Except for the historical information contained in this Annual Report, the matters discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements, the accuracy of which is necessarily subject to risks and uncertainties. Actual results may differ significantly from the discussion of such matters in the forward-looking statements. See “Risk Factors.”

      In the discussion of the material changes in our financial condition and results of operations between the reporting periods in the consolidated financial statements, management has sought to identify and, in some cases, quantify, the factors that contributed to such material changes. However, quantifying these factors may involve the presentation of numerical measures that exclude amounts that are included in the most directly comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (“GAAP”). Management uses this information to assess material changes in our financial condition and results of operations and is providing it to assist investors and potential investors to understand these assessments. In each instance, such information is presented immediately following (and in connection with an explanation of) the most directly comparable financial measure calculated in accordance with GAAP, and includes other material information necessary to reconcile the information with the comparable GAAP financial measure.

Overview

      STAAR Surgical Company develops, manufactures and distributes worldwide visual implants and other ophthalmic products to improve or correct the vision of patients with cataracts, refractive conditions, and glaucoma. Originally incorporated in California in 1982, STAAR Surgical Company reincorporated in Delaware in 1986. Unless the context indicates otherwise “we,” “us,” the “Company,” and “STAAR” refer to STAAR Surgical Company and its consolidated subsidiaries.

      Cataract Surgery. The production and sale of IOLs for use in cataract surgery remains our core business. Our products for cataract surgery include the following:

      Sales of cataract surgery products accounted for approximately 90% of our total revenues for the year ended December 31, 2004 and 92% for the 2003 fiscal year.

      Refractive Surgery. We have used our unique biocompatible Collamer material to develop and manufacture lenses to treat refractive disorders such as myopia (near-sightedness), hyperopia (far-sightedness) and astigmatism. These include the VISIAN ^tm ICL, or ICL®, and the Toric VISIAN ^tm TICL, or TICL®. Lenses of this type are generically called “phakic IOLs” or “phakic implants” because they work along with the patient’s natural lens, or phakos , rather than replacing it.

      The ICL and TICL have not yet been approved for use in the United States. The ICL is approved for use in the European Union and in Korea and Canada. The TICL completed enrollment in clinical trials in the United States in early 2005, and is approved for use in the European Union.

      Glaucoma Surgery. We have developed the AquaFlow ^tm Collagen Glaucoma Drainage Device, also referred to as the AquaFlow Device, as an alternative to current methods of treating open angle glaucoma. The AquaFlow Device is implanted in the sclera (the white of the eye), using a minimally invasive procedure, for the purpose of reducing intraocular pressure.

      Changing Focus of Research and Development. STAAR’s executive management was completely replaced commencing in 2001. The new management team assumed control of a company with a long record of innovation in ophthalmology, but one that had failing financial results and was expending cash at a significant rate. STAAR was also embroiled in several legal actions which affected our cash reserves. The new management implemented significant restructuring and other cost-cutting measures in 2001 to conserve our cash resources. Despite these cutbacks, STAAR has continued to devote a significant amount of its resources to developing and introducing the ICL.

      Because of its significant investment in ICL technology, STAAR had limited resources for further developing its mature and well accepted IOL products for cataract treatment. Nevertheless, in the fourth quarter of 2003, the Company introduced the first preloaded injector system which was developed by its joint venture company in Japan, Canon Staar. Management believes, however, that during the long process of developing and seeking approval for the ICL, STAAR overall failed to match some of its competitors’ improvements to IOL technology and standard delivery systems resulting in a loss of U.S. market share.

      As U.S. approval of the ICL appeared more likely in late 2003, and the focus of the ICL project shifted from development to marketing, management began to devote research and development resources to making STAAR’s IOL delivery systems more competitive. In an effort to strengthen the areas of research and

development, we separated our research and development function from our regulatory and compliance function and hired Tom Paul, PhD as Vice President, Research and Development and James Farnworth as Vice President, Regulatory and Quality Assurance. The resources for these efforts were made available by STAAR’s 2003 private sale of Common Stock, the proceeds of which were intended to fund the launching and marketing of the ICL.

      The Warning Letter received from the FDA on December 29, 2003 caused STAAR to accelerate its efforts to improve its quality and regulatory compliance systems. The delay in the approval of the ICL until compliance issues were resolved further accelerated the need to invest in improvements to its IOL delivery systems in order to maintain its core cataract business.

      As a result of the above factors and the receipt of a second Warning Letter, 2004 saw significant new investments in the restructuring of STAAR’s quality assurance and regulatory compliance functions, and in improving IOL technology, particularly lens delivery systems. While some R&D expense is directly attributable to the response to the FDA’s Warning Letters and related audits of STAAR’s facilities, the bulk of the expense results from systemic changes intended to produce a permanent improvement in the areas of research and development and quality assurance and regulatory compliance.

      As described below, the initiative to improve IOL delivery technology resulted in progress towards the completion of an improved one-piece Collamer IOL injector, continuous improvement efforts to cartridge injector components for all lenses and a redesigned three-piece Collamer IOL injector. The continuous effort to improve cartridges resulted in supply problems, particularly in the second quarter of 2004. The timing of this interruption in supply, which coincided with increased R&D expenditures and a decline in sales of silicone IOLs, contributed to the drop in earnings in the second quarter. The decision to upgrade our three-piece Collamer lens design to coincide with the introduction of the first dedicated injector for this lens, coupled with a revised quality system, have resulted in the combined introduction being delayed.

      Contraction of Silicone IOL Market. Our market share for silicone IOLs has steadily decreased over the last several years, as many surgeons now choose lenses made of acrylic material rather than silicone for their patients. Management believes that Collamer lens material will ultimately be competitive with acrylic, but to date sales of Collamer IOLs have only partially offset declining sales of silicone IOLs.

      Redesign of Injectors and Three-Piece Collamer IOL. In an effort to improve the competitiveness of our lens injection systems for Collamer IOLs, during 2004 we devoted significant resources to improving the injector for the one-piece Collamer IOL and redesigning the three-piece Collamer injector. The redesign of the three-piece Collamer injector resulted in a hiatus in three-piece Collamer lens production, which STAAR took as an opportunity to make minor improvements and enhancements to the lens design. As a result of these efforts, three-piece Collamer IOLs had limited availability during 2004.

      Decline in U.S. Sales of IOLs. During the year ended December 31, 2004, decreasing sales of silicone IOLs were further intensified by the negative perception in the marketplace caused by the Warning Letters and recalls described below, resulting in a 14% decline in U.S. silicone IOL sales compared to fiscal 2003. The market’s reaction to the compliance issues, along with an interruption in the supply of cartridges, also resulted in a decline in sales of Collamer IOLs. In contrast to recent periods in which improving sales of Collamer IOLs partially offset declining sales of silicone IOLs, sales of Collamer IOLs declined 8% in 2004 compared to fiscal 2003, worsening overall results for the U.S. cataract business and resulting in an overall decline of 7.8% in U.S. sales in 2004 compared to fiscal 2003.

      Growth in International Sales of VISIAN ICLs and Preloaded Silicone IOLs. The decline in the U.S. cataract business during 2004 was offset in part by a 37.6% increase in international sales of the VISIAN ICL and TICL. In addition, our preloaded silicone lens injector system, newly launched in international markets, experienced strong sales. This growth in the business resulted in an increase in international sales of 11.5% in 2004 compared to 2003.

