancer and other
tumors and on manufacturing and marketing vacuum technology as a
non-pharmacological option for treatment of erectile
dysfunction. Our cryosurgical products include a computerized
device (the Cryocare Surgical System), and
disposable cryoprobes and temperature probes used to safely and
effectively freeze cancerous tissue or other tumors through our
proprietary argon gas-based technology. We recently introduced
the next generation of our Cryocare Surgical System, the
Cryocare CS. Our erectile dysfunction products, sold through our
wholly-owned subsidiary, Timm Medical, include the ErecAid
Esteem and the ErecAid Classic for treatment of impotence as
well as the RigiScan for diagnostic evaluation of this condition.

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

We have incurred significant operating losses and
negative cash flows from operations in each full fiscal year
since January 1, 1996. We incurred a net loss of
approximately $4.7 million and $13.4 million,
respectively, for the quarter and nine months ended
September 30, 2002. As of September 30, 2002, we had
an accumulated deficit of $60.4 million. We expect to incur
additional losses as we expand our sales and marketing efforts,
strengthen our infrastructure, improve our financial reporting
processes and controls and continue to develop new products.

In addition to the cash needed to fund our
ongoing operations, there have been and will continue to be
substantial demands on cash in connection with ongoing
investigations by the SEC and DOJ of our historical accounting
and financial reporting and related matters, including
restatements of our consolidated financial statements filed in
our Annual Reports on Form 10-K for the years 2000 and 2001
and in our Quarterly Reports on Form 10-Q for the first and
second quarters of 2002, as well as expenses related to
shareholder litigation. (See Notes 1 and 2 to the condensed
consolidated financial statements included in this report and
below under Liquidity and Capital Resources.)

Results of Operations

A major factor contributing to the fluctuation in
our operating results in the three and nine months ended
September 30, 2002 compared to the same periods in 2001 was
the acquisition of Timm Medical on February 21, 2002. We
also acquired the mobile prostate treatment businesses
previously owned by USMD on

21



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##### Table of Contents



September 30, 2002. Both acquisitions
brought with them increases in costs and expenses. The Timm
Medical acquisition also brought with it additional sales.




| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | Three and Nine Months Ended
    September 30, 2002 Compared to Three and Nine Months Ended
    September 30, 2001

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

The procedure fee typically includes a procedure
kit containing cryoprobes and other disposables
needed to perform a cryosurgical procedure, in addition to a
service component. The service component of the procedure fee
generally consists of rental and transport of a Cryocare
Surgical System as well as the services of a technician to
assist the physician with the set-up, use and monitoring of the
equipment. In certain instances, we will provide the service
component of the procedure to the hospital as well as the
devices. At other times, we will contract with third parties to
perform the service component of the procedures and will remit a
service fee to the third party upon invoicing the hospital. We
also sell just the disposable devices to hospitals, without the
service component, where the hospital either owns the equipment
or independently contracts with a service provider.

We sell Cryocare Surgical Systems to distributors
and to independent cryosurgical service providers. In addition,
we sell disposable cryoprobes and temperature probes directly to
distributors, hospitals or independent service providers.
Disposables are sometimes packaged and sold in a procedure kit
containing the usual number of probes consumed in a single
cryosurgical procedure plus the service component.

In addition to our cryosurgery products, we sell
other urological products acquired when we purchased Timm
Medical, a urological device manufacturer, in February 2002. We
continue to sell our ErecAid vacuum therapy systems and RigiScan
monitors, although in 2003 we either divested or discontinued
the remaining product lines acquired in the Timm Medical
purchase.

A portion of our revenues also comes from sales
of the SurgiFrost cryosurgical line which we developed for
treatment of cardiac arrhythmia. In 2002 and through the first
quarter of 2003, we sold these products to CryoCath under the
terms of a distribution agreement. In April 2003, we licensed to
CryoCath the manufacturing and intellectual property rights to
these products and sold them the related assets. Beginning with
the first quarter of 2004, we are entitled to royalty income
based on CryoCaths sales of these products.

Revenues for the three months ended
September 30, 2002 increased 121.6% to $8,382,000 compared
to $3,783,000 for the three months ended September 30,
2001. The increase in revenues was partly attributable to an
increase in sales of cryosurgical probes and procedures into the
urology market. There were approximately 665 cryosurgical
procedures performed in the third quarter of 2002 compared to
approximately 300 for the same period in the prior year. In
addition we had sales of new products in the first nine months
of 2002 that we did not have during the same period in 2001,
including the SurgiFrost cardiac products we manufactured and
sold under the terms of our September 21, 2001 Global
Supply and Market Access Agreement with CryoCath and products we
acquired through our acquisition of Timm Medical. Sales to
CryoCath totaled $1,060,000 for the quarter ended
September 30, 2002. Sales of Timm Medical products,
including those later divested, were $3,863,000 for the three
months ended September 30, 2002.

Offsetting these increases in revenues were
reductions in sales of Cryocare Surgical Systems. We sold
14 systems in the third quarter of 2001 compared to two
systems during the same period in 2002 for a $2,033,000
reduction in revenues. Correspondingly, we sold 35 systems in
the first nine months of 2001 compared to 20 systems in the
first nine months of 2002, a decline of $2,151,000. The decline
in sales of Cryocare Surgical Systems is primarily due to the
decrease in sales of these units to USMD. During 2001 and prior
to our acquisition of the mobile prostate treatment businesses
from USMD in September 2002, we sold Cryocare Surgical Systems
and our disposable cryosurgical devices to USMD under the terms
of a distribution agreement that provided for minimum purchase
quotas in each quarter. During the nine months ended

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September 30, 2001 and 2002, we sold 16 and
five units, respectively, to USMD totaling approximately
$3.3 million and $1.0 million, respectively, in
revenues. Following the acquisition, the distribution agreement
was terminated.


