UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number: 000-50988

VNUS Medical Technologies, Inc.

VNUS Medical Technologies, Inc.
2200 Zanker Road, Suite F
San Jose, CA 95131
(Address of principal executive offices, including zip code)

(408) 473-1100
(Registrant’s Telephone Number, including area code)

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

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

     As of April 30, 2005, 14,479,110 shares of the registrant’s common stock, par value $0.001, were outstanding.

VNUS MEDICAL TECHNOLOGIES, INC.
FORM 10-Q for the Quarter Ended March 31, 2005

TABLE OF CONTENTS

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Part I.
FINANCIAL INFORMATION

Item 1. Financial Statements

VNUS MEDICAL TECHNOLOGIES, INC.

See accompanying notes to condensed consolidated financial statements

3

VNUS MEDICAL TECHNOLOGIES, INC.

See accompanying notes to condensed consolidated financial statements

4

VNUS MEDICAL TECHNOLOGIES, INC.

See accompanying notes to condensed consolidated financial statements

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VNUS MEDICAL TECHNOLOGIES, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1 – THE COMPANY

VNUS Medical Technologies, Inc. (the “Company”) was incorporated in Delaware on January 4, 1995. The Company develops, markets and sells medical devices to treat venous diseases. In late 1998, the Company introduced its Closure System in Europe. In October and November 1999, the Company launched commercial sales of the Closure System in the United States at meetings of the American College of Surgeons and American College of Phlebology.

The Company has funded its operations through the issuance of convertible preferred and common stock, and from operations. During 1999, the Company commenced volume shipment of its product and emerged from the development stage. Although no longer in the development stage, the Company continues to be subject to certain risks common to companies in similar stages of development, including the dependence on a limited product line; limited manufacturing, marketing and sales experience; reliance on key individuals; potential competition from larger, more established companies and uncertainty of future profitability. The Company completed its initial public offering of common stock in October 2004.

On July 15, 2004, the Company established a subsidiary, VNUS Medical Technologie GmbH, in Germany. The subsidiary is responsible for direct marketing and sales of the Closure system and other medical devices supplied by the Company for the treatment of venous disease in Germany, Austria and France. The Company also continues to market and sell its products through distributors in certain areas of the European Union.

NOTE 2 – BASIS OF PRESENTATION

Basis of Preparation

The accompanying condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles. However, certain information or footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The information furnished in this report reflects all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations and cash flows for the three-month periods ended March 31, 2005 and March 31, 2004, and the financial position as of March 31, 2005 and December 31, 2004, and such adjustments consist of items of a normal recurring nature. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year or for any other future period. The condensed consolidated financial statements included in this quarterly report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K as filed with the SEC on March 31, 2005.

The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles 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 condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

On September 20, 2004, the Company’s Board of Directors approved a two for three reverse stock split of its common shares. Such reverse stock split was effected on October 14, 2004. All common stock data presented herein have been restated to retroactively reflect this stock split. On October 20, 2004, the Company completed its initial public offering of common stock. The Company sold 4,000,000 shares of common stock in the offering and selling stockholders sold 1,375,995 shares of common stock. All of the preferred stock outstanding immediately prior to the offering automatically converted into common stock in connection with the completion of the offering. Net proceeds to the Company were approximately $54.0 million, after deducting the underwriting discount and commissions and the expenses of the offering.

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VNUS MEDICAL TECHNOLOGIES, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 151, “Inventory Costs — an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the provisions of SFAS No. 151 is not expected to have a material impact on the Company’s financial position and results of operations.

In December 2004, the FASB issued FASB Statement No. 123(R), Share Based Payment (“SFAS 123(R)”). SFAS 123(R) revises FASB Statement No. 123, Accounting for Stock-Based Compensation and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. The standard is effective for the Company’s quarter ending March 31, 2006 and will apply to the Company’s employee stock option and stock purchase plans. The Company is currently evaluating the impact of the adoption of SFAS 123(R) and has not selected a transition method or valuation model. As such, the Company is unable to estimate the expected effect on its financial statements, but believes it will have a significant adverse impact on its results from operations.

In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB 107 provides guidance for the implementation of SFAS 123(R) with respect to valuation techniques, expected volatility and expected term for valuing employee stock options among other matters. The provisions of SAB 107 will be effective for the Company at the time the Company adopts SFAS 123(R).

NOTE 3 – INVENTORIES

Inventories are stated at the lower of standard cost, which approximates actual cost under the first-in, first-out method, or market value.