      FDA Warning Letters and the 483 Observations. In 2004, we received Warning Letters and 483 Observations issued by the FDA, which outlined deficiencies related to our manufacturing and quality assurance systems in our Monrovia, California facility. For a discussion of the Warning Letters and 483

Observations, see “Business — Regulatory Matters — Warning Letters and the 483 Observations.” Costs associated with the preparation for these FDA inspections, and the improvements made to the quality assurance and regulatory compliance functions, contributed to the 22% increase in our research and development expenses (which included regulatory and quality assurance expenses) for fiscal 2004, compared to fiscal 2003. Additionally, the Warning Letters and 483 Observations have affected the Company’s reputation in the ophthalmic market and have adversely affected product sales for fiscal 2004. Until the FDA is satisfied with the Company’s response, it is unlikely to grant the Company approval to market the ICL in the United States. See “Risk Factors — We have received 483 Inspectional Observations and Warning Letters from the FDA, which until resolved to the satisfaction of the FDA will continue to delay approval of the ICL and could limit our existing business in the United States.” and “— Our success depends on the ICL, which has not been approved for use in the United States.”

      Foreign Currency Fluctuations. Our products are sold in more than 45 countries. For the year ended December 31, 2004, revenues from international operations were 58% of total revenues. The results of operations and the financial position of certain of our offshore operations are reported in the relevant local currencies and then translated into U.S. dollars at the applicable exchange rates for inclusion in our consolidated financial statements, exposing us to currency translation risk. For the year ended December 31, 2004, currency exchange rates had a favorable impact on product sales of approximately $2.2 million, and an adverse impact on our marketing and selling expenses of approximately $777,000.

      Product Recalls. During 2004, we initiated several voluntary recalls of STAAR manufactured product including 33 lots of IOL cartridges, three lots of injectors, and 529 lenses. In an action considered a recall, but with no requirement for product to be returned to us, we issued letters to healthcare professionals advising them of the potential for a change in manifest refraction over time in rare cases involving the single-piece Collamer IOL. Although the direct costs associated with recalls have not been material, we believe recalls have adversely affected our revenues from product sales, although the amount of the impact cannot be determined.

      Gross Profit. Our gross profit margin decreased to 50.6% in fiscal 2004 from 55.2% in fiscal 2003. Among the factors contributing to the decline in our gross profit margin were increased expenses associated with manufacturing engineering and quality control and assurance, an increase in inventory provisions, higher unit costs due to process changes and reduced volumes, and a shift in geographical and product mix.

      Research and Development. We spent 12.1% of our revenue on research and development (which includes regulatory and quality assurance expenses) for the year ended December 31, 2004, and we expect to spend approximately 10% of our revenue on an annual basis in the future. For the year ended December 31, 2004, research and development expenses increased 22% compared to 2003. This was primarily due to our increased investment in injection systems, the redesign of the Collamer three-piece IOL and injector and preparation for the FDA audit of our facilities in Nidau, Switzerland and Monrovia, California, described above. Increases in research and development expense were partially offset by decreased expenses at subsidiaries, as all research and development efforts were consolidated into one location.

      Private Placement. Due to the issues raised the FDA’s Warning Letters and the delay in the FDA approval of the ICL, we sought additional cash to invest in research and development, regulatory and compliance, and manufacturing engineering and to support other operating activities. This was accomplished through the private placement of 2,000,000 shares of our Common Stock on June 10, 2004 generating net proceeds of $11.6 million during the second quarter of 2004.

      Cash Flow and the Need for Further Financing. During fiscal 2004, we used $8.8 million in cash for operating activities and $1.7 million for property plant and equipment, ending fiscal 2004 with $9.3 million in cash and cash equivalents and short-term investments compared to $7.3 million in cash and cash equivalents at the end of fiscal 2003. We used $2.5 million in cash in the fourth quarter of 2004 and expect to use $3.5 million in the first quarter of 2005. During the fourth quarter of 2004, we took steps to reduce operating expenses by reducing our reliance on outside consultants. This reduction in spending is expected to result in savings of approximately $1.0 million annually. In early February 2005, we implemented additional cost reduction strategies, including the reduction in size of our direct sales force, which are expected to result in

another $1.0 million in annualized cost savings. We will continue to pursue other cost savings opportunities with the goal of realizing a total of $3.0 million in annual cost savings. We do not expect to realize significant benefits from the cost reductions in the first quarter of 2005 and while the benefit of the cost reductions will be fully implemented in the second quarter, a continued decline in U.S. sales could offset some of the savings for future periods. As a result of the level of cash available to the Company to fund ongoing operations as well as new product initiatives, we are exploring opportunities to raise additional financing. The Company expects operating losses and negative cash flows to continue until such time as the issues presented in the FDA Warning Letter dated December 22, 2003 and the 483 Observations are resolved and the ICL is approved for sale in the United States.

      Going Concern. Our recurring losses from operations, negative cash flows, and accumulated deficit raise substantial doubt about our ability to continue as a going concern. As a result, we have received a report from our independent registered public accounting firm regarding our financial statements for the year ended December 31, 2004 that included an explanatory paragraph stating that there is substantial doubt about our ability to continue as a going concern.

      Retention of Morgan Stanley. In December 2004, we engaged Morgan Stanley to assist our Board of Directors in a review of the strategic and financial options available to us.

      Litigation. During 2004, multiple class action lawsuits, which were subsequently consolidated, were filed against the Company and its Chief Executive Officer on behalf of all persons who acquired the Company’s securities during various periods between April 3, 2003 and September 28, 2004. See “Item 3. Legal Proceedings.”

      Purchase of Minority Interest. In May 2004, we entered into an agreement for the purchase of the 20% minority interest of an 80% owned subsidiary, ConceptVision Australia Pty Limited, in exchange for cash of $768,000 and a long-term note in the amount of $542,000 due on November 1, 2007. The transaction resulted in the recording of goodwill of $1.1 million.

Results of Operations

      The following table sets forth the percentage of total revenues represented by certain items reflected in the Company’s income statement for the period indicated and the percentage increase or decrease in such items over the prior period.

2004 Fiscal Year Compared to 2003 Fiscal Year

      Revenues. Product sales for the years ended December 31, 2004 (“fiscal 2004”) and January 2, 2004 (“fiscal 2003”) were $51.7 million and $50.4 million, respectively. Changes in currency exchange rates had a favorable impact on product sales of approximately $2.2 million for fiscal 2004. The primary reason for the decrease in product sales, excluding the impact of exchange rates, was a decrease in U.S. IOL sales due to (i) the decline in the silicone IOL market as many surgeons now choose lenses made of acrylic material, (ii) the Company’s failure to match competitors’ improvements to IOL technology, (iii) the market response to the Company’s compliance issues with the FDA and (iv) the lack of competitive lens delivery systems. The Company also experienced decreased sales of distributed products as it concentrates on the distribution of its higher margin proprietary products. The decreases in U.S. IOL sales and sales of distributed products were partially offset by increased sales of the Company’s Visian ^tm ICL (“ICL”) and Visian ^tm TICL (“TICL”) in international markets, sales of the newly launched preloaded IOLs in international markets, and increased sales of Cruise Control.