Revenues for the nine months ended
September 30, 2002 increased 150% to $23,808,000 compared
to $9,523,000 in 2001. Reasons for this increase in sales are
consistent with the explanations above. Products we acquired or
obtained a right to distribute from Timm Medical contributed
revenues of approximately $9,700,000 for the nine months ended
September 30, 2002. Sales of our cardiac products to
CryoCath were $1,589,000 for the first nine months of 2002.

Cost of Revenues.Cost of revenues consists of fixed and variable costs incurred
in the manufacture of our products in addition to depreciation
of Cryocare Surgical Systems placed in the field with customers
under our placement program or with our sales and service
personnel. We incur an additional cost of revenues in the form
of a fee for equipment usage and other services when a procedure
is performed on a Cryocare Surgical System owned by an unrelated
service provider. That portion of the procedure fee remitted to
the third-party service provider is charged to cost of revenues
when the procedure is performed and billed. We retain a larger
profit on procedures performed on systems owned by us where no
outside service fees are incurred.

In addition, charges for product warranties as
well as excess and obsolete inventory, shrinkage and other
inventory carrying costs are included in our cost of revenues as
are costs of maintaining patents or other intellectual property
rights to processes or technologies related to our products,
royalties on product sales and amortization of developed
technology acquired in connection with our acquisition of Timm
Medical.

Cost of revenues for the three months ended
September 30, 2002 increased 186.4% to $4,526,000 compared
to $1,580,000 for the three months ended September 30,
2001. The increase in cost of revenues resulted primarily from
sales of new products acquired in the Timm Medical purchase and
sales of our cardiac products to CryoCath under the agreement
referenced above. Costs related to the manufacture and sale of
products we acquired from Timm Medical and related to the
SurgiFrost products we sold to CryoCath, contributed
approximately $1,541,000 and $679,000, respectively, to the cost
of revenues for the quarter ended September 30, 2002.
Another factor in the increase in cost of revenues for the
quarter ended September 30, 2002 was the fact that we
recorded cost of revenues related to five Cryocare Surgical
Systems, which had been shipped during the period but for which
we could not recognize revenue. There were only two Cryocare
Surgical System shipped in the third quarter of 2001 for which
we could not recognize revenue in the period. Finally, there was
an increase in cost of revenues due to growth in the number of
cryosurgical procedures overall, as well as in the number of
procedures where we contracted with third-party service
providers, to perform the service component of the procedure. In
these instances, we billed the hospital for the procedure and
remitted up to half of the amount billed to the third-party
service provider. We include fees paid to the service providers
in our cost of revenues. Finally, we increased the number of
Cryocare Surgical Systems we loaned or placed with
hospitals in an effort to encourage them to adopt cryosurgery.
We depreciate these systems ratably over a three-year period and
include the depreciation charge in cost of revenues.

Cost of revenues for the nine months ended
September 30, 2002 increased 174.6% to $12,019,000 compared
to $4,377,000 in 2001. Reasons for this increase in sales are
consistent with the explanations above.

Gross Margins.Gross
margins on revenues decreased to 46.0% for the three months
ended September 30, 2002 compared to 58.2% for the three
months ended September 30, 2001. Gross margins on revenues
for the nine months ended September 30, 2002 decreased to
49.5% compared to 54.0% for the same period in 2001. The
reduction in our gross margins is significantly due to the
factors described above under cost of revenues, primarily to
1) an increase in the fees paid to third party service
providers, 2) an increase in depreciation on Cryocare
Surgical Systems loaned to or placed with our
customers 3) the inclusion in cost of revenues of the
manufacturing cost of five Cryocare Surgical Systems shipped to
our customers for which we could not record the corresponding
revenue and 4) reduction in sales of Cryocare Surgical
Systems which have a higher profit margin that sales of
disposable devices and procedure fees.

Research and Development
Expenses.Research and development
expenses include expenses associated with the design and
development of new products as well as significant enhancements
to existing products.

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


Research and development expenses for the three
months ended September 30, 2002 decreased 6.9% to $490,000
compared to $526,000 for the three months ended
September 30, 2001. The lower cost in third quarter of 2002
was primarily attributable to the winding down of development of
cryosurgical products for the cardiac and gynecology markets
created under strategic alliances formed with CryoCath and with
Sanarus, a company for which we developed cryosurgical products
for treatment of benign and malignant breast diseases. We
completed most of the development work in 2001 and
commercialized these products in 2002. These reductions in
spending were partly offset by investment in development of the
Horizon Prostatic Stent and the ThermaStent for treatment of BPH
and costs incurred for research and development related to
products acquired in the Timm Medical purchase. As a percentage
of revenues, research and development expenses decreased from
13.9% in the third quarter of 2001 to 5.8% during the third
quarter of 2002, due to the combination of reduced spending
levels and increased revenues.

Research and development expense for the nine
months ended September 30, 2002 increased 7.6% to
$2,052,000 compared to $1,907,000 for the same period in 2001.
As a percentage of revenues, research and development expenses
dropped from 20.0% in the first nine months of 2001 to 8.6% for
the same period in 2002.

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

Selling, general and administrative expenses for
the three months ended September 30, 2002 increased 91.2%
to $8,408,000 compared to $4,398,000 for the three months ended
September 30, 2001. The increase is primarily attributable
to our acquisition of Timm Medical in the first quarter of 2002
and relates to significant additions to staffing, particularly
in the sales and marketing area, and to administrative costs
incurred in connection with running our operations in Eden
Prairie, Minnesota, and to marketing our newly-acquired urology
products.

Headcount following the Timm Medical acquisition
more than doubled from 94 employees at year-end 2001 to 202
employees at the end of first quarter 2002. At
September 30, 2002, our headcount of 194 employees included
63 sales and marketing personnel (up from 23 at year-end 2001),
25 customer service employees (up from 10 at year-end 2001), and
corporate administrative staff of 28 (up from 16 at year-end
2001). We also acquired the lease on a 28,000 square foot
facility in Eden Prairie, Minnesota.

