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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q (Mark One) [X]
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
  or [  ]
    
    Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 
 Commission file number 0-18053 LASERSCOPE (Exact name of Registrant as Specified in Its Charter) CALIFORNIA
    
    77-0049527(State or Other Jurisdiction
    
    (I.R.S. Employer Identification No.)of Incorporation or Organization)
 3070 ORCHARD DRIVE, SAN JOSE, CALIFORNIA 95134-2011
(Address of Principal Executive Offices) Registrants Telephone Number, Including Area Code: (408) 943-0636 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. Yes   [X]    No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X]  No [  ] The number of shares of Registrants common stock issued and outstanding as of
October 31, 2004 was 21,421,296. 1




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TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements (unaudited)
    
    
    3Condensed Consolidated Balance Sheets
    
    
    3Condensed Consolidated Statements of Operations
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    12Results of Operations
    
    
    13Liquidity and Capital Resources
    
    
    15Risk Factors
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27PART II. OTHER INFORMATION
    
    
    28Item 5 Other Information
    
    
    28Item 6. Exhibits
    
    
    28SIGNATURES
    
    
    29EXHIBIT 10.11LEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I.  FINANCIAL INFORMATION. 
 Item 1.  Financial Statements. Laserscope 
 Condensed Consolidated Balance Sheets
(unaudited)
 September 30,
    
    December 31,(thousands)
    
    2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    12,670
    
    
    $
    7,158Accounts receivable, net
    
    
    19,149
    
    
    
    12,711Inventories, net
    
    
    18,817
    
    
    
    13,368Other current assets
    
    
    1,347
    
    
    
    1,315Total current assets
    
    
    51,983
    
    
    
    34,552Property and equipment, net
    
    
    3,031
    
    
    
    1,645Goodwill
    
    
    655
    
    
    
    655Other assets
    
    
    238
    
    
    
    176Total assets
    
    $
    55,907
    
    
    $
    37,028Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    5,740
    
    
    $
    4,094Accrued compensation
    
    
    4,251
    
    
    
    2,360Deferred revenue
    
    
    3,444
    
    
    
    2,022Other current liabilities
    
    
    6,932
    
    
    
    5,354Total current liabilities
    
    
    20,367
    
    
    
    13,830Long-term liabilities:Obligations under capital leases
    
    
    34
    
    
    
    Total long-term liabilities
    
    
    34
    
    
    
    Contingencies (Note 7)Shareholders equity:Common stock
    
    
    63,129
    
    
    
    60,427Accumulated deficit
    
    
    (27,447
    )
    
    
    (37,002
    )Accumulated other comprehensive loss
    
    
    (176
    )
    
    
    (227
    )Total shareholders equity
    
    
    35,506
    
    
    
    23,198Total liabilities and shareholders equity
    
    $
    55,907
    
    
    $
    37,028
 See Accompanying Notes to Condensed Consolidated Financial Statements 3




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Laserscope 
 Condensed Consolidated Statements of Operations
(Unaudited)
 Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Net revenue
    
    $
    24,156
    
    
    $
    14,293
    
    
    $
    64,340
    
    
    $
    39,611Cost of sales
    
    
    9,846
    
    
    
    6,790
    
    
    
    27,187
    
    
    
    19,388Gross margin
    
    
    14,310
    
    
    
    7,503
    
    
    
    37,153
    
    
    
    20,223Operating expenses:Research and development
    
    
    1,143
    
    
    
    1,195
    
    
    
    3,727
    
    
    
    3,300Selling, general and administrative
    
    
    8,666
    
    
    
    5,778
    
    
    
    23,582
    
    
    
    15,836Total operating expenses
    
    
    9,809
    
    
    
    6,973
    
    
    
    27,309
    
    
    
    19,136Operating income
    
    
    4,501
    
    
    
    530
    
    
    
    9,844
    
    
    
    1,087Interest income (expense) and other, net
    
    
    (52
    )
    
    
    7
    
    
    
    321
    
    
    
    (23
    )Income before income taxes
    
    
    4,449
    
    
    
    537
    
    
    
    10,165
    
    
    
    1,064Provision for income taxes
    
    
    96
    
    
    
    4
    
    
    
    610
    
    
    
    48Net income
    
    $
    4,353
    
    
    $
    533
    
    
    $
    9,555
    
    
    $
    1,016Basic net income per share
    
    $
    0.20
    
    
    $
    0.03
    
    
    $
    0.46
    
    
    $
    0.05Diluted net income per share
    
    $
    0.19
    
    
    $
    0.02
    
    
    $
    0.42
    
    
    $
    0.05Shares used in basic per share calculations
    
    
    21,364
    
    
    
    17,705
    
    
    
    20,875
    
    
    
    17,440Shares used in diluted per share calculations
    
    
    22,778
    
    
    
    20,057
    
    
    
    22,780
    
    
    
    19,671
 See Accompanying Notes to Condensed Consolidated Financial Statements 4




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Laserscope 
 Condensed Consolidated Statements of Cash Flows
(Unaudited)
 Nine Months EndedSeptember 30,(thousands)
    
    2004
    
    2003Cash flows from operating activities:Net income
    
    $
    9,555
    
    
    $
    1,016Adjustments to reconcile net income to
net cash provided by operating activities:Depreciation and amortization
    
    
    681
    
    
    
    905Provision for doubtful accounts
    
    
    (26
    )
    
    
    (59
    )Provision for excess and obsolete inventory
    
    
    286
    
    
    
    (603
    )Changes in assets and liabilities:Accounts receivable, net
    
    
    (6,362
    )
    
    
    (1,651
    )Inventories
    
    
    (5,728
    )
    
    
    (1,133
    )Prepayments and other current assets
    
    
    (44
    )
    
    
    (231
    )Accounts payable
    
    
    1,469
    
    
    
    651Accrued compensation
    
    
    1,893
    
    
    
    277Warranty
    
    
    383
    
    
    
    555Deferred revenue
    
    
    1,414
    
    
    
    463Other current liabilities
    
    
    946
    
    
    
    671Tax payable
    
    
    452
    
    
    
    (14
    )Net cash provided by operating activities
    
    
    4,919
    
    
    
    847Cash flows from investing activities:Acquisition of property and equipment
    
    
    (2,131
    )
    
    
    (566
    )Net cash used in investing activities
    
    
    (2,131
    )
    
    
    (566
    )Cash flows from financing activities:Payments on obligations under capital leases
    
    
    9
    
    
    
    (101
    )Proceeds from the sale of common stock under stock plans
    
    
    2,702
    
    
    
    1,100Proceeds from bank loans
    
    
    
    
    
    
    200Repayment of bank loans
    
    
    
    
    
    
    (200
    )Net cash provided by financing activities
    
    
    2,711
    
    
    
    999Effect of exchange rate changes on cash
    
    
    13
    
    
    
    145Net increase in cash and cash equivalents
    
    
    5,512
    
    
    
    1,425Cash and cash equivalents, beginning of period
    
    
    7,158
    
    
    
    4,661Cash and cash equivalents, end of period
    
    $
    12,670
    
    
    $
    6,086Supplemental disclosure of cash flow information:Cash paid during the period for:Interest
    
    $
    13
    
    
    $
    194Income taxes
    
    $
    223
    
    
    $
    54Issuance of common stock in exchange for conversion
of subordinated debentures
    
    $
    
    
    
    $
    400
 See Accompanying Notes to Condensed Consolidated Financial Statements 5