      Total revenues for 2003 included $49,000 in royalties from technology licenses that terminated in 2003.

      Gross profit. Gross profit margin decreased to 50.6% of revenues for fiscal 2004, from 55.2% of revenues for fiscal 2003. The most significant impact on gross margins resulted from increased expenses associated with manufacturing engineering and quality control and assurance, an increase in inventory provisions, higher unit costs due to process changes and reduced volumes, and a shift in geographical and product mix.

      Marketing and selling expenses. Marketing and selling expenses for fiscal 2004 increased $793,000, or 4%, over fiscal 2003. The increase is principally due to fluctuations in foreign exchange rates which negatively impacted marketing and selling expenses by $777,000. International sales and marketing expenses increased due to increased salaries, travel, and commissions. Headcount in the U.S. increased due to the addition of direct sales representatives for a newly established sales territory in the Pacific Northwest Region and as a result of the addition of proctors-trainers used principally to train physicians in the ICL implantation technique. These increases were offset by decreased promotional activities, primarily in response to the delay in the launch of the Visian ^tm ICL in the U.S. and the cost savings realized from the closure of a subsidiary.

      Research and development expenses. Research and development expenses for the fiscal 2004, increased $1,127,000, or 22%, compared to fiscal 2003. This was primarily due to our increased investment in insertion systems, the redesign of the Collamer three-piece IOL and injector and preparation for the FDA audit of our facilities in Nidau, Switzerland and Monrovia, California. Increases in research and development expense were partially offset by decreased research and development expenses of subsidiaries, as all research and development efforts were consolidated into one location.

      Other charges. Other charges for fiscal 2004 were $500,000 compared to $390,000 in fiscal 2003. During fiscal 2004, the Company recorded a $500,000 reserve against the notes of a former director of the Company which total $1.8 million including accrued interest. The notes are collateralized by 120,000 shares of the Company’s Common Stock and a second mortgage on a home in Florida. The current value of the collateral is approximately $1.3 million. The amount of the reserve is based on the difference between the note amount and the collateral value.

      Other expense, net. Other expense for fiscal 2004 decreased $549,000 over fiscal 2003. Included in other expense for fiscal 2003 was the write-off of a note receivable in the amount of $430,000. During fiscal 2004, the Company recovered $200,000 of the note and recorded the cash received as other income. These increases in other income were partially offset by losses recorded in 2004 by the Company’s joint venture, Canon Staar.

      Income taxes. For each of fiscal 2004 and fiscal 2003, the Company recorded income taxes of $1.1 million primarily based on the income of the Company’s German subsidiary.

      In 1995, a subsidiary of the Company obtained retroactively to 1993, a ten-year tax holiday for the payment of federal, cantonal and municipal income taxes in Switzerland. As such, Swiss income taxes were not due on the operations of this subsidiary for the ten-year period that ended on December 31, 2002. For 2004

and 2003, as the tax holiday from Swiss taxes has expired, the appropriate federal, cantonal and municipal income taxes have been included in the foreign tax provision.

      Negotiations to extend the Swiss tax holiday are ongoing. The Swiss tax authorities are considering granting an extension of the tax holiday with respect to “new” products including the ICL, the Toric ICL and the AquaFlow Device. If the tax holiday is extended, it will likely be applied prospectively.

2003 Fiscal Year Compared to 2002 Fiscal Year

      Revenues. Revenues for fiscal 2003 increased over the year ended January 3, 2003 (“fiscal 2002”) by 4.6% or $2,210,000 due to the favorable impact of foreign exchange on sales of other ophthalmic products distributed in international markets. Excluding the favorable impact of foreign exchange, sales decreased 2%. The decrease in sales is due primarily to a decrease in unit volume of the Company’s single and three-piece silicone IOL, primarily in the U.S. market, due to a decline in competitiveness of the Company’s lens delivery systems and believed contraction of this market segment. The decrease in sales of silicone IOLs was partially offset by increased sales in the U.S. of Collamer IOLs (28% increase in volume partially offset by a 6% decrease in average selling price “ASP”). As a result of the decreased silicone IOL sales in the U.S., overall sales in that market declined 3%. Sales of the AquaFlow Device decreased 19% (15% decrease in volume and a 5% decrease in ASP) over 2002. This sales decrease was also realized in the U.S. and was the result of sales and marketing resources which have been diverted from AquaFlow proctoring and training to surgical evaluations of silicone lens injection systems and preparation for possible FDA approval of the ICL.

      The decreases in single and three-piece silicone IOL and AquaFlow sales were further offset by increased sales of ICLs, Toric IOLs, STAARVisc, and Cruise Control. Sales of ICLs in international markets increased 31% due to a 26% increase in units and a 4% increase in ASP. Sales of STAARVisc increased 17% on a 25% increase in volume partially offset by a 7% decrease in ASP. Sales of Toric IOLs increased 3% due to a 10% increase in volume partially offset by a 6% decline in ASP. Sales in international markets decreased 2% (excluding the impact of exchange) due to a decrease in equipment sales in Australia.

      Gross profit. Gross profit for fiscal 2003 was 55.2% of revenues compared to fiscal 2002 when it was 50.1% of revenues. The improvement in gross profit margin is the result of successfully increasing standard margins across all of our primary product lines through reduced cost structures resulting from better yields, efficiencies and volume, and reducing other costs of sales through better management of excess and obsolete inventories. Additionally, the Company streamlined its phacoemulsification manufacturing and repair division, during the year, resulting in lower costs and improved gross profit for this product line.

      Marketing and selling expenses. Marketing and selling expenses for fiscal 2003 increased $2.7 million, or 16%, over fiscal 2002. Marketing and selling expense in the U.S. increased by $1.7 million as a result of marketing and promotional costs which increased, as planned, in preparation for the launch of the ICL and increased headcount and associated recruiting costs in preparation for launch of the ICL in the U.S., the addition of direct sales representatives for a newly established Pacific Northwest Region, increased travel expenses and increased salaries. Marketing and selling expense increased internationally by $1.0 million primarily due to the unfavorable impact of exchange rates partially offset by reduced expenses of subsidiaries which were closed in 2002 and 2003.

      Other charges. Other charges for fiscal 2003 were $390,000 compared to fiscal 2002 when they were $1.5 million. The charges in 2003 related to the write-down of $2.1 million (net book value) in capitalized patent costs in connection with the Company’s routine evaluation of such costs in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS 144”) — “Accounting for the Impairment of Long-Lived Assets.” The write-down related to patents acquired in 1999 in the purchase of the Company’s majority interest in Circuit Tree Medical, a developer and manufacturer of phacoemulsification equipment, whose ongoing operations were moved to the Company’s Monrovia, California facility. The $2.1 million charge was partially offset by the reversal of $1.7 million of reserves against former officers’ notes which were paid during the year.

      Other expense, net. Other expense for fiscal 2003 decreased $148,000 over fiscal 2002. The decreased expense is due to decreased interest expense and foreign exchange losses partially offset by decreased interest income from officers’ notes that were paid in full and a $430,000 reserve on a note receivable the Company recorded during the year.