Selling, general and administrative expenses for
the nine months ended September 30, 2002 increased 102.5%
to $24,075,000 compared to $11,892,000 for the same period in
2001. Reasons for this increase are consistent with the
explanations above for the quarter. In addition, we incurred
significantly higher costs related to training new cryosurgeons
in the first nine months of 2002, compared to the earlier
period, as well as higher marketing costs related to product
promotional literature and increased trade show activity.

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Interest Income,
Net.Interest income, net for the
three months ended September 30, 2002 was $317,000 compared
to $47,000 for the three months ended September 30, 2001.
The change was due to the reduction of interest expense
associated with the reduction of debt in 2001 and increased cash
and investment balances following our secondary public offering
in November of 2001.

Interest income, net for the nine months ended
September 30, 2002 was $935,000 compared to $12,000 for the
nine months ended September 30, 2001. The increase is
primarily due to reasons stated above.

Loss on Minority
Investment.Loss on investment for the
nine months ended September 30, 2001, relates to a charge
taken to reflect a decline, other then temporary, for the
Companys investment in Medical Resources Management, Inc.

Net Loss.Net loss
for the three months ended September 30, 2002 was
$4,725,000 or $0.19 per diluted share on 24,279,000
weighted average shares outstanding, compared to a net loss of
$2,674,000, or $0.16 per share on 16,920,505 weighted
average shares outstanding for the same period in 2001. The loss
for the three months ended September 30, 2002, compared to
the net loss for the same period in 2001, increased as a result
of lower gross margins and higher selling, general and
administrative expenses.

Our net loss for the nine months ended
September 30, 2002 was $13,403,000 or $0.57 per
diluted share on 23,695,667 weighted average shares outstanding,
compared to a net loss of $8,892,000 or $0.56 per diluted
share on 15,892,333 weighted average shares outstanding for the
same period in 2001.

Liquidity and Capital Resources

Since inception, we have incurred losses from
operations and have reported negative cash flows. As of
September 30, 2002, we had an accumulated deficit of
$60.4 million and cash, cash equivalents and
available-for-sale securities of $44.0 million.

After September 30, 2002, our cash reserves
continued to decline. From October 1, 2002 through
March 31, 2004, our cash was principally used to fund a
total of $52.4 million in operating losses (excluding
impairment charges and gains on divestiture). The losses include
$15.3 million in non-recurring legal and accounting fees
associated with the on-going investigations of our historical
accounting and financial reporting, $3.6 million in
executive severance costs related primarily to our former Chief
Executive Officer and Chief Financial Officer and
$1.5 million for the settlement of the BioLife litigation
(see Note 7 to our condensed consolidated financial
statements). These expenses were partially offset by
$10 million in proceeds from the sale of our cardiac
related product manufacturing operations to CryoCath and
$2 million from the sale of the Dura II penile implant
product line.

In February 2004 we paid approximately
$1.5 million in directors and officers
liability insurance premiums, and we paid approximately
$1.9 million to BioLife to settle litigation and repurchase
common shares previously issued to BioLife. During the first
quarter of 2004 we incurred approximately $3.3 million in
non-recurring legal and accounting fees associated with the
ongoing investigations into possible irregularities in our
accounting and financial reporting in earlier periods.

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

We may be required to pay judgments or
settlements and to incur expenses in defending against these
claims that could be material. Further, while we carry
$20 million of directors and officers liability
insurance coverage, this coverage may not be adequate to cover
all costs related to these lawsuits, including any resulting
judgments or settlements. As described below under Risks
Related to Our Business, for claims asserted during the
period from June 10, 2002 through June 10, 2003, our
three excess carriers have filed arbitration complaints,
contending our former management made misstatements or omissions
in the applications for

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insurance coverage and seeking rescission of the
policies. A claim in excess of our insurance coverage would have
to be paid out of cash reserves, which could have a material
adverse effect on our business, financial condition, results of
operations and cash flows.


Beyond the factors described above, we expect to
face significant demands on our capital resources related to the
execution of our 2004 operating plan, regaining compliance with
the SEC rules and regulations required of publicly traded
companies, including Section 404 of the Sarbanes-Oxley Act
of 2002, and fulfilling requirements prerequisite to becoming
re-listed on a national stock exchange or market. We incurred
net losses of $25.4 million and $42.0 million in 2003
and 2002, respectively, and are currently projecting an
operating loss for fiscal 2004, as well as a net use of cash.

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

At the same time, however, we have planned
certain strategic investments in sales and marketing activities
to increase our market penetration as well as in inventory
related to the introduction of our new Cryocare CS System. We
have also planned expenditures on staffing and infrastructure
improvements in finance and information technology to ensure
that we will be able to comply with internal control and other
SEC requirements.

Risks Related to Our Business

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



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

In order to execute our business plan, we need to
attract, retain and motivate a significant number of highly
qualified managerial, technical, financial and sales personnel.
If we fail to attract and retain skilled scientific and
marketing personnel, our research and development and sales and
marketing efforts will be hindered. Our future success depends
to a significant degree upon the continued services of key
management personnel, including Craig T. Davenport, our Chief
Executive Officer, William J. Nydam, our President and Chief
Operating Officer, and Katherine Greenberg, our Senior Vice
President and Chief Financial Officer. None of our key
management personnel is covered by an insurance policy of which
we are the beneficiary.



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

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

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| |                                             
| | --------------------------------------------
| | We face risks relating to our
    liquidity.

Since the fourth quarter of 2002, we have
incurred significant costs related to, among other things,
legal, accounting and other professional fees associated with
our internal reviews of various accounting and other matters,
the ongoing investigation of us by the SEC and DOJ, various
shareholder class-action and derivative lawsuits and other legal
proceedings described below. In addition we are making
significant investments in the development and implementation of
sound internal controls and corporate governance policies and
procedures designed to enhance the accuracy, quality and
consistency of our financial information and reporting. We will
continue to incur significant related expenses in the future.