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Laserscope Notes to Unaudited Condensed Consolidated Financial Statements: 1. Basis of presentation The accompanying unaudited condensed consolidated financial statements include
Laserscope (the Company, Laserscope, management, we, us, our) and
its wholly owned subsidiaries. All intercompany transactions and balances have
been eliminated. While the financial information in this report is unaudited,
in the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position and
results of operations as of and for the periods indicated have been recorded.
We suggest that these consolidated financial statements be read in conjunction
with the consolidated financial statements and notes for the year ended
December 31, 2003 included in the Companys annual report on Form 10-K for the
year ended December 31, 2003. The December 31, 2003 balance sheet data has
been derived from the audited financial statements at that date. The results
of operations for the three and nine month periods ended September 30, 2004 are
not necessarily indicative of the results expected for the full year or any
other interim period. 2. Stock-Based Compensation The Company accounts for stock-based compensation arrangements in accordance
with the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and its interpretations, and
complies with the disclosure provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Under
APB Opinion No. 25, compensation expense is based on the difference, if any, on
the date of grant, between the fair value of the Companys stock and the
exercise price. SFAS No. 123 defines a fair value based method of accounting
for an employee stock option or similar equity instrument. The Company accounts
for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123 and EITF Issue No. 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods and Services (EITF Issue No. 96-18). Under
SFAS No. 123 and EITF Issue No. 96-18, the fair value of options granted to
non-employees is estimated using the Black-Scholes option pricing model and is
periodically remeasured as the options vest. Had compensation cost for stock-based employee compensation arrangements been
determined based on the fair value at the date of the awards consistent with
the provisions of SFAS No. 123, the impact on the Companys net income would be
as follows (in thousands, except per share data): 6




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Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income as reported
    
    $
    4,353
    
    
    $
    533
    
    
    $
    9,555
    
    
    $
    1,016Amount allocated to holders of convertible
debentures
    
    
    
    
    
    
    (56
    )
    
    
    
    
    
    
    (116
    )Income available to common stockholders-
basic
    
    $
    4,353
    
    
    $
    477
    
    
    $
    9,555
    
    
    $
    900Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects
    
    
    (437
    )
    
    
    (293
    )
    
    
    (1,461
    )
    
    
    (900
    )Pro forma net income (loss)
    
    $
    3,916
    
    
    $
    184
    
    
    $
    8,094
    
    
    $
    0Net income (loss) per share:Basic-as reported
    
    $
    0.20
    
    
    $
    0.03
    
    
    $
    0.46
    
    
    $
    0.05Basic-pro forma
    
    $
    0.18
    
    
    $
    0.01
    
    
    $
    0.39
    
    
    $
    0.00Diluted-as reported
    
    $
    0.19
    
    
    $
    0.02
    
    
    $
    0.42
    
    
    $
    0.05Diluted-pro forma
    
    $
    0.17
    
    
    $
    0.01
    
    
    $
    0.36
    
    
    $
    0.00
 3. Inventories Inventories were comprised of the following (in thousands): September 30,
    
    December 31,2004
    
    2003Sub-assemblies and purchased parts
    
    $
    9,124
    
    
    $
    6,356Work-in-process
    
    
    5,504
    
    
    
    3,213Finished goods
    
    
    4,189
    
    
    
    3,799$
    18,817
    
    
    $
    13,368
 4. Warranty and Service Contracts Warranty
We have a direct field service organization that provides service for our
products. We generally provide a twelve month warranty on our laser systems.
After the warranty period, maintenance and support is provided on a service
contract basis or on an individual call basis. Our warranties and premium
service contracts provide for a 99.0% Uptime Guarantee on our laser systems.
Under provisions of this guarantee, we extend the term of the related warranty
or service contract if specified system uptime levels are not maintained. The
number of warranties extended under this program are not material. The Company currently provides for the estimated cost to repair or replace
products under warranty at the time of sale. The cost estimate is based on
warranty costs experienced in the prior 12 months, and the outstanding warranty
liability is revalued on a quarterly basis. 7




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Nine months endedSeptember 30,Warranty Reserve (in thousands)
    
    2004
    
    2003Balance at beginning of period
    
    $
    1,947
    
    
    $
    1,127Add: Accruals for warranties issued
    
    
    2,186
    
    
    
    1,871Accruals related to pre-existing warranties
    
    
    0
    
    
    
    77Less:Settlements made during the period
    
    
    (1,803
    )
    
    
    (1,393
    )Balance at end of period
    
    $
    2,330
    
    
    $
    1,682
 Service Contracts
Deferred service contract revenue is recognized on a pro rata basis
over the period of the applicable service contract. Costs are
recognized as incurred. Nine months endedSeptember 30,Deferred Service Contract Revenue (in thousands)
    
    2004
    
    2003Balance at beginning of period
    
    $
    1,433
    
    
    $
    1,086Add: Payments received
    
    
    3,416
    
    
    
    2,450Costs incurred under extended service contracts
    
    
    1,982
    
    
    
    1,398Less: Revenue recognized
    
    
    (2,828
    )
    
    
    (2,128
    )Settlements made under extended service
contracts during the period
    
    
    (1,982
    )
    
    
    (1,398
    )Balance at end of period
    
    $
    2,021
    
    
    $
    1,408
 8




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5. Net income per share Basic net income per share is computed by dividing net income available to
holders of common shares by the weighted average number of common shares
outstanding during the period. Diluted net income per share is computed by
giving effect to all dilutive potential common shares, including options,
warrants, and convertible debentures. A reconciliation of the numerator and
denominator used in the calculation of historical basic and diluted net income
per share follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(thousands)
    
    2004
    
    2003
    
    2004
    
    2003Basic earnings per shareNumerator:Net income used in computing basic and
diluted net income per share
    
    $
    4,353
    
    
    $
    533
    
    
    $
    9,555
    
    
    $
    1,016Amount allocated to holders of convertible
debentures
    
    
    
    
    
    
    (56
    )
    
    
    
    
    
    
    (116
    )Income available to common stockholdersbasic
    
    $
    4,353
    
    
    $
    477
    
    
    $
    9,555
    
    
    $
    900Denominator:Weighted average number of common shares
outstanding used in computing basic net income
per share
    
    
    21,364
    
    
    
    17,705
    
    
    
    20,875
    
    
    
    17,440Diluted earnings per shareNumerator:Net income used in computing basic and
diluted net income per share
    
    $
    4,353
    
    
    $
    533
    
    
    $
    9,555
    
    
    $
    1,016Amount allocated to holders of convertible
debentures
    
    
    
    
    
    
    (56
    )
    
    
    
    
    
    
    (116
    )Income available to common stockholdersdiluted
    
    $
    4,353
    
    
    $
    477
    
    
    $
    9,555
    
    
    $
    900Denominator:Weighted average number of common shares
outstanding used in computing basic net income
per share
    
    
    21,364
    
    
    
    17,705
    
    
    
    20,875
    
    
    
    17,440Add dilutive potential common shares used in
computing dilutive net income per share:Assumed exercise of stock options
    
    
    1,155
    
    
    
    1,911
    
    
    
    1,588
    
    
    
    1,780Assumed exercise of warrants
    
    
    259
    
    
    
    441
    
    
    
    316
    
    
    
    451Total weighted average number of shares used in
Computing diluted net income per share
    
    
    22,778
    
    
    
    20,057
    
    
    
    22,780
    
    
    
    19,671
 The Company adopted Emerging Issues Task Force Statement No. 03-06
Participating Securities and the Two Class Method Under FASB Statement No.
128, Earnings Per Shareduring the period ended June 30, 2004 and has
retroactively adjusted reported earnings per share for the three and nine month
periods ended September 30, 2003. 9




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The following outstanding options and warrants (prior to the application of the
treasury stock method) and convertible debentures (on an as-converted basis)
were excluded from the computation of diluted net income per common share for
the periods ended September 30, 2004 and 2003 because including them would have
had an anti-dilutive effect: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(thousands)
    
    2004
    
    2003
    
    2004
    
    2003Options to purchase common stock
    
    
    276
    
    
    