      Income taxes. Income taxes for fiscal 2003 decreased $7.7 million over the fiscal 2002. The high provision for income taxes in 2002 was the result of a valuation allowance of $9.0 million recorded against the Company’s deferred tax assets, partially offset by an income tax benefit of approximately $1.0 million related to a federal carryback claim filed in 2002. The tax refund from the carryback claim was received in 2003.

      In 1995, a subsidiary of the Company obtained retroactively to 1993, a ten-year tax holiday for the payment of federal, cantonal and municipal income taxes in Switzerland. As such, Swiss income taxes were not due on the operations of this subsidiary for the ten-year period that ended on December 31, 2002. For 2003, as the tax holiday from Swiss taxes has expired, the appropriate federal, cantonal and municipal income taxes have been included in the foreign tax provision.

      Negotiations to extend the Swiss tax holiday are ongoing. The Swiss tax authorities are considering granting an extension of the tax holiday with respect to “new” products including the ICL, the Toric ICL and the AquaFlow Device. If the tax holiday is extended, it will likely be applied prospectively.

Liquidity and Capital Resources

      The Company has funded its activities over the past several years principally from cash flow generated from operations, credit facilities provided by institutional domestic and foreign lenders, the private placement of Common Stock, the repayment of former officers’ notes, and the exercise of stock options.

      Net cash provided by (used in) operating activities was ($8.8) million, ($4.1) million, and $0.6 million for fiscal 2004, 2003, and 2002, respectively. For fiscal 2004, cash used in operations was the result of the net loss, adjusted for depreciation, amortization, and other non-cash charges, and increases in working capital — primarily accounts receivable, inventory, accounts payable and other current liabilities. For fiscal 2003, cash used in operations was the result of the net loss, adjusted for depreciation, amortization, the write-off of patents, and other non-cash charges. For fiscal 2002, cash provided by operations was the result of the net loss, adjusted for depreciation, amortization, deferred income taxes, and other non-cash charges, and decreases in working capital — primarily accounts receivable, inventory, and accounts payable.

      Accounts receivable was $6.2 million in 2004, $5.7 million in 2003, and $6.0 million in 2002. The increase in accounts receivable is due to increased sales, the write-off of a receivable, reserved in the previous year, of a distributor that discontinued its operations and a slight increase in day’s sales outstanding (“DSO”). Although DSO improved from 45 days in 2002 to 39 days in 2003 it increased slightly, as expected, to 41 days in 2004. The Company expects DSO to continue in the 40-43 day range for 2005.

      Inventory at year-end 2004, 2003, and 2002 was $15.1 million, $12.8 million, and $11.8 million, respectively. Day’s inventory on hand increased from 176 days in 2002 to 204 days in 2003, and decreased to 186 days in 2004. Although inventory units have decreased overall from 2003 to 2004, the decrease was more than offset by higher cost inventory that was produced during the year as a result of lower than planned production volume resulting in an increase in inventory of $2.3 million in 2004 over 2003. Inventory, at the end of 2003, increased $1.0 million over 2002 levels due to the build-up of ICL inventory in preparation of the launch of the product in the U.S. and increased collamer IOL inventory based on increased demand for the product. High cost inventory, built in 2001, was sold during 2002 and replaced with lower cost inventory resulting in an overall decrease in inventory at the end of 2002 of $3.5 million over 2001.

      Net cash provided by (used in) investing activities was approximately ($7,294,000), $2,151,000, and ($406,000) for fiscal 2004, 2003, and 2002, respectively. During 2004, the Company invested $8.0 million of the proceeds of a private placement in taxable auction-rate securities which are classified as available for sale investments and sold $2.9 million of the investment during the year to provide cash for operations. Also during 2004, the Company purchased the 20% minority interest in an 80% owned subsidiary in exchange for cash of $768,000 and a long-term note in the amount of $542,000 due on November 1, 2007. The transaction resulted

in the recording of goodwill of $1.1 million. Proceeds from the payment of notes of former officers were the primary source of cash provided by investing activities in 2003. The principal investments of the Company are in property and equipment. Investments in property and equipment were $1.7 million, $1.3 million, and $874,000 for fiscal 2004, 2003, and 2002, respectively. The investments are generally made to upgrade and improve existing production equipment and processes. The Company expects to spend approximately $1.0 million on property and equipment in 2005.

      Net cash provided by (used in) financing activities were approximately $12,547,000, $7,589,000, and ($592,000) for fiscal 2004, 2003, and 2002, respectively. In 2004, cash provided by financing activities resulted from the receipt of net proceeds of $11.6 million from a private placement of 2.0 million shares of the Company’s Common Stock and $829,000 received from the exercise of stock options. In 2003, cash provided by financing activities is primarily the result of net proceeds of $8.9 million from a private placement of the Company’s Common Stock and $1.6 million received from the exercise of stock options. The Company used approximately $2.1 million of the proceeds to pay off the note to its domestic lender and $812,000 to pay down other notes payable. In 2002, the Company used $592,000 in cash to pay down notes payable.

      Subsidiaries of the Company have foreign credit facilities with different banks to support operations in Switzerland and Germany.

      The Swiss credit agreement, as amended on August 2, 2004, provides for borrowings of up to 3.75 million Swiss Francs “CHF” (approximately $3.3 million based on the rate of exchange on December 31, 2004), and permits either fixed-term or current advances. The interest rate on current advances was 6.0% per annum at both December 31, 2004 and January 2, 2004, plus a commission rate of 0.25% payable quarterly. There were no current advances outstanding at December 31, 2004 or January 2, 2004. The base interest rate for fixed-term advances follows Euromarket conditions for loans of a corresponding term and currency, plus an individual margin (4.5% at December 31, 2004 and 4.2% at January 2, 2004). Borrowings outstanding under the facility were CHF 3.4 million at December 31, 2004 (approximately $3.0 million based on the rate of exchange at December 31, 2004) and CHF 3.7 million at January 2, 2004 (approximately $3.0 million based on the rate of exchange on January 2, 2004). The credit facility is secured by a general assignment of claims and includes positive and negative covenants which, among other things, require the maintenance of a minimum level of equity of at least $12.0 million and prevents the Swiss subsidiary from entering into other secured obligations or guaranteeing the obligations of others. The agreement also prohibits the sale or transfer of patents or licenses without the prior consent of the lender and the terms of intercompany receivables may not exceed 90 days.

      The Swiss credit facility is divided into two parts. Part A provides for borrowings of up to CHF 3.0 million ($2.7 million based on the exchange rate on December 31, 2004) and does not have a termination date. Part B presently provides for borrowings of up to CHF 750,000 ($662,000 based on the exchange rate on December 31, 2004). The loan amount under Part B of the agreement is reduced by CHF 250,000 ($220,000 based on the exchange rate on December 31, 2004) semi-annually.

      The German credit agreement, entered into during fiscal 2003, provides for borrowings of up to 210,000 EUR ($286,000 based on the exchange rate on December 31, 2004), at a rate of 8.5% per annum and renews automatically each November. The agreement prohibits our German subsidiary from paying dividends and is personally guaranteed by the president of the subsidiary. There were no borrowings outstanding as of December 31, 2004 or January 2, 2004.

      The Company was in compliance with the covenants of these credit facilities as of December 31, 2004.

      The following table represents the Company’s known contractual obligations included in the Company’s balance sheet as of December 31, 2004.