If we are not able to significantly grow market
share, improve our gross margins and reduce our operating
expenses, or if we become subject to significant judgments or
settlements in connection with the legal proceedings described
in Part II, Item 1 of this Quarterly Report on
Form 10-Q, we will require additional financing. Additional
equity or debt financing may not be available on acceptable
terms, or at all, in part because our common stock was de-listed
from The Nasdaq Stock Market. If we are unable to obtain
additional capital, we may be required to reduce our sales and
marketing activities, reduce the scope of or eliminate our
research and development programs, relinquish rights to
technologies that we might otherwise seek to develop or
commercialize, or sell certain assets.

We recently made several significant payments
that have reduced our cash reserves. On March 8, 2004, we
paid to our former Chief Executive Officer an aggregate of
$750,000, which we owed to him under a separation agreement and
consulting agreement that we previously executed. Also on
March 8, 2004, we paid to our former Chief Financial
Officer an aggregate of $616,000, which we owed to him under an
employment agreement we previously executed. At the request of
the SEC, these payments were deposited into escrow accounts
during the fourth quarter of 2003; the funds were released upon
termination of the related escrow agreements. Additionally, on
February 20, 2004, we paid approximately $1.5 million
in directors and officers liability insurance
premiums. Furthermore, as described below in Part II,
Item 1 of this Quarterly Report on Form 10-Q, in
February 2004 we paid approximately $1.9 million to BioLife
to settle litigation.

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

For a further description of the nature of the
risks relating to our liquidity see, Part I,
Item 2  Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.



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

We have limited experience in manufacturing,
marketing and selling our Cryocare Surgical System in commercial
quantities. In addition, during 2002, we completed our
acquisitions of Timm Medical, the cryosurgical assets of
BioLife, and our acquisition of the mobile prostate treatment
businesses owned by USMD. As a result, we have a short history
in marketing and selling the products we acquired or have rights
to commercialize through these acquisitions or to market our
products on the scale required by these acquisitions. In
addition, we have limited experience in managing the complex
demands of a business with multiple entities and locations, a
large workforce and diverse information technology systems.

We have incurred annual operating losses each
year since our inception. For the quarter ended March 31,
2004, we had losses from operations of approximately
$8.6 million. As of March 31, 2004, our accumulated
deficit was approximately $123.0 million. It is possible
that we will not generate sufficient revenues from product sales
and service revenues to achieve or sustain profitability. Even
if we do achieve significant

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revenues from our product sales and service
revenues, we expect that increased operating expenses will
result in significant operating losses over the next several
quarters, as we, among other things:




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

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



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

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



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

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



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

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

In addition, we and certain former officers and
certain current and former board members have been named
defendants in a class action and a derivative lawsuit. The
findings and outcome of the investigations described above may
affect the class action and the derivative lawsuit that are
pending. We are generally

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obliged, to the extent permitted by law, to
indemnify our directors and officers who are named defendants in
some of these lawsuits. We are unable to estimate what our
liability in these matters may be, and we may be required to pay
judgments or settlements and incur expenses in aggregate amounts
that could have a material adverse effect on our business,
financial condition, results of operations and cash flows.


We have $20 million of directors and
officers liability insurance coverage. The coverage is
provided in four $5 million policies issued by a primary
insurance carrier and three excess insurance carriers. For
claims asserted during the period from June 10, 2002
through June 10, 2003, the three excess carriers have filed
arbitration complaints, contending our former management made
misstatements or omissions in the applications for insurance
coverage and seeking rescission of the policies. A claim in
excess of our insurance coverage would have to be paid out of
cash reserves, which could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.



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

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



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

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

As a result of the delisting of our common stock
from The Nasdaq Stock Market, our common stock has become
subject to the penny stock regulations, including
Rule 15g-9 under the Securities Exchange Act of 1934. That
rule imposes additional sales practice requirements on
broker-dealers that sell low-priced securities to persons other
than established customers and institutional accredited
investors. For transactions covered by this rule, a
broker-dealer must make a special suitability determination for
the purchaser and have received the purchasers written
consent to the transaction prior to sale. Consequently, the rule
may affect the ability of broker-dealers to sell our common
stock and affect the ability of holders to sell their shares of
our common stock in the secondary market. To the extent our
common stock remains subject to the penny stock regulations, the
market liquidity for the shares will be adversely affected.



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

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

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the foreseeable future, although we expect
revenue from system sales to fluctuate from quarter to quarter
and decrease, over time, as a percentage of our revenue.


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



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

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



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

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



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

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

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

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

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

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



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

We primarily handle the marketing, distribution
and sales of our Cryocare Surgical Systems through our own work
force. We have limited experience marketing and selling our
Cryocare Surgical System in commercial quantities or on a
nationwide basis. We will face significant challenges and risks
in training, managing and retaining our sales and marketing
teams, including managing geographically dispersed efforts and
adequately training our people in the use and benefits of our
Cryocare Surgical System. We may not be able to hire significant
additional personnel or deploy sufficient other resources needed
to create increased demand for our Cryocare Surgical System. In
addition, we have distribution arrangements, some of which are
exclusive, for the sale of our Cryocare Surgical System both
domestically and internationally, and we are dependent upon the
sales and marketing efforts of our third-party distributors.
These distributors may not commit the necessary resources to
effectively market and sell our Cryocare Surgical System. If we
are unable to expand our sales and marketing capabilities or if
our senior sales and marketing personnel are not retained, we
may not be able to effectively commercialize our Cryocare
Surgical System.