    237
    
    
    
    87
    
    
    
    327Convertible debentures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,080276
    
    
    
    237
    
    
    
    87
    
    
    
    2,407
 6. Comprehensive income Total comprehensive income during the periods ended September 30, 2004 and 2003
consisted of (in thousands): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    4,353
    
    
    $
    533
    
    
    $
    9,555
    
    
    $
    1,016Translation adjustments
    
    
    8
    
    
    
    37
    
    
    
    51
    
    
    
    225Comprehensive income
    
    $
    4,361
    
    
    
    570
    
    
    $
    9,606
    
    
    $
    1,241
 7. Contingencies The Company is at times a party to legal proceedings and claims arising in the
ordinary course of its business. While it is not feasible to predict or
determine the outcome of the actions brought against the Company, management
believes that the ultimate resolution of these claims will not ultimately have
a material adverse effect on the Companys financial position, results of
operations, or future cash flows. 8. Indemnifications In the ordinary course of business, the Company enters into contractual
arrangements under which the Company may agree to indemnify the third party to
such arrangement from any losses incurred relating to the services they perform
on behalf of the Company or for losses arising from certain events as defined
within the particular contract, which may include, for example, patents,
litigation or claims relating to past performance. Such indemnification
obligations may not be subject to maximum loss clauses. Historically, payments
made related to these indemnifications have been immaterial. The Company has entered into indemnification agreements with its directors and
officers that may require the Company: to indemnify its directors and officers
against liabilities that may arise by reason of their status or service as
directors or officers, other than liabilities arising
from willful misconduct of a culpable nature; to advance their expenses
incurred as a result of 10




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any proceeding against them as to which they could be
indemnified; and to make good faith determination whether or not it is
practicable for the Company to obtain directors and officers insurance. The
Company currently has directors and officers insurance. 9. Income Taxes Provision for income taxes increased $562,000, from $48,000 to $610,000 during
the nine months ended September 30, 2004 compared to the corresponding period
in 2003. The effective tax rate in the nine month period ended September 30,
2004 was 6% compared to 4.5% in the corresponding period in 2003. Due to experiencing only a short history of profitability, management believes
that there is sufficient uncertainty regarding the realization of deferred tax
assets and a full valuation allowance was appropriate at September 30, 2004 and
December 31, 2003. Management reviews its assumptions regarding the realization of deferred
tax assets on an ongoing basis. Continued profitability and future changes in
managements assumptions may result in a partial or full release of the
deferred tax valuation allowance. A release of the valuation allowance would
have a favorable impact on the tax provision within the statement of
operations. The Companys reporting of net income would be on a fully-taxed
basis following a release of the full valuation allowance. 10. Subsequent event On October 11, 2004, Laserscope entered into a Net Lease Agreement with Realtec
Properties I, L.P. (Realtec) for properties totaling approximately 69,000
square feet located at 3052 Orchard Drive and 3070 Orchard Drive, San Jose,
California 95134. The lease commences on November 1, 2004 and has an initial
term of eight years, with an option for Laserscope to renew for an additional
five-year period. The base monthly rent under the lease is approximately
$58,347 for the first year of the lease, approximately $59,514 for the second
year of the lease, approximately $60,705 for the third year of the lease,
approximately $61,919 for the fourth year of the lease, approximately $63,157
for the fifth year of the lease, approximately $64,420 for the sixth year of
the lease, approximately $65,709 for the seventh year of the lease and
approximately $67,023 for the eighth year of the lease. Under the terms of the Agreement, the currently existing leases, between
Laserscope and Realtec, for properties totaling approximately 41,000 square
feet located at 3070 Orchard Drive and 3075 North First Street, San Jose,
California terminate without penalty to Laserscope effective November 1, 2004.
The base monthly rent for the terminated leases was approximately $139,222. 11




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. INTRODUCTORY STATEMENT Some of the statements in this Quarterly Report on Form 10-Q, including but not
limited to Managements Discussion and Analysis of Financial Condition and
Results of Operations, and elsewhere in this document are forward-looking
statements within the meaning of the Private Securities Litigation Act of 1995.
These statements relate to future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our actual results, performance or achievements to be materially
different from those expressed or implied by any forward-looking statements. In
some cases, you can identify forward-looking statements by terminology such as
may, will, could, would, should, expect, plan, anticipate,
intend, believe, estimate, predict, potential or continue or the
negative of these terms or other comparable terminology. These statements are
only predictions. Actual events or results may differ materially. We refer you
to the factors described under the heading Risk Factors in this Quarterly
Report on Form 10-Q as well as to our Annual Report on Form 10-K for the year
ended December 31, 2003 under the heading Risk Factors. Readers are
cautioned not to place undue reliance on forward-looking statements. Moreover,
neither we nor any other person assumes responsibility for the accuracy and
completeness of those statements. We are under no duty to publicly release any
revision to the forward-looking statements after the date of this document. Overview. Laserscope is a leading provider of medical laser systems for surgical and
aesthetic applications. Founded in 1984, we are a pioneer developer of
innovative technologies with over 7,000 lasers installed worldwide in doctors
offices, out-patient surgical centers and hospitals. Our product portfolio
consists of more than 150 products, including KTP/532, Nd:YAG, Er:YAG, and Dye
medical laser systems and related energy delivery devices. Laserscope primarily serves the needs of two medical specialties: urology and
aesthetic surgery. The GreenLight laser offers a breakthrough treatment for a
urological disorder called benign prostatic hyperplasia (BPH), an enlargement
of the prostate gland experienced by most men after the age of fifty. For aesthetic applications, we offer a full line of products used to perform a
wide variety of treatments including the removal of leg and facial veins,
unwanted hair, pseudo-folliculitis and wrinkles. Our newest laser, the
Gemini laser, was recently Food and Drug Administration cleared for the
treatment of acne, permanent hair reduction and wrinkle reduction, and is now
cleared for a total of 21 different procedures. This laser system can perform
over 90% of all aesthetic laser procedures. In the United States, we distribute our products to hospitals, outpatient
surgical centers and physician offices through our own direct sales force and
through the McKesson Corporation Medical Group, (McKesson). In December
2000, we signed a five year distribution agreement that grants to McKesson the
exclusive distribution rights for our core aesthetic laser products in the
United States. McKessons Primary Care Division has a sales force of more than
500 representatives throughout the United States who are supported by our own
direct sales force. 12




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In the United Kingdom and France, we distribute our products to hospitals,
outpatient surgical centers and physician offices through our own direct sales
force. Elsewhere, we sell our products through regional distributor networks
throughout Europe, the Middle East, Latin America, Asia and the Pacific Rim.
Laserscope is both ISO 13485 and CE certified. During the first quarter of 2004, the center for Medicare and Medicaid Services
announced the assignment of the Companys Photoselective Vaporization of the
Prostate procedure for the treatment of Benign Prostate Hyperplasia, or
enlarged prostate, to a New Technology Ambulatory Payment Classification
(APC) code. The new classification carries with it a payment rate of
$3,750.00 per procedure, approximately twice that of the old rate. 
 Results of Operations. The following discussion should be read in conjunction with the unaudited
condensed consolidated financial statements and notes included in Part I 
Item 1 of this Quarterly Report and the audited consolidated financial
statements and notes contained in the Companys Annual Report on Form 10-K for
the year ended December 31, 2003 and the accompanying Managements Discussion
and Analysis of Financial Condition and Results of Operations. The following table contains selected income statement information, which
serves as the basis of the discussion of the Companys results of operations
for the quarter and nine months ended September 30, 2004 and 2003 (in
thousands, except percentages): Three months ended
    
    
    
    
    
    Nine months endedSept 30, 2004
    
    Sept 30, 2003
    
    %
    
    Sept 30, 2004
    
    Sept 30, 2003
    
    %Amount
    
    %(a)
    