      The table presented above excludes the following information: (a) interest due on notes payable under the Swiss credit agreement and (b) employment agreements for the two previous minority owners of our Australian subsidiary. See Note 9 to the Consolidated Financial Statements.

      Due to a continued decline in U.S. sales, lower gross profit, and increased operating expenses the Company sustained significant losses and negative cash flows from operations for the year ended December 31, 2004. Our current sources of working capital are not sufficient to satisfy our anticipated working capital requirements for fiscal 2005. The Company expects operating losses and negative cash flows to continue until such time as the issues presented in the FDA Warning Letter dated December 22, 2003 and the 483 Observations are resolved and the ICL is approved for sale in the U.S. To enhance its ability to continue as a going concern through the year ended December 30, 2005, the Company expects to take the following actions: (1) continue to aggressively address the issues presented in the FDA Warning Letter of December 22, 2003 and the 483 Observations; (2) work closely with the independent sales force and ophthalmic community to reverse the negative perceptions and sales trends of the Company’s existing lines of business; (3) further reduce discretionary spending; (4) seek other sources of funding; and (5) explore other strategic and financial options. However, there can be no assurance as to the availability or terms upon which capital might be obtained, or that the Company will be successful in executing its other strategies. Accordingly, the Company’s independent registered public accounting firm has issued an opinion that substantial doubt exists as to the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

      The Company’s liquidity requirements arise from the funding of its working capital needs, primarily inventory, work-in-process and accounts receivable. The Company’s primary sources for working capital and capital expenditures are cash flow from operations, proceeds from the private placement of Common Stock, proceeds from option exercises, debt repayments by former officers, and borrowings under the Company’s foreign bank credit facilities. Any withdrawal of support from its banks could have serious consequences on the Company’s liquidity. The Company’s liquidity is dependent, in part, on customers paying within credit terms, and any extended delays in payments or changes in credit terms given to major customers may have an impact on the Company’s cash flow. In addition, any abnormal product returns or pricing adjustments may also affect the Company’s short-term funding.

      The business of the Company is subject to numerous risks and uncertainties that are beyond its control, including, but not limited to, those set forth above and in the other reports filed by the Company with the Securities and Exchange Commission. Such risks and uncertainties could have a material adverse effect on the Company’s business, financial condition, operating results and cash flows. See “Risk Factors.”

Critical Accounting Policies

      The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory reserves and income taxes, among others. Our estimates are based upon historical experiences, market trends and financial forecasts and projections, and upon various other assumptions that management believes to be reasonable under the circumstances and at that certain point in time. Actual results may differ, significantly at times, from these estimates under different assumptions or conditions.

      The Company believes the following represent its critical accounting policies.

Risk Factors

      Our short and long-term success is subject to many factors that are beyond our control. Stockholders and prospective stockholders in the Company should consider carefully the following risk factors, in addition to other information contained in this report. This Annual Report on Form l0-K contains forward-looking statements, which are subject to a variety of risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below.

     Risks Related to Our Business

      We have reported losses in each of the last three fiscal years and have an accumulated deficit of $60.5 million as of December 31, 2004. There can be no assurance that we will report net income in any future period.

      Our current sources of working capital are not sufficient to satisfy our anticipated working capital requirements for fiscal 2005.

      As of December 31, 2004, we have outstanding balances on the credit facility of a European subsidiary of approximately $3.0 million, based on exchange rates on that date. If our losses continue, we risk defaulting on the terms of our credit facility, particularly as it relates to the maintenance of minimum levels of equity and the payment of intercompany receivables.

      Because of our history of losses, there is substantial doubt about our ability to obtain adequate financing on satisfactory terms or at all. Any such financing may involve substantial dilution to existing shareholders.

      We have received a report from our independent registered public accounting firm regarding our financial statements for the year ended December 31, 2004 stating that there is substantial doubt about our ability to continue as a going concern.

      The Company expects to continue to experience negative cash flows, similar to those of fiscal 2004, until such time as the issues presented in the FDA Warning Letter of December 22, 2003 and the 483 Observations are resolved and the ICL is approved for sale in the United States. To enhance its ability to continue as a going concern through the year ended December 30, 2005, the Company expects to take the following actions: (1) continue to aggressively address the issues presented in the Warning Letter of December 22, 2003 and the 483 Observations; (2) work closely with the independent sales force and ophthalmic community to reverse the negative perceptions and sales trends of the Company’s existing lines of business; (3) further reduce discretionary spending; (4) seek other sources of funding; and (5) explore other strategic and financial options. However, there can be no assurance as to the availability or terms upon which capital might be obtained or that the Company will be successful in executing its other strategies. In addition, doubt about our ability to continue as a going concern could adversely affect our ability to enter into collaborative relationships with strategic partners and our ability to sell our products and could have a material adverse effect on our business, financial condition and results of operations.

      On December 29, 2003 and April 26, 2004, we received Warning Letters issued by the FDA. A copy of the first Warning Letter is attached as Exhibit 99.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 9, 2004, and a copy of the second Warning Letter is attached as Exhibit 99.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 6, 2004.

      On September 23, 2004, the FDA completed a re-audit of our Monrovia, California manufacturing facility. At the conclusion of the audit, the FDA issued a form “FDA 483 Inspectional Observations” described more fully in our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2004.

      The Warning Letters and 483 Observations have adversely affected our reputation in the ophthalmic industry and our product sales. Until the FDA is satisfied with our response, it is unlikely to grant us approval to market the ICL and the TICL in the United States and may place restrictions on our domestic lines of business. See “Business — Regulatory Matters — Warning Letters and the 483 Observations.”

      We have devoted significant resources and management attention to the development and introduction of our ICL and TICL. Management believes that the future success of STAAR depends on the approval of the

ICL for sale in the United States by the FDA. The ICL is already approved for use in the European Union and Canada and in parts of Asia. The TICL is approved for use in the European Union. In October 2003, the FDA Ophthalmic Devices Panel recommended that the FDA approve, with conditions, specified uses of the ICL. The FDA has not yet acted on this recommendation, and it could decide to reject the Ophthalmic Devices Panel recommendations. Until the FDA is satisfied with our response to its Warning Letter dated December 22, 2003 and its 483 Observations issued on September 23, 2004, it is unlikely to grant us approval to market the ICL and the TICL in the United States. If the FDA does not grant approval of the ICL, or significantly delays its approval, whether because of the issues contained in the Warning Letter, the 483 Observations or otherwise, our prospects for success will be severely diminished.

      Even if it is approved by the FDA for sale in the United States, the ICL will not reach its full sales potential unless we successfully plan and execute its launch and marketing in the United States. This will present new challenges to our sales and marketing staff and to our independent manufacturers’ representatives. In countries where the ICL has been approved to date, our sales have grown steadily, but slowly. In the United States in particular, patients who might benefit from the ICL have already been exposed to a great deal of advertising and publicity about laser refractive surgery, but have little if any awareness of the ICL. As a result, we expect to make extensive use of advertising and promotion targeted to potential patients through providers, and to carefully manage the introduction of the ICL. We do not have significant resources and we cannot predict whether the particular marketing, advertising and promotion strategies we pursue will be as successful as we intend. If we do not successfully market the ICL in the United States, we will not achieve our planned profitability and growth.