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

We continue to face numerous risks and expenses
related to integration of the businesses we acquired from Timm
Medical, BioLife and USMD. In addition, the acquired businesses
have suffered because managements resources have been
consumed by, among other things, the internal and external
investigations involving various accounting and related matters
as well as the work involved in re-auditing and restating our

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consolidated financial statements for the years
ended December 31, 2000 and 2001 and for the first two
quarters of 2002. The businesses acquired from Timm Medical have
suffered because resources have been diverted in divesting
certain non-core product lines and in downsizing our Eden
Prairie operations. The businesses we acquired from USMD have
suffered for many of the same reasons in addition to the fact
that we recently assumed administrative responsibility for
management of these complex businesses. If we do not
successfully integrate and grow the acquired businesses, our
business will suffer.




| |                                                                   
| | ------------------------------------------------------------------
| | Introduction of alternative therapies may
    affect our revenues.

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



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

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



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

Our success will depend to a significant degree
on our ability to secure and protect intellectual property
rights and to enforce patent and trademark protections relating
to our technology. From time to time, litigation may be
advisable to protect our intellectual property position.
However, these legal means afford only limited protection and
may not adequately protect our rights or permit us to gain or
keep any competitive advantage. Any litigation in this regard
could be costly, and it is possible that we will not have
sufficient resources to fully pursue this litigation or to
protect our other intellectual property rights. It could result
in the rejection or invalidation of our existing and future
patents. Any adverse outcome in litigation relating to the
validity of our patents, or any failure to pursue litigation or
otherwise to protect our patent position, could have a material
adverse effect on our business, financial condition, results of
operations and cash flows. Also, even if we prevail in
litigation, the litigation would be costly in terms of
management distraction as well as in money. In addition,
confidentiality agreements with our employees, consultants,
customers, and key vendors may not prevent the unauthorized
disclosure or use of our technology. It is possible that these
agreements will be breached or that they will not be enforceable
in every instance, and that we will not have adequate remedies
for any such breach. Enforcement of these agreements may be
costly and time consuming. Furthermore, the laws of foreign
countries may not protect our intellectual property rights to
the same extent as the laws of the United States.



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

The medical technology industry has in the past
been characterized by a substantial amount of litigation and
related administrative proceedings regarding patents and
intellectual property rights. In addition, major

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medical device companies have used litigation
against emerging growth companies as a means of gaining or
preserving a competitive advantage.


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

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

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



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

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

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



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

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



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

Government regulation has a significant impact on
our business. Government regulation in the United States and
other countries is a significant factor affecting the research
and development, manufacture and

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


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



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

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



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

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

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

Our business exposes us to potential product
liability claims that are inherent in the testing, production,
marketing and sale of medical devices. We are also subject to
various other claims as described below in Part II,
Item 1  Legal Proceedings. While we
believe that we are reasonably insured against these risks, we
may not be able to maintain insurance in amounts or scope
sufficient to provide us with adequate coverage against all
potential liabilities. A claim in excess of our insurance
coverage would have to be paid out of cash reserves, which could
have a material adverse effect on our business, financial
condition, results of operations and cash flows. In addition,
any product liability claim likely would harm our reputation in
the industry and our business.

We have $20 million of directors and
officers liability insurance coverage. The coverage is
provided in four $5 million policies issued by a primary
insurance carrier and three excess insurance carriers. For
claims asserted during the period from June 10, 2002
through June 10, 2003, the three excess carriers have filed
arbitration complaints, contending our former management made
misstatements or omissions in the applications for insurance
coverage and seeking rescission of the policies. A claim in
excess of our insurance coverage would have to be paid out of
cash reserves, which could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.



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

The medical device industry generally, and the
urological disease treatment market in particular, are
characterized by rapid technological change, changing customer
needs, and frequent new product introductions. If our
competitors existing products or new products are more
effective than or considered superior to our products, the
commercial opportunity for our products will be reduced or
eliminated. We face intense competition from companies in the
cryosurgical marketplace as well as companies offering other
treatment options, including radical surgery, radiation therapy
and hormone therapy. If we are successful in penetrating the
market for treatment of prostate cancer with our cryosurgical
treatment, other medical device companies may be attracted to
the marketplace. Many of our potential competitors are
significantly larger than we are and have greater financial,
technical, research, marketing, sales, distribution and other
resources than we do. We believe there will be intense price
competition for products developed in our markets. Our
competitors may develop or market technologies and products,
including drug-based treatments, that are more effective or
commercially attractive than any that we are developing or
marketing. Our competitors may obtain regulatory approval, and
introduce and commercialize products before we do. These
developments could have a material adverse effect on our
business, financial condition, results of operations and cash
flows. Even if we are able to compete successfully, we may not
be able to do so in a profitable manner.



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

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



| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | impact of legal proceedings;                                                                                                                 
|
| |  | costs of expanding our infrastructure to support
    more robust internal controls, including more effective policies
    and procedures;    
|
| |  | costs to strengthen our accounting practices,
    disclosure controls and corporate governance;                                              
|
| |  | market acceptance of our existing products, as
    well as products in development;                                                          
|
| |  | timing of payments received and the recognition
    of such payments as revenue under collaborative arrangements and
    strategic alliances;
|
| |  | ability to manufacture products efficiently;                                                                                                 

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| |   |                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------
| |  | timing of our research and development
    expenditures;                                                    
|
| |  | timing of customer orders;                                                                                  
|
| |  | changes in reimbursement rates for our products
    and procedures by Medicare and other third-party payors;
|
| |  | potential impact of acquisitions;                                                                           
|
| |  | timing of regulatory approvals for new products;                                                            
|
| |  | outcomes of clinical studies by us or our
    competitors;                                                  
|
| |  | competition from other treatment
    modalities; and                                                        
|
| |  | physician and patient acceptance of cryosurgery.                                                            

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



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

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



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

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



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

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



| |                                                              
| | -------------------------------------------------------------
| | Our intangible assets and goodwill could
    become impaired.

Intangible assets acquired in a purchase, such as
intellectual property or developed technology, are generally
amortized over various periods depending on their anticipated
economic benefits or useful lives. Long-lived assets, including
amortizable intangibles, are reviewed for impairment whenever
events or changes

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in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to
be generated by the asset. Following a review, if such assets
are considered to be impaired, the impairment to be recognized
is measured by the amount by which the carrying value of the
assets exceeds the fair value of the assets.