    Amount
    
    %(a)
    
    Change
    
    Amount
    
    %(a)
    
    Amount
    
    %(a)
    
    ChangeRevenues from sales of:Lasers & Instrumentation
    
    $
    14,638
    
    
    
    61
    %
    
    $
    9,230
    
    
    
    65
    %
    
    
    59
    %
    
    $
    39,600
    
    
    
    62
    %
    
    $
    26,233
    
    
    
    66
    %
    
    
    51
    %Disposable supplies
    
    
    7,587
    
    
    
    31
    %
    
    
    3,408
    
    
    
    24
    %
    
    
    123
    %
    
    
    19,277
    
    
    
    30
    %
    
    
    8,749
    
    
    
    22
    %
    
    
    120
    %Service
    
    
    1,931
    
    
    
    8
    %
    
    
    1,655
    
    
    
    11
    %
    
    
    17
    %
    
    
    5,463
    
    
    
    8
    %
    
    
    4,629
    
    
    
    12
    %
    
    
    18
    %Total net revenues
    
    $
    24,156
    
    
    
    100
    %
    
    $
    14,293
    
    
    
    100
    %
    
    
    69
    %
    
    $
    64,340
    
    
    
    100
    %
    
    $
    39,611
    
    
    
    100
    %
    
    
    62
    %Gross margin
    
    $
    14,310
    
    
    
    59
    %
    
    $
    7,503
    
    
    
    52
    %
    
    
    91
    %
    
    $
    37,153
    
    
    
    58
    %
    
    $
    20,223
    
    
    
    51
    %
    
    
    84
    %Operating expenses:Research & development
    
    $
    1,143
    
    
    
    5
    %
    
    $
    1,195
    
    
    
    8
    %
    
    
    (4
    %)
    
    $
    3,727
    
    
    
    6
    %
    
    $
    3,300
    
    
    
    8
    %
    
    
    13
    %Selling, general & admin.
    
    $
    8,666
    
    
    
    36
    %
    
    $
    5,778
    
    
    
    40
    %
    
    
    50
    %
    
    $
    23,582
    
    
    
    37
    %
    
    $
    15,836
    
    
    
    40
    %
    
    
    49
    %Net income
    
    $
    4,353
    
    
    
    18
    %
    
    $
    533
    
    
    
    4
    %
    
    
    717
    %
    
    $
    9,555
    
    
    
    15
    %
    
    $
    1,016
    
    
    
    3
    %
    
    
    840
    %
  (a)
    
    expressed as a percentage of total net revenues. Revenues from the sales of lasers and instrumentation increased during the
three and nine month periods ended September 30, 2004 compared to the same
periods in 2003. The increases were due in large part to a higher volume of
GreenLightTM lasers sold. In the three month period ended September 30, 2004
we sold 63 GreenLight units compared to 34 units in the corresponding period in
2003. Through the nine month period of 2004 we recorded revenue from the sale
of 170 GreenLight laser units whereas in the first nine months of 2003, we had
sold 60 GreenLight lasers. Also, worldwide aesthetic laser and instrumentation
revenues increased during the three and nine month periods ended September 30,
2004 compared to the same periods in 2003. The increase is mainly due to
continued success of
the Mckesson distribution relationship and the introduction of the Gemini
laser. The Gemini, introduced at the American Academy of Dermatology Annual
Meeting, held February 7-10, 13




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##### Table of Contents



2004, is FDA cleared for the treatment of acne,
permanent hair reduction and wrinkle reduction. In total, the Gemini is now
cleared for a total of 21 different procedures, and can perform over 90% of all
aesthetic laser procedures available in a physicians office. The Company
expects a continued trend of increasing GreenLight and Gemini laser and
accessory shipments. Revenues from the sales of disposable supplies increased 123% and 120% during
the three and nine month periods ended September 30, 2004 compared to the
corresponding periods in 2003. The increases are driven by higher unit sales
of GreenLight fibers. In the nine months ended September 30, 2004 we sold
24,884 GreenLight fibers whereas in the corresponding period of 2003 we sold
7,895 GreenLight fibers. Increased GreenLight fiber sales is a direct result
of an increase in our GreenLight laser installed base. The Company expects
revenues from the sales of disposable supplies to incrementally increase,
including in the fourth quarter of this year, as a result of an April 2004
increase in the Medicare reimbursement rate for the BPH procedure that uses
Laserscopes GreenLight laser and fiber optic delivery device. Also, revenues
are expected to increase as the Company ships more GreenLight lasers, which
require a single-use fiber optic energy delivery device. Laserscopes service revenues increased during the three and nine-month periods
ended September 30, 2004 compared to the same periods in 2003. Increased
service revenues were primarily experienced in the domestic region as a result
of a larger contract installed base. The Company believes that increases in
future revenues depend on increases to the installed base of lasers as well as
the acceptance of its service contracts by its customers. Gross margin as a percentage of revenues increased seven percentage points
during the three month period and seven percentage points during the nine month
periods ended September 30, 2004 relative to the corresponding periods of 2003.
The increase in gross margin percentage is due primarily to a change in the
laser-type product mix and increased GreenLight fibers sold. Laserscope
expects gross margin as a percentage of 2004 revenues to be in the range of 59%
- 61% for the full year. Research and development expenses are the result of activities related to the
development of new laser, instrumentation and disposable products and the
modification and enhancement of Laserscopes existing products. These expenses
remained comparable to 2003 expenses, for the three month period in absolute
terms, yet decreased 3 points as a percentage of revenues. In the nine month
period ended September 30, 2004 compared to the same period in 2003, these
expenses increased in absolute terms, yet decreased 2 points as a percentage of
revenues. The Company expects the amounts spent in research and developments
to increase in the remaining period of 2004, as a variety of development
projects are pursued. Selling, general and administrative expenses increased in absolute terms, but
decreased as a percentage of revenue during the three and nine month period
ended September 30, 2004. The increase is comprised of higher variable selling
expenses resulting from higher revenues, increased costs associated with
Sarbanes Oxley compliance and clinical education in the three and nine month
periods ended September 30, 2004 relative to the same periods of 2003. We
expect amounts spent in selling, general and administrative expenses to
increase during the
remainder of 2004 as we continue to expand marketing programs related to the
Gemini and GreenLight products. Provision for income taxes increased $562,000, from $48,000 to $610,000 during
the nine months ended September 30, 2004 compared to the corresponding period
in 2003. The 14




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effective tax rate in the nine month period ended September 30,
2004 was 6% compared to 4.5% in the corresponding period in 2003. Due to experiencing only a short history of profitability, management believes
that there is sufficient uncertainty regarding the realization of deferred tax
assets and a full valuation allowance was appropriate at September 30, 2004 and
December 31, 2003. Management reviews its assumptions regarding the realization of deferred
tax assets on an ongoing basis. Continued profitability and future changes in
managements assumptions may result in a partial or full release of the
deferred tax valuation allowance. A release of the valuation allowance would
have a favorable impact on the tax provision within the statement of
operations. The Companys reporting of net income would be on a fully-taxed
basis following a release of the full valuation allowance. 
 Liquidity and Capital Resources. The following table contains selected balance sheet information that serves as
the basis of the discussion of the Companys liquidity and capital resources at
September 30, 2004 and for the nine months then ended (in thousands): September 30,
    