      STAAR pioneered the foldable IOL for use in cataract surgery, and the foldable silicone IOL is one of our largest sources of revenue. Since we introduced the product, however, competitors have introduced IOLs employing a variety of designs and materials. Over the years these products have gradually taken a larger share of the IOL market, while the market share for our IOLs has decreased. In particular, many surgeons now choose lenses made of acrylic material rather than silicone for their typical patients. In an effort to maintain our competitive position we have introduced a new biocompatible lens material, Collamer, to our line of IOLs. We have also introduced new IOL designs, such as the Toric IOL, and have continued to improve and refine the silicone IOL. Sales of these new products, however, have only partially offset declining sales of our silicone IOLs.

      In an effort to manage costs and bring our products to a wider market, we have entered into long-term agreements with certain independent regional manufacturers’ representatives, who introduce our products to eye surgeons and provide the training needed to begin using some of our products. Under our agreements with these representatives, each receives a commission on all of our sales within a specified region, including sales on products we sell into their territories without their assistance. Because they are independent contractors, we have a limited ability to manage these representatives or their employees. In addition, a representative may represent manufacturers other than STAAR, although not in competing products. We have been relying on the independent representatives to introduce our new products like Collamer IOLs, Toric IOLs and the AquaFlow Device, and we will rely on them, in part, to help introduce the ICL if it is approved. If our independent manufacturers’ representatives do not devote sufficient resources to marketing our products, or if they lack the skills or resources to market our new products, our new products will fail to reach their full sales potential and sales of our established products could decline.

      Medical devices must be manufactured to the highest standards and tolerances, and often incorporate newly developed technology. Despite all efforts to achieve the highest level of quality control and advance testing, from time to time defects or technical flaws in our products may not come to light until after the products are sold or consigned. In those circumstances, we have previously made voluntary recalls of our products. During 2004, we initiated several voluntary recalls of STAAR manufactured product including 33 lots of IOL cartridges, three lots of injectors, and 529 lenses, and in February 2004, in an action considered a recall but with no requirement for product to be returned to us, we issued a letter to healthcare professionals advising them of the potential for a change in manifest refraction over time in rare cases involving the single-piece Collamer IOL. Similar recalls could take place again. Courts or regulators can also impose mandatory recalls on us, even if we believe our products are safe and effective. Recalls can result in lost sales of the recalled products themselves, and can result in further lost sales while replacement products are manufactured, especially if the replacements must be redesigned. If recalled products have already been implanted, we may bear some or all of the cost of corrective surgery. Recalls may also damage our professional reputation and the reputation of our products. The inconvenience caused by recalls and related interruptions in supply, and the damage to our reputation, could cause some professionals to discontinue using our products.

      We have in the past been, and continue to be, subject to product liability claims. As part of our risk management policy, we have obtained third-party product liability insurance coverage. Product liability claims against us may exceed the coverage limits of our insurance policies or cause us to record a self-insured loss. A product liability claim in excess of applicable insurance could have a material adverse effect on our business, financial condition and results of operations. Even if any product liability loss is covered by an insurance policy, these policies have retentions or deductibles that provide that we will not receive insurance proceeds until the losses incurred exceed the amount of those retentions or deductibles. To the extent that any losses are below these retentions or deductibles, we will be responsible for paying these losses. The payment of retentions or deductibles for a significant amount of claims could have a material adverse effect on our business, financial condition, and results of operations.

      Any product liability claim would divert managerial and financial resources and could harm our reputation with customers. We cannot assure you that we will not have product liability claims in the future or that such claims would not have a material adverse effect on our business.

      Our competitors, including Alcon, Advanced Medical Optics, and Bausch & Lomb, have much greater financial resources than we do and some of them have large international markets for a full suite of ophthalmic products. Their greater resources for research, development and marketing, and their greater capacity to offer comprehensive products and equipment to providers, make it difficult for us to compete. We have lost significant market share to some of our competitors.

      We manufacture all of our products either at one of our facilities in California or at our facility in Switzerland. Most of our products are approved for manufacturing only at one of these sites. Before we can use a second manufacturing site for an implantable device we must obtain the approval of regulatory authorities. Because this process is expensive we have generally not sought approvals needed to manufacture at an additional site. If a natural disaster, fire, or other serious business interruption struck one of our manufacturing facilities, it could take a significant amount of time to validate a second site and replace lost product. We could lose customers to competitors, thereby reducing sales, profitability and market share.

      Our products are sold in more than 45 countries. Revenues from international operations make up a significant portion of our total revenue. For the year ended December 31, 2004 revenues from international operations were 58% of total revenues. The results of operations and the financial position of certain of our offshore operations are reported in the relevant local currencies and then translated into United States dollars at the applicable exchange rates for inclusion in our consolidated financial statements, exposing us to translation risk. In addition, we are exposed to transaction risk because some of our expenses are incurred in a different currency from the currency in which our revenues are received. Our most significant currency exposures are to the Euro, the Swiss Franc, and the Australian dollar. The exchange rates between these and other local currencies and the United States dollar may fluctuate substantially. We have not attempted to offset our exposure to these risks by investing in derivatives or engaging in other hedging transactions. Fluctuations in the value of the United States dollar against other currencies have not had a material adverse effect on our operating margins and profitability in the past.

      Economic, social and political conditions, laws, practices and local customs vary widely among the countries in which we sell our products. Our operations outside of the United States are subject to a number of risks and potential costs, including lower profit margins, less stringent protection of intellectual property and economic, political and social uncertainty in some countries, especially in emerging markets. Our continued success as a global company depends, in part, on our ability to develop and implement policies and strategies that are effective in anticipating and managing these and other risks in the countries where we do business. These and other risks may have a material adverse effect on our operations in any particular country and on our business as a whole. We price some of our products in U.S. dollars, and as a result changes in exchange rates can make our products more expensive in some offshore markets and reduce our revenues. Inflation in emerging markets also makes our products more expensive there and increases the credit risks to which we are exposed.

      We obtain some of the components for our products from a single source. For example, only one supplier produces our viscoelastic product. Although we believe we could find alternate supplies for any of these components, the loss or interruption of any of these suppliers could increase costs, reducing our revenue and profitability, or harm our customer relations by delaying product deliveries.

      Our manufacturing, research and development practices involve the controlled use of hazardous materials. We are subject to federal, state, local and foreign laws and regulations in the various jurisdictions in which we have operations governing the use, manufacturing, storage, handling and disposal of these materials and certain waste products. Although we believe that our safety and environmental procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. Remedial environmental actions could require us to incur substantial unexpected costs, which would materially and adversely affect our results of operations. If we were involved in a major environmental accident or found to be in substantial non-compliance with applicable environmental laws, we could be held liable for damages or penalized with fines.