NOTE 4 — CONTINGENCIES

The Company is subject to claims and assessments from time to time in the ordinary course of business. The Company’s management does not believe that any such matters, individually or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

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VNUS MEDICAL TECHNOLOGIES, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 5 – STOCK-BASED COMPENSATION

The Company accounts for stock-based employee compensation arrangements using the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, and has adopted the disclosure-only provisions of SFAS No. 123 “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” The Company is required to disclose the pro-forma effects on net income as if it had elected to use the fair value approach to account for all of its stock-based employee compensation plans. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Equity instruments issued to non-employees are recorded at their fair value on the measurement date and are subject to periodic adjustment as the underlying equity instruments vest. Non-employee stock-based compensation charges are amortized over the vesting period on a straight-line basis.

The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation arrangements (in thousands, except per share data):

The weighted average per share fair value of options granted in the three months ended March 31, 2005 and 2004 was $11.49 and $3.00, respectively.

The amounts disclosed above are not necessarily indicative of the amounts that will be expensed upon adoption of FAS 123R “Share-Based Payment”. Compensation expense calculated under FAS 123R may differ from amounts currently disclosed within these footnotes based on changes in the fair value of the Company’s common stock, changes in the number of options granted or the terms of such options, the treatment of tax benefits and changes in interest rates or other factors. In addition, upon adoption of FAS 123R, the Company may choose to use a different valuation model to value the compensation expense associated with employee stock options.

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VNUS MEDICAL TECHNOLOGIES, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following assumptions were used for the Black-Scholes option pricing model for options granted in the periods presented:

NOTE 6 – NET INCOME PER SHARE

The Company adopted EITF Statement No. 03-06 “Participating Securities and the Two Class Method Under SFAS No. 128, Earnings Per Share,” during the period ended June 30, 2004. Basic net income per share excludes the dilutive effect of potential stock, including stock options, common stock subject to repurchase and warrants. Diluted net income per share reflects the dilution of potential common shares outstanding during the period. In computing diluted net income per share, the Company adjusts share count by assuming that all in-the-money options and warrants are exercised and that the Company repurchases shares with the proceeds of these hypothetical exercises. The Company further assumes that any unamortized deferred stock-based compensation is also used to repurchase shares. In determining hypothetical shares repurchased, the Company uses the average stock price for the period. The following table sets forth the computation of pro forma basic and diluted net income per share (in thousands, except per share data) and assumes that the price at which the convertible preferred stock automatically converts to common stock is in accordance with the conversion terms:

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Anti-dilutive securities

The following outstanding options, warrants and convertible preferred stock (prior to the application of the treasury stock method) were excluded from the computation of diluted net income per common share for the periods presented because including them would have had an anti-dilutive effect, as calculated based on the weighted average closing price of common stock for the period (in thousands):

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

     This financial review presents our operating results for the three-month periods ended March 31, 2005 and March 31, 2004. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in this report and our audited consolidated financial statements and related notes in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission (“SEC”) on March 31, 2005.

     Except for the historical information contained herein, this discussion contains forward-looking statements, such as statements of our plans, objectives, expectations and intentions, that involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include those discussed in “Risk Factors” below, as well as those discussed elsewhere. The cautionary statements made herein should be read as applying to all related forward-looking statements wherever they appear herein.

     Unless expressly stated or the context otherwise requires, the terms “we”, “our”, “us” and “VNUS” refer to VNUS Medical Technologies, Inc. and its consolidated subsidiaries.

Business Overview

We are a leading provider of medical devices for the minimally invasive treatment of venous reflux disease. Venous reflux disease, a progressive condition caused by incompetent vein valves, is characterized by the poor return of blood from the legs to the heart. The disease results in symptoms such as leg pain, swelling, fatigue, skin ulcers and painful varicose veins. Our primary product line, the Closure system, consists of a proprietary radiofrequency, or RF, generator and proprietary disposable endovenous catheters to close diseased veins through the application of temperature-controlled RF energy. We estimate that in excess of 80,000 patients have been treated using our Closure system since 1999.

Since our inception in January 1995, we have focused on the development of minimally invasive treatments for venous reflux disease. Until 1999, our operations consisted primarily of start-up activities, including the development of our Closure system, recruiting personnel and raising capital. We launched commercial sales of the Closure system in Europe in late 1998 and in the United States in late 1999.

For the three months ended March 31, 2005, we generated net revenues of $11.2 million and net income of $1.5 million. As of March 31, 2005, we have incurred cumulative losses of approximately $39.6 million. From inception to September 30, 2003 we were not profitable. We were profitable beginning in the last quarter of 2003 and have been profitable in each of the five quarters since.