    December 31,2004
    
    2003Cash and cash equivalents
    
    $
    12,670
    
    
    $
    7,158Total assets
    
    $
    55,907
    
    
    $
    37,028Total liabilities
    
    $
    20,401
    
    
    $
    13,830Net working capital
    
    $
    31,616
    
    
    $
    20,722
 The increase in cash and cash equivalents was primarily due to cash provided by
operating and financing activities, partially offset by cash used in investing
activities. During the nine months ended September 30, 2004, cash provided by operating
activities totaled $4.9 million. This was the combined result of the following
sources: net income- $9.6 million; an increase in accrued compensation- $1.9
million due to an increase in accrued salaries and wages and employee bonuses;
an increase in accounts payable- $1.5 million due to higher purchasing volume;
an increase in deferred revenue- $1.4 million as a result of higher volume of
contract revenue bookings; an increase in other current liabilities- $0.9
million partly due to higher rebates to customers who purchased fibers, travel
expenses and audit and tax consulting expenses; depreciation- $0.7 million; an
increase in tax payable- $0.4 million due to additional tax provision as a
result of higher income; an increase in warranty reserve- $0.3 million; and
an increase in inventory reserve- $0.3 million. These sources were offset by:
an increase in accounts receivable- $6.4 million due to higher revenue; an
increase in inventory- $5.7 million due to an increase in material purchases to
meet projected demand. During the nine months ended September 30, 2004, cash provided by financing
activities consisted of the sale of common stock under stock plans  $2.7
million. During the nine months ended September 30, 2004, cash used in investing
activities consisted of capital expenditures of $2.1 million. A significant
portion of total capital spending is attributable to in-progress Enterprise
Resource Planning (ERP) costs. The Company expects lower accounting system
costs for the remainder of the year. Additional increases were in office
equipment, test and production equipment, and capitalized laser systems used by
Service and Research and Development. 15




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##### Table of Contents



We have in place an asset based line of credit which provides up to $5.0
million in borrowings off-set against $1.0 million in letter of credit reserve
requirements. The line of credit was renewed September 24, 2004 and currently
expires September 2006. Credit is extended based on the Companys eligible
accounts receivable and inventory. At September 30, 2004, the Company had
approximately $4.0 million in borrowing capacity under the line of credit
facility. The Companys assets collateralize the line of credit which bears an
interest rate equivalent to the banks prime rate plus 2.0%. The prime rate at
September, 2004 was 4.75%. Borrowings against the line of credit are paid down
as the Company collects its accounts receivable. Provisions of the bank loan
agreement prohibit the payment of dividends on non-preferred stock, or the
redemption, retirement, repurchase or other acquisition of Company stock. The
agreement further requires the Company to maintain a minimum tangible net
worth. As of September 30, 2004, the Company was in compliance with all
covenants and had no outstanding borrowings under the line of credit facility. We anticipate that future changes in cash and working capital will be dependent
on a number of factors including:  
    
    our ability to effectively manage inventory and accounts receivable;
    
    our ability to anticipate and adapt to the changes in our industry
such as new and alternative medical procedures;
    
    our level of profitability;
    
    our determination to acquire or invest in products and businesses
complementary to ours; and
    
    the market price for our common stock as it affects the exercise of
stock options and sale of common stock under stock plans. We have historically financed acquisitions using our existing cash resources.
While we believe our existing cash resources, including our bank line of
credit, will be sufficient to fund our operating needs for the next twelve
months, additional financing may be required for our currently envisioned
long-term needs. There can be no assurance that any additional financing will be available on
terms acceptable
to us, or at all. In addition, future equity financings could result in
dilution to our shareholders, and future debt financings could result in
certain financial and operational restrictions. 16




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##### Table of Contents



Contractual Obligations. We did not enter into any additional material contractual obligations during
the quarter ended September 30, 2004. The following table discloses aggregate information about our contractual
obligations and the periods in which payments are due as of September 30, 2004 Payments Due by PeriodContractual
    
    
    
    
    
    Less Than
    
    
    
    
    
    
    
    
    
    More Than 5Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    YearsOperating Leases
    
    $
    6,010
    
    
    $
    642
    
    
    $
    1,440
    
    
    $
    1,498
    
    
    $
    2,430Capital Leases
    
    $
    70
    
    
    $
    36
    
    
    $
    34
    
    
    
    
    
    
    
    Total
    
    $
    6,080
    
    
    $
    678
    
    
    $
    1,474
    
    
    $
    1,498
    
    
    $
    2,430
 The long-term commitments under operating leases shown above includes
payments related to our new real estate lease in Santa Clara, California,
commencing November 2004 and expiring October 2012. This agreement was entered
into during October 2004. 
 Risk Factors. Our business, financial condition and results of operations have been, and in
the future may be, affected by a variety of factors, including those set forth
below and elsewhere in this report. Limited Working Capital; Potential Need to Raise Additional Capital. Current and anticipated demand for our products as well as procurement and
production affect our need for capital. Changes in these or other factors could
have a material impact on capital requirements and may require us to raise
additional capital. History of Losses; Uncertainty of Future Profitability. There can be no assurance that we can maintain profitability on a quarterly
basis or at all. Government Regulation; Uncertainty of Obtaining Regulatory Approval. Government regulation in the United States and other countries is a significant
factor in the development, manufacturing and marketing of many of our products. Laserscope and its products are regulated in the United States by the Food and
Drug Administration (the FDA) under the Federal Food, Drug and Cosmetic Act
(the FDC Act) and the Radiation Control for Health and Safety Act. The FDC
Act provides two basic review procedures for medical devices. Certain products
qualify for a Section 510(k) (510(k)) procedure under which the manufacturer
gives the FDA pre-market notification of the manufacturers intention to
commence marketing the product. The manufacturer must, among other things,
establish that the product to be marketed is substantially equivalent to a
previously marketed product. In some cases, the manufacturer may be required
to include clinical data gathered under an investigational device exemption
(IDE) granted by the FDA allowing human clinical studies. There can be no assurance that the FDA will grant marketing clearance for our
future products on a timely basis, or at all. Delays in receiving such
clearances could have a significant adverse impact on our ability to compete in
our industry, as well as our business, financial condition, results of
operations, and future cashflows. The FDA may also require post-market testing
and surveillance programs to monitor certain products. If the product does not qualify for the 510(k) procedure, the manufacturer must
file a pre-market approval application (PMA) based on testing intended to
demonstrate that the product is both safe and effective. The PMA requires more
extensive clinical testing than the 510(k) procedure and generally involves a
significantly longer FDA review process. Approval of a PMA allowing commercial
sale of a product requires pre-clinical laboratory and animal tests and human
clinical studies conducted under an IDE establishing safety and effectiveness.
Generally, because of the amount of information required, the 510(k) procedure
takes less time than the PMA procedure. 17




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##### Table of Contents



To date, all of our products (except for the 600 Series Dye Module) have been
marketed through the 510(k) procedure. Future products, however, may require
clearance through the PMA procedure. There can be no assurance that such
marketing clearances can be obtained on a timely basis, or at all. Delays in
receiving such clearances could have a significant adverse impact on our
ability to compete in our industry. The FDA may also require post-market
testing and surveillance programs to monitor certain products. Certain other countries require medical device manufacturers to obtain
clearances for products prior to marketing the products in those countries. The
requirements vary widely from country to country and are subject to change. We are also required to register with the FDA and state agencies, such as the
Food and Drug Branch of the California Department of Health Services (CDHS), as
a medical device manufacturer. We are inspected routinely by these agencies to
determine our compliance with the FDAs current Quality Systems regulations.
Those regulations impose certain procedural and documentation requirements upon
medical device manufacturers concerning manufacturing, testing and quality
control activities. If these inspections determine violations of applicable
regulations, the continued marketing of any products manufactured by us may be
adversely affected. In addition, our laser products are covered by a performance standard for laser
products set forth in FDA regulations. The laser performance standard imposes
certain specific record-keeping, reporting, product testing, and product
labeling requirements on laser manufacturers. These requirements also include
affixing warning labels to laser systems, as well as incorporating certain
safety features in the design of laser products. Complying with applicable governmental regulations and obtaining necessary
clearances or approvals can be time consuming and expensive. There can be no
assurance that regulatory review will not involve delays or other actions
adversely affecting the marketing and sale of our products. We also cannot
predict the extent or impact of future legislation or regulations. We are also subject to regulation under federal and state laws regarding, among
other things, occupational safety, the use and handling of hazardous materials
and protection of the environment. We believe that we are in material
compliance with these requirements. Insurance Reimbursement. Demand for certain of our products depends on government and private insurance
reimbursement of hospitals and physicians for health care costs, including, but
not limited to, reimbursement of capital equipment costs. Reductions or delays
in such insurance coverage or reimbursement may negatively impact hospitals
and physicians decisions to purchase our
products, adversely affecting our future sales, as well as our business,
financial condition, results of operations, and future cash flows. A substantial portion of our laser sales are for aesthetic procedures that are
generally not subject to reimbursement by government or private health
insurance. The general absence of insurance coverage for these cosmetic
procedures may restrict the development of this market. In November 2003, CMS notified Laserscope that its application for assignment
of Photoselective Vaporization of the Prostate (PVP) to treat BPH with a new
technology APC had been accepted. In March 2004, CMS determined that PVP meets
the new technology APC qualification criteria and assigned a new APC code
effective April 1, 2004. The new 18