      Since September 1, 2004, multiple class action lawsuits have been filed in the United States District Courts for the Central District of California and the District of New Mexico against the Company and its Chief Executive Officer on behalf of all persons who acquired the Company’s securities during various periods between April 3, 2003 and September 28, 2004. On December 15, 2004, the Court ordered consolidation of the complaints that had been filed in the United States District Court for the Central District of California and directed that the plaintiffs file a consolidated complaint as soon as practicable. The plaintiffs have proposed a

stipulation pursuant to which they would file a consolidated amended complaint on or about April 29, 2005. The New Mexico action was voluntarily dismissed on January 28, 2005. The lawsuits generally allege that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, by issuing false and misleading statements regarding intraocular lenses and implantable lenses, and failing timely to disclose significant problems with the lenses, as well as the existence of serious injuries and/or malfunctions attributable to the lenses, thereby artificially inflating the price of the Company’s Common Stock. The plaintiffs generally seek to recover compensatory damages, including interest. While we intend to vigorously defend the consolidated lawsuit, the lawsuit will require significant attention of management and could result in substantial costs and harm our reputation.

      We are currently party to various claims and legal proceedings arising out of the normal course of our business. These claims and legal proceedings relate to contractual rights and obligations, employment matters, and claims of product liability. While we do not believe that any of the claims known to us is likely to have a material adverse effect on our financial condition or results of operations, new claims or unexpected results of existing claims could lead to significant financial harm.

      We depend on the continued service of our senior management and other key employees. The loss of a key employee could hurt our business. We could be particularly hurt if any key employee or employees went to work for competitors. Our future success depends on our ability to identify, attract, train and motivate other highly skilled personnel. Failure to do so may adversely affect future results.

      We have granted to the Canon Staar joint venture, a perpetual exclusive license under the Licensed Technology (as defined in the license agreement) to make and sell our products in Japan, and to make our products in China and to sell such products in Japan and China. In addition, we have granted Canon Staar a perpetual non-exclusive license under the Licensed Technology to make and sell our products in the rest of the world. Subject to the approval of the Board of Directors of the joint venture, such licenses may allow the Canon Staar joint venture to sell products in the rest of the world or grant others the right to do so. The term “Licensed Technology” includes any intellectual property owned or controlled by STAAR.

      Upon the occurrence of certain events, including the merger, sale of substantially all of the assets or change in the management of any party to the Canon Staar joint venture, any joint venture partner may have the right to acquire the first party’s interest in the joint venture at book value, without terminating the licenses under the Licensed Technology.

      The joint venture agreement, license agreement and settlement agreement relating to Canon Staar have been filed or incorporated by reference to this Annual Report.

     Risks Related to the Ophthalmic Products Industry

      Constant development of new technologies and techniques, frequent new product introductions and strong price competition characterize the ophthalmic industry. The first company to introduce a new product or technique to market usually gains a significant competitive advantage. Our future growth depends, in part, on our ability to develop products to treat diseases and disorders of the eye that are more effective, safer, or incorporate emerging technologies better than our competitors’ products. Sales of our existing products may decline rapidly if one of our competitors introduces a substantially superior product, or if we announce a new product of our own. Similarly, if we fail to make sufficient investments in research and development or if we focus on technologies that do not lead to better products, our current and planned products could be surpassed by more effective or advanced products.

      In addition, we must manufacture these products economically and market them successfully by persuading a sufficient number of eye care professionals to use them. For example, glaucoma requires ongoing treatment over a long period of time; thus, many doctors are reluctant to switch a patient to a new treatment if the patient’s current treatment for glaucoma remains effective. This has been a challenge in selling our AquaFlow Device.

      We spent 12.1% of our revenue on research and development (including regulatory and quality assurance expenses) for the year ended December 31, 2004, and we expect to spend between 10-11% of our revenue on an annual basis in the future. Development of new implantable technology, from discovery through testing and registration to initial product launch, is expensive and typically takes from three to seven years. Because of the complexities and uncertainties of ophthalmic research and development, products we are currently developing may not complete the development process or obtain the regulatory approvals required for us to market the products successfully. It is possible that few or none of the products currently under development will become commercially successful.

      Many of our products, in particular IOLs and products related to the treatment of glaucoma, are used in procedures that are typically covered by health insurance, HMO plans, Medicare or Medicaid. These third-party payors have recently been trying to contain costs by restricting the types of procedures they reimburse to those viewed as most cost-effective and capping or reducing reimbursement rates. These policies could adversely affect sales and prices of our products. Physicians, hospitals and other health care providers may be reluctant to purchase our products if third-party payors do not adequately reimburse them for the cost of our products and the use of our surgical equipment. For example:

      Government regulations and agency oversight apply to every aspect of our business, including testing, manufacturing, safety and environmental controls, efficacy, labeling, advertising, promotion, record keeping, the sale and distribution of products and samples. We are also subject to government regulation over the prices we charge and the rebates we offer to customers. Complying with government regulation substantially increases the cost of developing, manufacturing and selling our products.

      In the United States, we must obtain approval from the FDA for each product that we market. Competing in the ophthalmic products industry requires us to continuously introduce new or improved products and processes, and to submit these to the FDA for approval. Obtaining FDA approval is a long and expensive process, and approval is never certain. In addition, our operations in the United States are subject to periodic inspection by the FDA. Such inspection may result in the FDA ordering changes in our business practices, which changes could be costly and have a material adverse effect on our business and results of operations. In particular, we received Warning Letters from the FDA on December 29, 2003 and April 26, 2004, and FDA 483 Inspectional Observations on September 23, 2004, requiring us to take corrective action as discussed elsewhere in this report.

      Products distributed outside of the United States are also subject to government regulation, which may be equally or more demanding. Our new products could take a significantly longer time than we expect to gain regulatory approval and may never gain approval. If a regulatory authority delays approval of a potentially significant product, the potential sales of the product and its value to us can be substantially reduced. Even if the FDA or another regulatory agency approves a product, the approval may limit the indicated uses of the product, or may otherwise limit our ability to promote, sell and distribute the product, or may require post-marketing studies. If we cannot obtain regulatory approval of our new products, or if the approval is too narrow, we will not be able to market these products, which would eliminate or reduce our potential sales and earnings.

      We have numerous patents and pending patent applications. We rely on a combination of contractual provisions, confidentiality procedures and patent, trademark, copyright and trade secrecy laws to protect the proprietary aspects of our technology. These legal measures afford limited protection and may not prevent our competitors from gaining access to our intellectual property and proprietary information. Any of our patents may be challenged, invalidated, circumvented or rendered unenforceable. Furthermore, we cannot be certain that any pending patent application held by us will result in an issued patent or that if patents are issued to us, the patents will provide meaningful protection against competitors or competitive technologies. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of our proprietary rights. Any litigation could result in substantial expense, may reduce our profits and may not adequately protect our intellectual property rights. In addition, we may be exposed to future litigation by third parties based on claims that our products infringe their intellectual property rights. This risk is exacerbated by the fact that the validity and breadth of claims covered by patents in our industry may involve complex legal issues that are not fully resolved.

      Any litigation or claims against us, whether or not successful, could result in substantial costs and harm our reputation. In addition, intellectual property litigation or claims could force us to do one or more of the following: to cease selling or using any of our products that incorporate the challenged intellectual property, which would adversely affect our revenue; to negotiate a license from the holder of the intellectual property right alleged to have been infringed, which license may not be available on reasonable terms, if at all; or to redesign our products to avoid infringing the intellectual property rights of a third party, which may be costly and time-consuming or impossible to accomplish.