We market the Closure system through a direct sales organization in the United States. On July 15, 2004, we established a subsidiary in Germany. This subsidiary is responsible for direct marketing and sales of the Closure system and other medical devices supplied by us for the treatment of venous disease in Germany, Austria and France. We also continue to market and sell our products through distributors in certain areas of the European Union.

Our customers are reimbursed by governmental and third-party payors, and that reimbursement is subject to periodic review and adjustment. Currently, our Closure procedure is covered by the policies of approximately 100 health insurers, representing over 220 million covered lives in the United States.

Our net revenues are derived from the sale of disposable catheters, RF generators and accessory products, which comprised 73%, 22% and 5% of our net revenues, respectively, for the three-month period ended March 31, 2005. We manufacture, package and label our disposable catheters and outsource the manufacture of our RF generators and accessory packs.

We have a diverse customer base of hospitals, physicians and physician groups. No one customer accounted for 10% or more of our net revenues or accounts receivable in the first three months of 2005.

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Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, 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 ongoing basis we re-evaluate our judgments and estimates, including those related to doubtful accounts, income taxes and loss contingencies. We base our estimates and judgments on our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these policies.

Revenue Recognition. We recognize revenues in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition.” SAB No. 104 requires that four basic criteria must be met before revenues can be recognized: (1) persuasive evidence of an arrangement exists; (2) title has transferred; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured.

We generally use contracts and customer purchase orders to determine the existence of an arrangement. We use shipping documents and third-party proof of delivery to verify delivery. We assess whether the fee is fixed or determinable based on the terms of the agreement associated with the transaction. In order to determine whether collection is probable, we assess a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. If we determine that collection is not reasonably assured, we would defer the recognition of revenue until collection becomes reasonably assured, which is generally upon receipt of payment.

Our domestic and international return policy allows customers to return unused products for a period of 30 and 60 days, respectively, subject to restocking fees. We make provisions for estimated returns and allowances based on historical levels. To date, returns and allowances have been insignificant. If actual returns and allowances were to deviate significantly from our estimates, our revenues could be adversely affected.

Valuation of Inventory. We value our inventory at the lower of cost or market. We calculate an inventory reserve for estimated obsolescence or excess inventory based upon historical demand and assumptions about future demand for our products and market conditions. The allowance is measured as the difference between the current cost of the inventory and estimated market value and is charged to the provision for inventory obsolescence, which is a component of our cost of revenues. At the point of recognition of the loss, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology, we could be required to increase our inventory allowance and our gross profit could be adversely affected.

Warranty Costs. At the time we recognize revenues, we establish an accrual for estimated warranty expense associated with revenues, recorded as a component of cost of revenues. We offer a standard one-year limited warranty on our RF generator which is included in the sales price of the generator. Our estimate of costs to service our warranty obligations is based upon the number of units sold, historical and anticipated cost per claim and rates of warranty claims. We primarily estimate material costs based upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the equipment. Our service agreement with our RF generator manufacturer provides us with a one-year warranty from the date of shipment to us on all generators supplied. As such, our warranty expense is only required to cover those expenses not covered by our service agreement. If we experience an increase in warranty claims compared with our historical experience, or if costs of servicing warranty claims are greater than the expectations on which the accrual has been based, our gross profit could be adversely affected.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We estimate the allowance based on the aging of account balances, collection history, credit quality of the customer and current economic conditions that may affect a customer’s ability to pay.

We generally maintain a diverse customer base that mitigates the risk of concentration with one customer. However, if the overall condition of the healthcare industry were to deteriorate, resulting in an impairment of our customers’ ability to make payments, significant additional allowances could be required. Additionally, if a major customer’s creditworthiness deteriorates, or if actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our financial results.

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Income Taxes. We account for income taxes under the liability method. Under this method, we determine deferred tax assets and liabilities at the balance sheet date based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year’s financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenues, expenses and gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in our financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or a liability and its reported amount on the balance sheet will result in a taxable or a deductible amount in some future year or years when the related liabilities are settled or the reported amounts of the assets are recovered. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and unless we believe that recovery is more likely than not, we must establish a valuation allowance to reduce the deferred tax assets to the amounts expected to be realized.

As part of the process of preparing our financial statements, we are required to estimate our income taxes. This process involves estimating our current tax liability, together with assessing temporary differences that may result in deferred tax assets. Our effective tax rates differ from the statutory rates due to the impact of net operating loss carryforwards, research and experimentation tax credits, state taxes and the tax impact of non-U.S. operations. Because we have had a history of annual net losses from inception through December 31, 2003, recovery of the deferred tax assets is in doubt and we have established a valuation allowance against the entire balance of the deferred tax assets. If we are able to demonstrate consistent profitability in the future, and we are able to establish that recovery is more likely than not, we would reduce the valuation allowance at a future date.