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##### Table of Contents



classification carries with it a Facility
Fee national average payment rate of $3,750.00, approximately twice that of
the old rate. Over the next several quarters, we will continue to work
closely with CMS and the American Urological Association to ensure that the
hospital outpatient reimbursement rates for furnishing PVP continue to reflect
the appropriate costs of performing the procedure. In addition to the Facility Fee or outpatient hospital reimbursement, the
adoption of PVP is also dependent upon the payment, known as the Fee Schedule
reimbursement, that is paid directly to the physician for performing the
procedure. The adoption rate of PVP may also be affected by changes in the Fee
Schedule reimbursement. Over the next several quarters, Laserscope will work
closely with CMS and the American Urological Association in an attempt to
ensure that the reimbursement paid to the physician for performing PVP
accurately reflects the work value and appropriate costs of performing the
procedure in a site of service of the physicians choosing. If CMS were to reduce reimbursement rates or if Laserscope is unsuccessful in
obtaining improved Fee Schedule reimbursement for the physicians, it will
likely have an adverse effect on the adoption and sales growth of the PVP
procedure in the United States as some customers who would normally consider
adopting the PVP procedure delay their purchases or adoption in hopes of a
favorable change in the reimbursement climate or would select other more
profitable treatment solutions for their patients. Uncertainty of Technological Change; Uncertainty of New Product Development and
Acceptance. We operate in an industry that is subject to rapid technological change. Our
ability to remain competitive and future operating results will depend upon,
among other things,
our ability to anticipate and respond rapidly to such change by developing,
manufacturing and marketing technologically innovative products in sufficient
quantities at acceptable costs to meet such demand. As we introduce new
products this may cause some of our existing products to become obsolete, which
may result in the write-off of inventory. However, without new products and
enhancements, our existing products will likely become obsolete due to
technological advances by other companies, which could result in the write-off
of inventory as well as diminished revenues. Therefore, we intend to continue
to invest significant amounts in research and development. We anticipate that our ability to compete will require significant research and
development expenditures with a continuing flow of innovative, high-quality
products. We cannot assure that we will be successful in designing,
manufacturing or selling enhanced or new products in a timely manner. Nor can
we assure that a competitor could not introduce a new or enhanced product or
technology that could have an adverse effect on our competitive position. Our current research and development programs are directed toward the
development of new laser systems and delivery devices. We cannot assure that
these markets will develop as anticipated or that our product development
efforts will prove successful. Nor can we assure that such new products, if
developed and introduced, will be accepted by the market. Dependence on Single-Source Suppliers and Certain Third Parties. Certain of the components used in our laser products, including certain optical
components, are purchased from single sources. While we believe that most of
these components are available from alternate sources, an interruption of these
or other supplies could adversely affect our ability to manufacture lasers. 19




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##### Table of Contents



Manufacturing. We manufacture in the United States the laser resonators, system chassis and
certain accessories including disposable products and re-usable hand pieces
used in our laser systems. Our laser manufacturing operations concentrate on
the assembly and test of components and subassemblies manufactured to our
designs and specifications by outside vendors. We believe that we have
sufficient manufacturing capacity in our present facilities to support current
operations at least through the end of 2004. Competition. We compete in the non-ophthalmic surgical segment of the worldwide medical
laser market. In this market, lasers are used in hospital operating rooms,
outpatient surgery centers and individual physician offices for a wide variety
of procedures. This market is highly competitive. Our competitors are numerous
and include some of the worlds largest organizations as well as smaller,
highly specialized firms. Our ability to compete effectively depends on such
factors as:  
    
    market acceptance of our products;
    
    product performance;
    
    price;
    
    customer support;
    
    the success and timing of new product development; and
    
    continued development of successful distribution channels. Some of our current and prospective competitors have or may have significantly
greater financial, technical, research and development, manufacturing and
marketing resources than we have. To compete effectively, we will need to
continue to expand our product offerings, periodically enhance our existing
products and continue to enhance our distribution. Certain surgical laser manufacturers have targeted their efforts on narrow
segments of the market, such as angioplasty and lithotripsy. Their products
may compete for the same capital equipment funds as our products, and
accordingly, these manufacturers may be considered our competitors. Generally,
surgical laser manufacturers such as Laserscope compete with standard surgical
methods and other medical technologies and treatment modalities including
pharmaceuticals. We cannot assure that we can compete effectively against such
competitors. In addition, we cannot assure that these or other companies will
not succeed in developing technologies, products or treatments that are more
effective than ours or that would render our technology or products obsolete or
non-competitive. Reliance on Patents and Licenses. We hold several patents issued in the United States, generally covering
surgical laser systems, delivery devices, calibration inserts and the laser
resonator. We have also licensed certain technologies from others. We cannot assure that any patents or licenses that we hold or that may be
issued as a result of our patent applications will provide any competitive
advantages for our products. Nor can we assure that any of the patents that we
now hold or may hold in the future will not be successfully challenged,
invalidated or circumvented in the future. In addition, we cannot assure that
competitors, many of which have substantial resources and have made substantial
investments in competing technologies, will not seek to apply for and obtain
patents that will prevent, limit or interfere with our ability to make, issue,
use and sell our products. 20




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##### Table of Contents



Furthermore, we cannot be certain that the steps we have taken will prevent the
misappropriation of our intellectual property, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States. We believe that we own or have the right to use the basic patents covering our
products. However, the laser industry is characterized by a very large number
of patents, many of which are of questionable validity and some of which appear
to overlap with other issued patents. As a result, there is a significant
amount of uncertainty in the industry regarding patent protection and
infringement. Because patent applications are maintained in secrecy in the
United States until such patents are issued and are maintained in secrecy for a
period of time outside the United States, we can conduct only limited searches
to determine whether our technology infringes any patents or patent
applications of others. Potential Intellectual Property Litigation. Our industry has been characterized by frequent demands for licenses and
litigation. Our competitors or other patent holders may assert that our
products and the methods we employ are covered by their patents. In addition,
we do not know whether our competitors will apply for and obtain patents that
will prevent, limit or interfere with our ability to make, use, sell or import
our products. Although we may seek to resolve any potential future claims or
actions, we may not be able to do so on reasonable terms, or at all. If
following a successful third-party action for infringement, we cannot obtain a
license or redesign our products, we may have to stop manufacturing and
marketing our products, and our business would suffer as a result. We may become involved in litigation not only as a result of alleged
infringement of a third partys intellectual property rights but also to
protect our own intellectual property. We have and may hereafter become
involved in litigation to protect the trademark rights associated with our
company name or the names of our products. If we have to change the name of
our products, we may experience a loss in goodwill associated with customer
confusion and a loss of sales. Infringement and other intellectual property claims, with or without merit, can
be expensive and time-consuming to litigate, and could divert managements
attention from our core business. We do not know whether necessary licenses
would be available to us on satisfactory terms, or whether we could redesign
our products or processes to avoid infringement. If we lose this kind of
litigation, a court could require us to pay substantial damages, and prohibit
us from using technologies essential to our products, any of which would have a
material adverse effect on our business, results of operations and financial
condition. Failure to Attract or Retain Key Personnel Can Adversely Affect Results. We depend upon the efforts and abilities of a number of current key personnel.
If we are unable to attract and retain key employees it would have a material
adverse effect on our business, financial condition, results of operations, and
future cash flows. Reliance on Key Customers. In December 2000, Laserscope and McKesson entered into a five year agreement
whereby McKesson would obtain exclusive distribution rights for the Companys
aesthetic product lines to doctors offices in the United States. At September
30, 2004, accounts receivable from McKesson accounted for approximately 16% of
our total accounts receivable. If we are unable to maintain a favorable
relationship with McKesson or if McKesson encounters financial difficulties, it
would have a material adverse effect on our business, financial condition,
results of operations, and future cashflows. 21