      Most of our products are covered by patents that give us a degree of market exclusivity during the term of the patent. We have also earned revenue in the past by licensing some of our patented technology to other ophthalmic companies. The legal life of a patent is 20 years from application. Patents covering our products will expire from this year through the next 20 years. Upon patent expiration, our competitors may introduce products using the same technology. As a result of this possible increase in competition, we may need to charge a lower price in order to maintain sales of our products, which could make these products less profitable. If we fail to develop and successfully launch new products prior to the expiration of patents for our existing products, our sales and profits with respect to those products could decline significantly. We may not

be able to develop and successfully launch more advanced replacement products before these and other patents expire.

     Risks Related to Ownership of Our Common Stock

      Our Certificate of Incorporation empowers the Board of Directors to establish and issue a class of preferred stock, and to determine the rights, preferences and privileges of the preferred stock. We also have a Stockholders’ Rights Plan, which could discourage a third party from making an offer to acquire us. These provisions give the Board of Directors the ability to deter, discourage or make more difficult a change in control of our company, even if such a change in control would be in the interest of a significant number of our stockholders or if such a change in control would provide our stockholders with a substantial premium for their shares over the then-prevailing market price for the common stock.

      We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our Common Stock or preventing changes in our management.

      Our Board of Directors could issue shares of common or preferred stock, to raise additional capital or for other corporate purposes without stockholder approval. In addition, the Board of Directors could designate and sell a class of preferred stock with preferential rights over the Common Stock with respect to dividends or other distributions. Sales of common or preferred stock could dilute the interest of existing stockholders and reduce the market price of our Common Stock. Even in the absence of such sales, the perception among investors that additional sales of equity securities may take place could reduce the market price of our Common Stock.

      Our stock price has fluctuated widely, ranging from $2.88 to $11.26 during the year ended December 31, 2004. Our stock price could continue to experience significant fluctuations in response to factors such as quarterly variations in operating results, operating results that vary from the expectations of securities analysts and investors, changes in financial estimates, changes in regulatory status, changes in market valuations of competitors, announcements by us or our competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations. Also, general political and economic conditions such as recession or interest rate fluctuations may adversely affect the market price of our stock.

Foreign Exchange

      Management does not believe that the fluctuation in the value of the dollar in relation to the currencies of its suppliers or customers in the last three fiscal years has adversely affected the Company’s ability to purchase or sell products at agreed upon prices. No assurance can be given, however, that adverse currency exchange rate fluctuations will not occur in the future, which would affect the Company’s operating results.

Inflation

      Management believes inflation has not had a significant impact on the Company’s operations during the past three years.

New Accounting Pronouncements

      In October 2004, the American Jobs Creation Act of 2004 (“Act”) became effective in the U.S. Two provisions of the Act may impact the Company’s provision (benefit) for income taxes in future periods, namely those related to the qualified production activities deduction (“QPA”) and foreign earnings repatriation (“FER”).

      The QPA will be effective for the Company’s U.S. federal tax return year beginning after December 31, 2004. In summary, the Act provides for a percentage deduction of earnings from qualified production activities, as defined, commencing with an initial deduction of 3 percent for tax years beginning after 2009, with the result that the statutory federal tax rate currently applicable to the Company’s qualified production activities of 35 percent could be reduced initially to 33.95 percent and ultimately to 31.85 percent. However, the Act also provides for the phased elimination of the extraterritorial income exclusion provision of the Internal Revenue Code, which have previously resulted in tax benefits to the Company. Due to the interaction of the law provisions noted above as well as the particulars of the Company’s tax position, the ultimate effect of the QPA on the Company’s future provision (benefit) for income taxes has not been determined at this time. The Financial Accounting Standards Board (“FASB”) issued FASB Staff Position FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (“FSP 109-1”), in December 2004. FSP 109-1 requires that tax benefits resulting from the QPA should be recognized no earlier than the year in which they are reported in the entity’s tax return, and that there is to be no revaluation of recorded deferred tax assets and liabilities as would be the case had there been a change in an applicable statutory rate.

      The FER provision of the Act provides generally for a one-time 85 percent dividends received deduction for qualifying repatriations of foreign earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S. in certain qualifying activities and expenditures, as defined by the Act. In December 2004, the FASB issued FASB Staff Position FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”). FSP 109-2 allows additional time for entities potentially impacted by the FER provision to determine whether any foreign earnings will be repatriated under this provision. At this time, the Company has not undertaken an evaluation of the application of the FER provision and any potential benefits of effecting such repatriations under this provision. Numerous factors, including previous actual and deemed repatriations under federal tax law provisions, are factors impacting the availability of the FER provision to the Company and its potential benefit to the Company, if any. The Company intends to examine the issue and will provide updates in subsequent periods.

      In November 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs.” This statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage). SFAS No. 151 requires that those items be recognized as current-period charges. In addition, this statement requires that allocation of fixed production overheads to costs of conversions be based upon the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory cost incurred in fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of fiscal 2006. The adoption of this pronouncement is not expected to have a material effect on the Company’s financial statements.

      In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS No. 123R addresses all forms of share-based payment (“SBP”) awards including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Under

SFAS No. 123R, SBP awards result in a cost that will be measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest. This statement is effective for public entities as of the first interim or annual reporting period that begins after June 15, 2005. The Company has not quantified the potential effect of adoption of SFAS No. 123R, but believes that the adoption of this statement will result in a decrease to earnings.

      In December 2004, the FASB issued SFAS No. 153, “Exchange of Nonmonetary Assets.” This statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this statement are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after December 16, 2004. The provisions of this statement should be applied prospectively. The adoption of this pronouncement is not expected to have a material effect on the Company’s financial statements.

      In the normal course of business, our operations are exposed to risks associated with fluctuations in interest rates and foreign currency exchange rates. The Company manages its risks based on management’s judgment of the appropriate trade-off between risk, opportunity and costs. Management does not believe that these market risks are material to the results of operations or cash flows of the Company, and, accordingly, does not generally enter into interest rate or foreign exchange rate hedge instruments.

      Interest rate risk. Our $3.0 million of debt is based on the borrowings of our international subsidiaries. The majority of our international borrowings bear an interest rate that is linked to Euro market conditions and, thus, our interest rate expense will fluctuate with changes in those conditions. If interest rates were to increase or decrease by 1% for the year, our annual interest rate expense would increase or decrease by approximately $30,000.

      Foreign currency risk. Our international subsidiaries operate in and are net recipients of currencies other than the U.S. dollar and, as such, our revenues benefit from a weaker dollar and are adversely affected by a stronger dollar relative to major currencies worldwide (primarily, the Euro and Australian dollar). Accordingly, changes in exchange rates, and particularly the strengthening of the US dollar, may negatively affect our consolidated sales and gross profit as expressed in U.S. dollars. Additionally, as of December 31, 2004, all of our debt is denominated in Swiss Francs and as such, we are subject to fluctuations of the Swiss Franc as compared to the U.S. dollar in converting the value of the debt to U.S. dollars. The U.S. dollar value of the debt is increased by a weaker dollar and decreased by a stronger dollar relative to the Swiss Franc.

      In the normal course of business, we also face risks that are either non-financial or non-quantifiable. Such risks include those set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.”

      Financial Statements and the Report of Independent Registered Public Accounting Firm are filed with this Annual Report on Form 10-K in a separate section following Part IV, as shown on the index under Item 15 of this Annual Report.

      Not applicable.