Our future effective tax rates could be adversely affected by changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof. In addition, we are subject to examination of our income tax returns by the Internal Revenue Service and other tax authorities; however, we are not currently under audit by any taxing jurisdiction. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

Deferred Compensation Expense. We account for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and Financial Accounting Standards Board, or FASB, Interpretation, or FIN, No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” and comply with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” Under APB Opinion No. 25, compensation cost is recognized based on the difference, if any, on the date of grant between the fair value of our stock and the amount an employee must pay to acquire the stock. SFAS No. 123 defines a “fair value” based method of accounting for an employee stock option or similar equity investment.

We award a limited number of stock options and warrants to non-employees. We account for non-cash stock-based expense from options and warrants issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force Pronouncement No. 96-18, “Accounting for Equity Investments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” For these options and warrants, we recognize the non-cash stock-based expense over the service period of the underlying awards, based on an estimate of their fair value on the vesting dates using the Black-Scholes option-pricing model. All unvested options issued to non-employees are marked to market until such options vest.

We amortize deferred stock-based compensation on the accelerated vesting method over the vesting periods of the stock options, which is generally four years. The accelerated vesting method provides for vesting of portions of the overall awards at interim dates and results in accelerated vesting as compared to the straight-line method.

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Financial Operations Overview

Net Revenues. Our net revenues are derived primarily from the sale of disposable endovenous catheters and RF generators. Our large installed base of RF generators facilitates a recurring revenue stream from the sale of disposable catheters. In addition, we derive a small portion of our revenues from the sale of accessory products.

Cost of Revenues. Our cost of revenues represents the cost of materials, overhead, direct labor and delivery charges associated with the manufacture of disposable catheters, the purchase and delivery of RF generators, the purchase and delivery of accessory products, depreciation and amortization of deferred stock-based compensation.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of marketing personnel compensation, sales force base and incentive compensation, travel, promotional materials, advertising, patient education materials, other expenses incurred to provide reimbursement services, clinical training and amortization of deferred stock-based compensation.

Research and Development Expenses. Research and development expenses consist primarily of personnel expenses, supplies, materials and expenses associated with product development, expenses associated with preclinical and clinical studies and amortization of deferred stock-based compensation.

General and Administrative Expenses. General and administrative expenses consist primarily of personnel expenses for accounting, human resources, information technology and corporate administration, legal fees, accounting fees, facilities expenses and amortization of deferred stock-based compensation.

Results of Operations

The following table sets forth our results of operations, expressed as percentages of revenues, for the three months ended March 31, 2005 and 2004.

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

Net Revenues. Net revenues for the three-month period ended March 31, 2005 increased by approximately $3.6 million, or 47%, as compared to the same period in 2004. This increase resulted from an increase in the volume of disposable catheters and RF generators, partially offset by an approximately 5% decline in the average selling price of disposable catheters and an approximately 13% decrease in the average selling price of RF generators as compared to the three-month period ended March 31, 2004. We expect modest price discounting to continue throughout 2005. Disposable catheters represented 73%, RF generators represented 22% and accessories represented 5% of net revenues during the three-month period ended March 31, 2005 compared to 73% for disposable catheters, 23% for RF generators and 4% for accessories in the same period in 2004.

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Gross profit. Gross profit margin for the three-month period ended March 31, 2005 was 75.6% compared with 75.8% for the three-month period ended March 31, 2004. While our domestic average selling price on catheters decreased approximately 5% during the March 2005 quarter compared to our average selling price during the first quarter of 2004, our manufacturing overhead was amortized over a greater number of catheters produced, lowering the average standard cost of a catheter. Our RF generators sold domestically experienced a decline in average selling price of approximately 13% during the March 2005 quarter, when compared to the March 2004 quarter, partially offset by a reduction in the average cost of a generator. These factors taken together resulted in relatively consistent gross profit margins in the three-month period ended March 31, 2005 as compared with the three-month period ended March 31, 2004. We expect gross margins to remain consistent with recent periods in the near term.

Sales and Marketing Expenses. Sales and marketing expenses increased 26%, to $4.4 million in the three-month period ended March 31, 2005 from $3.5 million in the three-month period ended March 31, 2004. The increase in expenses reflects a 40% increase in our direct sales force to better support our increased customer base, in addition to investments in additional marketing personnel and new marketing programs. These new programs include patient outreach programs consisting of patient education and screening events to be held across the U.S. and a television advertising campaign designed to educate the general public about the Closure procedure. As a percentage of net revenue, sales and marketing expense dropped to 39.6% in the three-month period ended March 31, 2005 compared with 46.1% in the three-month period ended March 31, 2004. We expect sales and marketing related expenses in dollars to increase in 2005 as we continue to expand our sales and marketing organizations.