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Fluctuations in Quarterly Operating Results. A number of factors affect our quarterly financial results including the timing
of shipments and orders. Our laser products are relatively expensive pieces of
medical capital equipment and the precise shipment date of specific units can
have a marked effect on our results of operations on a quarterly basis. Any
delay in product shipments near the end of a quarter could cause our quarterly
results to fall short of anticipated levels. Furthermore, to the extent we
receive orders near the end of a quarter, we may not be able to fulfill the
order during the balance of that same quarter. Moreover, we typically receive
a disproportionate percentage of orders toward the end of each quarter. To the
extent that we do not receive anticipated orders or orders are delayed beyond
the end of the applicable quarter, our results may be adversely affected and
may be unpredictable from quarter to quarter. In addition, because a
significant portion of our revenues in each quarter result from orders received
in that quarter, we base our production, inventory and operating expenditure
levels on anticipated revenue levels. Thus, if sales do not occur when
expected, expenditure levels could be disproportionately high and operating
results for that quarter and potentially future quarters, would be adversely
affected. We cannot assure that Laserscope will accomplish revenue growth or
profitability on a quarterly or annual basis. Nor can we assure that revenue
growth or profitability will not fluctuate significantly from quarter to
quarter. Potential of Product Defects. Laser systems are inherently complex in design and require ongoing regular
maintenance. The manufacture of our lasers, laser products and systems
involves a highly complex and precise process. As a result of the technical
complexity of our products, changes in our or our suppliers manufacturing
processes or the inadvertent use of defective materials by us or our suppliers
could result in a material adverse effect on our ability to achieve acceptable
manufacturing yields and product reliability. To the extent that we do not
achieve such yields or product reliability, our business, operating results,
financial condition and customer relationships would be adversely affected. Our customers may discover defects in our products after the products have been
fully deployed and operated under peak stress conditions. In addition some of
our products are combined with products from other vendors, which may contain
defects. As a result, should problems occur, it may be difficult to identify
the source of the problem. If we are unable to fix defects or other problems,
we could experience, among other things:  
    
    loss of customers;
    
    increased costs of product, returns and warranty expenses;
    
    damage to our brand reputation;
    
    failure to attract new customers or achieve market acceptance;
    
    diversion of development and engineering resources; and
    
    legal actions by our customers. The occurrence of any one or more of the foregoing factors could seriously harm
our business, financial condition and results of operations. Product Liability Risk; Limited Insurance Coverage. Our business has significant risks of product liability claims. We have
experienced product liability claims from time to time, which we believe are
ordinary for our business. While we cannot predict or determine the outcome of
the actions brought against us, we believe that 22




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these actions will not
ultimately have a material adverse impact on our financial position, results of
operations and/or future cash flows. At present, we maintain product liability insurance on a claims made basis
with coverage of $10.0 million in the aggregate with a deductible of $0.1
million per occurrence and an annual maximum aggregate deductible of $0.5
million. We cannot assure that such insurance coverage will be available to us
in the future at a reasonable cost, if at all. Nor can we assure that other
claims will not be brought against us in excess of our insurance coverage. Natural Catastrophic Events; Terrorism and Other Manmade Problems. Our corporate headquarters, including our research and development operations,
our manufacturing facilities, and our principal sales, marketing and service
offices, are located in the Silicon Valley area of Northern California, a
region known for seismic activity. A significant natural disaster, such as an
earthquake or a flood, could have a material adverse impact on our business,
operating results, and financial condition. In addition, despite our
implementation of network security measures, our servers are vulnerable to
computer viruses, break-ins, and similar disruptions from unauthorized
tampering with our computer systems. Any such event could have a material
adverse effect on our business, operating results, and financial condition. In
addition, the effects of war or acts of terrorism could have a material adverse
effect on our business, operating results, and financial condition. The
terrorist attacks in New York and Washington, D.C. on September 11, 2001
disrupted commerce throughout the world and intensified the uncertainty of the
United States and other economies. The continued threat of terrorism and
heightened security and military action in response to this threat, or any
future acts of terrorism, may cause further disruptions to these economies and
create further uncertainties. To the extent that such disruptions or
uncertainties result in delays or cancellations of customer orders, or the
manufacture or shipment of our products, our business, operating results and
financial condition could be materially and adversely affected. Factors Affecting Financial Results and Stock Price. A number of factors affect our financial results and stock price including, but
not limited to:  
    
    product mix;
    
    competitive pricing pressures;
    
    material costs;
    
    revenue and expenses related to new products and enhancements to
existing
products;
    
    delays in customer purchases in anticipation of new products or
product
enhancements by Laserscope or its competitors; and
    
    the risk of loss or interruption to our operations or increased costs
due to
earthquakes, the availability of power and energy supplies and other
events
beyond our control. The market price of our common stock may be subject to significant
fluctuations. These fluctuations may be due to factors specific to Laserscope,
such as:  
    
    quarterly fluctuations in our financial results;
    
    changes in analysts estimates of future results;
    
    changes in investors perceptions of our products or business
prospects;
    
    announcement of new or enhanced products by us or our competitors;
    
    announcements relating to acquisitions and strategic transactions by
us or our
competitors; 23




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
    
    general conditions in the medical equipment industry; and
    
    general conditions in the financial markets. The stock market has from time to time experienced extreme price and volume
fluctuations, particularly among stocks of high technology companies, which, on
occasion, have been unrelated to the operating performance of particular
companies. Factors not directly related to Laserscopes performance, such as
negative industry reports or disappointing earnings announcements by publicly
traded competitors, may have an adverse impact on the market price of our
common stock. As of October 31, 2004, we had 21,421,296 shares of outstanding common stock.
The sale of a substantial number of shares of common stock or the perception
that such sales could occur, could adversely affect prevailing market prices
for our common stock. International Business. Our international sales are made through international distributors and
wholly-owned subsidiaries with payments to us typically denominated in the
local currencies of the United Kingdom and France, and in U.S. Dollars in the
rest of the world. We intend to continue our operations outside of the United
States and potentially to enter additional international markets, These
activities, require significant management attention and financial resources
and further subject us to the risks of operating internationally. These risks
include, but are not limited to:  
    
    changes in regulatory requirements;
    
    delays resulting from difficulty in obtaining export licenses for
certain technology;
    
    customs, tariffs and other barriers and restrictions; and
    
    the burdens of complying with a variety of foreign laws. We are also subject to general geopolitical risks in connection with our
international operations, such as:  
    
    differing economic conditions;
    
    changes in political climate;
    
    differing tax structures; and
    
    changes in diplomatic and trade relationships and war. In addition, fluctuations in currency exchange rates may negatively affect our
ability to compete in terms of price against products denominated in local
currencies. Accordingly, our future results could be materially adversely affected by
changes in these regulatory, geopolitical and other factors. We do not engage in hedging transactions for speculative or trading purposes. Legal Proceedings. Laserscope is a party to a number of legal proceedings and claims arising in
the ordinary course of business. While it is not feasible to predict or
determine the outcome of the actions brought against us, we believe that the
ultimate resolution of these claims will not have a material adverse effect on
Laserscopes financial position, results of operations, or future cash flows. 24