We had no reported goodwill prior to
January 1, 2002. With the adoption of Statement of
Financial Accounting Standards No. 142 Goodwill and
Intangible Assets, goodwill can no longer be amortized
against earnings. Goodwill balances are subject to an impairment
review on an annual basis or sooner if indicators of potential
impairment exist. The test for impairment requires us to first
compare the fair value of the net assets of each reporting unit
to their carrying value, including goodwill. If the fair value
of the reporting unit is less than the carrying value, goodwill
of the reporting unit is potentially impaired and we next
calculate the implied fair value of goodwill by deducting the
fair value of all tangible and intangible net assets of the
reporting unit from the fair value of the reporting unit. If the
implied fair value of goodwill is less then the carrying amount
of goodwill, an impairment loss is recognized equal to the
difference. In the past, we have recorded goodwill impairment
related to our Timm Medical acquisition and an impairment of our
investment in U.S. Medical Development, Inc. Significant
estimates, including assumptions regarding future events and
circumstances that cannot be easily predicted are required to
perform an analysis of the value of goodwill. These estimates
and assumptions may differ materially from actual outcomes and
occurrences. Furthermore, no assurance can be given that we will
not have further impairment charges related to Timm Medical or
other acquisitions.



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

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



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

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






|        |                                                               
|------- | --------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures
    About Market Risk

The primary objective of our investment
activities is to preserve principal while at the same time
maximizing the income we receive from our invested cash without
significantly increasing risk of loss. Our financial instruments
include cash, cash equivalents, short-term investments, accounts
receivable, investments, accounts payable and accrued
liabilities. The carrying values of our financial instruments
approximated their fair values. Our policy is not to enter into
derivative financial instruments. In addition, we do not enter
into any

37



---



##### Table of Contents



futures or forward contracts and therefore, we do
not have significant market risk exposure with respect to
commodity prices.


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






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

(a) Evaluation of Disclosure Controls and
Procedures. As required by Securities and Exchange
Commission Rule 13a-15(b), our Chief Executive Officer and
our Senior Vice President, Chief Financial Officer have
evaluated the effectiveness of our disclosure controls and
procedures within 90 days prior to the filing date of this
report. Based on their evaluation, our Chief Executive Officer
and our Senior Vice President, Chief Financial Officer have
concluded that our disclosure controls and procedures are not
yet effective because, until the filing of this report and the
other past due reports on Form 10-Q that we are filing
concurrently with this report, we have not been current in our
reporting under Section 15(d) of the Securities Exchange
Act of 1934. Our inability to timely file the required reports
is due to, among other things, the fact that managements
time and attention have been consumed by the auditing and
re-auditing of our financial statements for the years ended
December 31, 2000, 2001, 2002 and 2003, and the resulting
restatements, by the development and implementation of
improvements to our internal controls and financial reporting
processes, and by the internal and external investigations into
the accounting and other matters described in our consolidated
financial statements and the related Notes contained in this
report in Part I, Item 1 and in our Annual Reports on
Form 10-K for the years ended December 31, 2002 and
2003 and in Part I, Item 2 of this report,
Managements Discussion and Analysis of Financial Condition
and Results of Operations.

Since March 2003, management has implemented and
continues to implement significant changes in organization,
policies and procedures designed to enhance our disclosure
controls and procedures and the related internal controls. These
include, among other measures: new restrictions and guidelines
governing sales personnel, terms and conditions of sale and
revenue recognition; new and more stringent credit approval
policies; new policies governing approval, review and recording
of expenditures and other legal and financial transactions; new
procedures governing documentation and approval of options and
warrants issued in connection with legal and financial
transactions; and new internal reporting procedures.
Nevertheless, during much of 2003, many of these enhancements to
our disclosure controls and procedures and the related internal
controls were not yet in place, or were only partially in place.
For this reason, management has undertaken an extensive and
substantive review and evaluation of all financial transactions
that, individually or collectively, could have a material impact
on the information contained in this Form 10-Q. These
review procedures, in combination with the changes in internal
control that have been implemented as of the date of the filing
of this report, form the basis for our determination that the
financial statements and other information contained in this
report fairly present, in all material respects, our financial
condition, results of operations and cash flows for the nine
months ended September 30, 2002 and 2001.

(b) Changes in Internal Controls.
Except as described above in subsection (a) of this
Item 4, there have been no significant changes in our
internal controls or in other factors which could significantly
affect internal controls subsequent to the date of our most
recent evaluation of our internal controls.




PART II  OTHER
INFORMATION





|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

We are a party to lawsuits in the normal course
of our business. Litigation and governmental investigation can
be expensive and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult
to predict. We can provide no assurance that significant
judgments or settlements in connection with the legal
proceedings described below will not have a material adverse
effect on our business, financial condition, results of
operations and cash flows. See Note 7 to our condensed
consolidated financial

38



---



##### Table of Contents



statements included herein and Part I,
Item 2  Managements Discussion and
Analysis of Financial Condition and Results of Operations.
Other than as described below, we are not a party to any
material legal proceedings.


In November 2002, we were named as a defendant,
together with certain former officers, one of whom is also a
former board member, in a class-action lawsuit filed in the
United States District Court for the Central District of
California. On February 2, 2003, the court issued an order
consolidating this action with various other similar complaints
and ordering plaintiffs to file a consolidated complaint, which
was filed on October 31, 2003. The consolidated complaint
asserts two claims for relief, alleging that the defendants
violated sections of the Securities Exchange Act of 1934 by
purportedly issuing false and misleading statements regarding
our revenues and expenses in press releases and SEC filings.
Plaintiffs seek class certification and unspecified damages from
us, as well as forfeiture and reimbursement of bonus
compensation received by two of the individual defendants. On
April 26, 2004, the court issued an order denying our
motion to dismiss the consolidated complaint. We intend to
defend the case vigorously, but cannot assure you that it will
be resolved in our favor.