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Interest Rate Risk. (See Item 3. Quantitative and Qualitative Disclosures About Market Risk in
this Quarterly Report on Form 10-Q.) Warranty Obligations. We have a direct field service organization that provides service for our
products. We generally provide a twelve month warranty on our laser systems.
After the warranty period, maintenance and support is provided on a service
contract basis or on an individual call basis. Our warranties and premium
service contracts provide for a 99.0% Uptime Guarantee on our laser systems.
Under provisions of this guarantee, we extend the term of the related warranty
or service contract if specified system uptime levels are not maintained.
Although most systems covered by this guarantee have achieved a 99.0% uptime
rate to date, we cannot assure that we can maintain such uptime rates in the
future. No Dividends. We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends on the common stock in the foreseeable future. The
payment of dividends on the common stock will depend on our earnings, financial
condition and other business and economic factors affecting us at such time as
the Board of Directors may consider relevant. Penny Stock Rules. Our common stock is traded on the National Association of Securities Dealers
Automated Quotation (NASDAQ) National Market System, which requires that a
company have, among other things, a minimum bid price of $1.00 in order to
qualify for continued listing. If we fail to maintain our listing for our
common stock on the NASDAQ National Market System, and no other exclusion from
the definition of penny stock under the Exchange Act is available, any
brokers engaging in transactions in our securities would be required to provide
their customers with a risk disclosure document, the compensation of the
broker/dealer in the transaction and monthly account statements showing the
market values of our securities held in the customers accounts. The bid and
offer quotations and compensation information must be provided prior to
effecting the transaction and must be contained on the customers confirmation.
If brokers
become subject to the penny stock rules when engaging in transactions in our
securities, they may become less willing to engage in such transactions,
thereby making it more difficult for shareholders to dispose of their shares of
Laserscope common stock. Dilution. Shareholders may experience dilution in the net tangible book value of their
investment upon the exercise of outstanding options and warrants granted under
Laserscopes stock option plans and other options and warrants currently
outstanding. Other. Other risks are detailed from time to time in our press releases and other
public disclosure filings with the United States Securities and Exchange
Commission (SEC), copies of which are available upon request from the
Company. 25




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Item 3. Quantitative and Qualitative Disclosures About Market Risk. Laserscope is exposed to a variety of risks, including changes in interest
rates affecting the return on its investments, outstanding debt balances and
foreign currency fluctuations. In the normal course of business, the Company
employs established policies and procedures to manage its exposure to
fluctuations in interest rates and foreign currency values. Interest Rate Risk. Our exposure to market rate risk for changes in interest rates relates
primarily to our outstanding debt. However, at September 30, 2004, we had no
bank loans or debentures. Also, in the nine months ended September 30, 2004
and 2003, we did not use derivative financial instruments. We invest our
excess cash in money market funds. Historically, our debt financings generally
consisted of convertible debentures and bank loans requiring either fixed or
variable rate interest payments. Investments in and borrowings under both
fixed-rate and floating-rate interest-earning instruments carry a degree of
interest rate risk. On the investment side, fixed-rate securities may have
their fair market value adversely affected due to a rise in interest rates,
while floating-rate securities may produce less income than expected if
interest rates fall. In addition, our future investment income may fall short
of expectations due to changes in interest rates or we may suffer losses in
principal if forced to sell securities that have declined in market value due
to changes in interest rates. On the debt side, borrowings that require
fixed-rate interest payments require greater than current market rate interest
payments if interest rates fall, while floating rate borrowings may require
greater interest payments if interest rates rise. While we had no borrowing in
the current quarter, if we borrow in the future, our interest expense may be
greater than expected due to changes in interest rates. Foreign Currency Risk. Our international revenues were 23% and 25% of total revenues in each of the
quarters ended September 30, 2004 and 2003, respectively. Our international
sales are made through international distributors and wholly owned subsidiaries
with payments to the Company typically denominated in the local currencies of
the United Kingdom and France, and in United States dollars in the rest of the
world. Our international business is subject to risks typical of an
international business, including, but not limited to, differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility.
Accordingly, our future results could be materially adversely affected by
changes in these or other factors. We do not engage in hedging transactions
for speculative or trading purposes. 26




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Item 4. Controls and Procedures. (a) Our Chief Executive Officer and Chief Financial Officer have reviewed, as
of the end of the period covered by this report, the disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-,
15(e) and 15d-15(e)) that ensure that information relating to the Company
required to be disclosed by us in the reports that we file or submit under the
Exchange Act, is recorded, processed, summarized and reported in a timely and
proper manner. Based upon this review, we believe that the controls and
procedures in place are effective to ensure that information relating to the
Company that is required to be disclosed by us in the reports that we file or
submit under the Exchange Act is properly disclosed as required by the Exchange
Act and related regulations. (b) Changes in internal controls.
No change in the Companys internal control over financial reporting identified
in connection with the evaluation required by paragraph (d) of Exchange Act
Rules 13a-15 or 15d-15 that occurred during the Companys third fiscal quarter
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 27




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PART II. OTHER INFORMATION 
 Item 5. Other Information. We have in place an asset based line of credit which provides up to $5.0
million in borrowings off-set against $1.0 million in letter of credit reserve
requirements. The line of credit was renewed September 24, 2004 and currently
expires September 2006. Credit is extended based on the Companys eligible
accounts receivable and inventory. At September 30, 2004, the Company had
approximately $4.0 million in borrowing capacity under the line of credit
facility. The Companys assets collateralize the line of credit which bears an
interest rate equivalent to the banks prime rate plus 2.0%. The prime rate at
September, 2004 was 4.75%. Borrowings against the line of credit are paid down
as the Company collects its accounts receivable. Provisions of the bank loan
agreement prohibit the payment of dividends on non-preferred stock, or the
redemption, retirement, repurchase or other acquisition of Company stock. The
agreement further requires the Company to maintain a minimum tangible net
worth. As of September 30, 2004, the Company was in compliance with all
covenants and had no outstanding borrowings under the line of credit facility. 
 Item 6.     Exhibits  Exhibits filed herewith (numbered in accordance with Item 601 of
Regulation S-K): ExhibitNumber
    
    Description10.11L
    
    Amendment to the Loan and Security Agreement between the
Registrant and Silicon Valley Bank dated September 24, 200431.1
    
    Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Principal Executive Officer pursuant to 18 U.S.C
Section 1350.32.2
    
    Certification of Principal Financial Officer pursuant to 18 U.S.C.
Section 1350.
 28




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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. LASERSCOPERegistrant/s/ Dennis LaLumandiereDennis LaLumandiereVice President, Financeand Chief Financial Officer(Principal Financial andAccounting Officer)Date: November 8, 2004
 29




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Exhibit Index ExhibitNumber
    
    Description10.11L
    
    Amendment to the Loan and Security Agreement between the
Registrant and Silicon Valley Bank dated September 24, 200431.1
    
    Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Principal Executive Officer pursuant to 18 U.S.C
Section 1350.32.2
    
    Certification of Principal Financial Officer pursuant to 18 U.S.C.
Section 1350.
 30