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

On December 6, 2002, Frederick Venables
filed a purported derivative action against us and certain
former officers and certain current and former board members in
the California Superior Court for the County of Orange alleging
breach of fiduciary duty, abuse of control, gross mismanagement,
waste of corporate assets and unjust enrichment. On
April 23, 2004, the parties filed a stipulation agreeing to
a conditional stay of the action for 270 days, continuing
the deadline to respond to the complaint until after expiration
of the stay. The complaint seeks unspecified monetary damages,
equitable relief and injunctive relief based upon allegations
that the defendants issued false and misleading statements
regarding our revenues and expenses in press releases and SEC
filings. We intend to defend the case vigorously, but cannot
assure you that it will be resolved in our favor.

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

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

39



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##### Table of Contents



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

In June 2003, we were awarded a favorable
judgment for $351,000 in a litigation matter previously
initiated by Timm Medical against a third party. Since
collection is not assured, any amount recovered in connection
with this judgment will be recorded in the period when it is
actually paid to us.






|        |                      
|------- | ---------------------
|Item 2. | Changes in Securities

In June 2002, we issued 120,022 shares of
our common stock to BioLife, an accredited investor, as partial
consideration for our acquisition of its cryosurgical assets. We
issued these shares in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act
of 1933, in that the issuance did not involve a public offering.
BioLife represented to us its intention to acquire the shares
for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends
were affixed to the certificate evidencing the shares.






|        |                                    
|------- | -----------------------------------
|Item 3. | Defaults Upon Senior
    Securities

None.






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

None.






|        |                  
|------- | -----------------
|Item 5. | Other Information

None.






|        |                                      
|------- | -------------------------------------
|Item 6. | Exhibits and Reports on
    Form 8-K.



| |     |         
| | --- | --------
| | (a) | Exhibits

|            |   |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                           
|----------- | - | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |   | Description
|            |   |            
|            | 2 | .1(1)       |  | Agreement and Plan of Reorganization, dated
    February 21, 2002, by and among the Company, Technologies,
    Inc., TMT Acquisition Corporation and certain stockholders of
    Timm Medical Technologies, Inc. Certain schedules and other
    attachments to this exhibit were omitted. We agree to furnish
    supplementally a copy of any omitted schedules or attachments to
    the Commission upon request.      
|            | 2 | .2(2)       |  | Agreement and Plan of Merger, dated June 30,
    1999, by and among the Company, Advanced Medical Procedures,
    Inc., Advanced Medical Procedures, LLC, Gary M. Onik, M.D.,
    Robert F. Byrnes and Jerry Anderson. Certain schedules and other
    attachments to this exhibit were omitted. We agree to furnish
    supplementally a copy of any omitted schedules or attachments to
    the Commission upon request.
|            | 2 | .3(3)       |  | Asset Purchase Agreement, dated February 6,
    2002, by and between the Company and Gary M. Onik, M.D.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                               

40



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##### Table of Contents



|            |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 2  | .4(3)       |  | Asset Purchase Agreement, dated May 28,
    2002, by and among the Company and Cryomedical Sciences, Inc.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                                                                                         
|            | 2  | .5(4)       |  | Partnership and Limited Liability Company
    Membership Interest Purchase Agreement, dated as of
    August 12, 2002, by and among Endocare, Inc. and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C. (the Purchase Agreement).
    Certain schedules and exhibits referenced in the Purchase
    Agreement have been omitted. We agree to furnish supplementally
    a copy of any omitted schedules or exhibits to the Commission
    upon request.
|            | 2  | .6(5)       |  | Amendment No. 1 to Partnership and Limited
    Liability Company Membership Interest Purchase Agreement, dated
    as of September 30, 2002, by and among Endocare, Inc. and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C.                                                                                                                                                                                                                            
|            | 3  | .1(2)       |  | Certificate of Amendment of Restated Certificate
    of Incorporation of the Company.                                                                                                                                                                                                                                                                                                                                                                                                 
|            | 3  | .2(2)       |  | Certificate of Designation of Series A
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                                                                                                                                                                                                       
|            | 3  | .3(2)       |  | Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | 3  | .4(6)       |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            | 10 | .1(7)      |  | Executive Separation Benefits Plan, approved by
    the Compensation Committee of the Board of Directors on
    July 17, 2002.                                                                                                                                                                                                                                                                                                                                                        
|            | 10 | .2(8)       |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                                                                    
|            | 10 | .3(9)       |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical
    Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                                
|            | 31 | .1          |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                                                                                                                                                                                                                                                                                                                                                         
|            | 31 | .2          |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                                                                                                                                                                                                                                                                                                                                                        
|            | 32 | .1          |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                                                                                                                                                                                                                                                                                                                                                         
|            | 32 | .2          |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                                                                                                                                                                                                                                                                                                                                                        



---



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



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



|    |                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------
|(1) | Previously filed as an exhibit with our
    Form 8-K filed on March 5, 2002.                                                      
|   
|(2) | Previously filed as exhibits with our
    Registration Statement on Form S-3 filed on
    September 20, 2001 and October 31, 2001.
|   
|(3) | Previously filed as exhibits with our
    Form 10-Q filed on August 14, 2002.                                                     
|   
|(4) | Previously filed as an exhibit with our
    Form 8-K filed on August 16, 2002.                                                    
|   
|(5) | Previously filed as an exhibit with our
    Form 8-K filed on October 15, 2002.                                                   
|   
|(6) | Previously filed as an exhibit with our
    Form 10-K filed on March 15, 2004.                                                    
|   
|(7) | Previously filed as an exhibit with our
    Form 10-K filed on December 3, 2003.                                                  
|   
|(8) | Previously filed as an exhibit with our
    Form 8-K filed on August 16, 2002.                                                    
|   
|(9) | Previously filed as an exhibit with our
    Form 8-K filed on October 15, 2002.                                                   

(b) Reports on Form 8-K

On August 16, 2002, we filed a Form 8-K
regarding our execution of a definitive Partnership and Limited
Liability Company Membership Interest Purchase Agreement (the
Purchase Agreement), to purchase the mobile
prostrate treatment businesses of U.S. Medical Development,
Inc., U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. for
aggregate consideration of approximately $11,210,000.

41



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##### Table of Contents






SIGNATURES

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



| |               
| | --------------
| | ENDOCARE, INC.



| |     |                       
| | --- | ----------------------
| | By: | /s/ CRAIG T. DAVENPORT

| |                                                                                      
| | -------------------------------------------------------------------------------------
| |                                                                                      
| | Craig T. Davenport                                                                   
| | Chief Executive Officer and Chairman of the
    Board 
     (Duly Authorized Officer)



| |     |                        
| | --- | -----------------------
| | By: | /s/ KATHERINE GREENBERG

| |                                                      
| | -----------------------------------------------------
| |                                                      
| | Katherine Greenberg                                  
| | Senior Vice President and Chief Financial
    Officer
| | (Principal Financial and Accounting
    Officer)     

Date: June 28, 2004

42



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##### Table of Contents






EXHIBIT INDEX

|            |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 2  | .1(1)       |  | Agreement and Plan of Reorganization, dated
    February 21, 2002, by and among the Company, Technologies,
    Inc., TMT Acquisition Corporation and certain stockholders of
    Timm Medical Technologies, Inc. Certain schedules and other
    attachments to this exhibit were omitted. We agree to furnish
    supplementally a copy of any omitted schedules or attachments to
    the Commission upon request.                                                                  
|            | 2  | .2(2)       |  | Agreement and Plan of Merger, dated June 30,
    1999, by and among the Company, Advanced Medical Procedures,
    Inc., Advanced Medical Procedures, LLC, Gary M. Onik, M.D.,
    Robert F. Byrnes and Jerry Anderson. Certain schedules and other
    attachments to this exhibit were omitted. We agree to furnish
    supplementally a copy of any omitted schedules or attachments to
    the Commission upon request.                                                            
|            | 2  | .3(3)       |  | Asset Purchase Agreement, dated February 6,
    2002, by and between the Company and Gary M. Onik, M.D.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                                                                                           
|            | 2  | .4(3)       |  | Asset Purchase Agreement, dated May 28,
    2002, by and among the Company and Cryomedical Sciences, Inc.
    Certain schedules and other attachments to this exhibit were
    omitted. We agree to furnish supplementally a copy of any
    omitted schedules or attachments to the Commission upon request.                                                                                                                                                                         
|            | 2  | .5(4)       |  | Partnership and Limited Liability Company
    Membership Interest Purchase Agreement, dated as of
    August 12, 2002, by and among Endocare, Inc. and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C. (the Purchase Agreement).
    Certain schedules and exhibits referenced in the Purchase
    Agreement have been omitted. We agree to furnish supplementally
    a copy of any omitted schedules or exhibits to the Commission
    upon request.
|            | 2  | .6(5)       |  | Amendment No. 1 to Partnership and Limited
    Liability Company Membership Interest Purchase Agreement, dated
    as of September 30, 2002, by and among Endocare, Inc. and
    U.S. Medical Development, Inc., U.S.M.D., Ltd. and
    U.S.M.D. I, L.L.C.                                                                                                                                                                                                                            
|            | 3  | .1(2)       |  | Certificate of Amendment of Restated Certificate
    of Incorporation of the Company.                                                                                                                                                                                                                                                                                                                                                                                                 
|            | 3  | .2(2)       |  | Certificate of Designation of Series A
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                                                                                                                                                                                                       
|            | 3  | .3(2)       |  | Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | 3  | .4(6)       |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            | 10 | .1(7)      |  | Executive Separation Benefits Plan, approved by
    the Compensation Committee of the Board of Directors on
    July 17, 2002.                                                                                                                                                                                                                                                                                                                                                        
|            | 10 | .2(8)       |  | Promissory Note, dated July 15, 2002, issued
    by U.S. Medical Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                                                                    
|            | 10 | .3(9)       |  | First Amended and Restated Promissory Note, dated
    September 30, 2002, issued by U.S. Medical
    Development, Inc. to the Company.                                                                                                                                                                                                                                                                                                                                                
|            | 31 | .1          |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                                                                                                                                                                                                                                                                                                                                                         
|            | 31 | .2          |  | Certification under Section 302 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                                                                                                                                                                                                                                                                                                                                                        
|            | 32 | .1          |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Craig T. Davenport.                                                                                                                                                                                                                                                                                                                                                                                         
|            | 32 | .2          |  | Certification under Section 906 of the
    Sarbanes-Oxley Act of 2002 for Katherine Greenberg.                                                                                                                                                                                                                                                                                                                                                                                        



---



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



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



|    |                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------
|(1) | Previously filed as an exhibit with our
    Form 8-K filed on March 5, 2002.                                                      
|   
|(2) | Previously filed as exhibits with our
    Registration Statement on Form S-3 filed on
    September 20, 2001 and October 31, 2001.
|   
|(3) | Previously filed as exhibits with our
    Form 10-Q filed on August 14, 2002.                                                     
|   
|(4) | Previously filed as an exhibit with our
    Form 8-K filed on August 16, 2002.                                                    

43



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##### Table of Contents





|    |                                                                                 
|--- | --------------------------------------------------------------------------------
|(5) | Previously filed as an exhibit with our
    Form 8-K filed on October 15, 2002. 
|   
|(6) | Previously filed as an exhibit with our
    Form 10-K filed on March 15, 2004.  
|   
|(7) | Previously filed as an exhibit with our
    Form 10-K filed on December 3, 2003.
|   
|(8) | Previously filed as an exhibit with our
    Form 8-K filed on August 16, 2002.  
|   
|(9) | Previously filed as an exhibit with our
    Form 8-K filed on October 15, 2002. 

44