Research and Development Expenses. Research and development expenses in the three-month period ended March 31, 2005 were $988,000, essentially flat when compared with the three-month period ended March 31, 2004. Research and development expenses include regulatory and clinical costs associated with our compliance with FDA regulations, in addition to new product development expenses. We expect research and development expenses to increase during 2005 as we continue to develop new products and conduct new clinical trials.

General and Administrative Expenses. General and administrative expenses incurred during the three-month period ended March 31, 2005 increased $866,000 to $1.7 million from $876,000 for the three-month period ended March 31, 2004. This 99% increase was primarily comprised of $393,000 in professional services fees primarily associated with public company compliance and our efforts to comply with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002, $244,000 in personnel-related expenses from the addition of finance and information technology personnel and $111,000 in insurance premiums. We expect general and administrative expenses to increase in 2005 primarily due to complying with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 and other expenses associated with being a public company.

Interest Income and Other, Net. Interest income and other, net increased to $361,000 for the three-month period ended March 31, 2005 from $32,000 for the three-month period ended March 31, 2004, primarily due to increased average cash balances in 2005 and, to a lesser extent, higher interest rates earned on our interest-bearing accounts.

Provision for Income Taxes. We incurred income tax expenses of $116,000 in the three-month period ended March 31, 2005, a $73,000 increase over the three-month period ended March 31, 2004, primarily the result of a 286% increase in income before income taxes compared to the three-month period ended March 31, 2004 and, to a lesser extent, by a reduction in our effective tax rate. Our effective tax rate for the three-month period ended March 31, 2005 was 7% compared to an effective tax rate of 10% for the three-month period ended March 31, 2004. We expect our effective tax rate will be approximately 7% for the balance of 2005. However, if we are able to demonstrate consistent profitability throughout 2005, and we are able to establish that recovery of our deferred tax assets is more likely than not, we may conclude that we need to reduce the full valuation allowance established against our deferred tax assets. As a result, our effective tax rate for 2005 could differ significantly from our current expectations.

Liquidity and Capital Resources

As of March 31, 2005, we had approximately $68.3 million in cash and cash equivalents, $72.4 million in working capital and $110,000 in long term lease obligations. As of December 31, 2004, we had approximately $68.6 million in cash and cash equivalents, $70.7 million in working capital and $111,000 in long term lease obligations. The decrease in cash and cash equivalents primarily reflects cash used in operating activities of $152,000 and cash used in investing activities of $195,000, offset in part by proceeds from the exercise of stock options for common stock. The $1.7 million increase in working capital primarily reflects increases of $266,000 and $555,000 in accounts receivable and inventories, respectively, as well as a $972,000 reduction in accrued liabilities. As of March 31, 2004, we had approximately $10.7 million in cash and cash equivalents, $13.2 million in working capital and $111,000 in long term lease obligations. The increase in cash and cash equivalents compared with the same period a year ago was due primarily to the cash raised in our initial public offering in late 2004. We currently invest our cash and cash equivalents in a large money market fund consisting of debt instruments of the U.S. government and its agencies and high-quality corporate issuers.

Net cash used in operating activities was $152,000 for the three-month period ended March 31, 2005, compared with net cash used by operations of $900,000 for the three-month period ended March 31, 2004. Net cash used in operating activities during the three-month period ended March 31, 2005 included a $972,000 decrease in accrued liabilities related primarily to the payment of the annual employee bonus, increases in inventory to support expected sales growth totaling $555,000, a decrease of $373,000 in accounts payable and a $266,000 increase in accounts receivable. These uses were partially offset by $1.5 million in net income and a decrease in prepaid expenses of $153,000. We expect that net cash used in or provided by operating activities may fluctuate in future periods as a result of a number of factors including fluctuations in our operating results, collection of accounts receivable, timing of payments and inventory levels.

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Net cash used in investing activities totaled $195,000 for the three-month period ended March 31, 2005 compared with $177,000 for the three-month period ended March 31, 2004. For each of these periods, the net cash used in investing activities reflected purchases of property and equipment, mainly used in research and development, information technology, manufacturing processes, and facility improvements.

Net cash provided by financing activities totaled $79,000 for the first three month period ended March 31, 2005 compared with $30,000 for the three-month period ended March 31, 2004. These amounts reflect proceeds received from the exercise of stock options. We expect that proceeds from the exercise of stock options will increase in the near term due to the expiration on April 18, 2005 of transfer restrictions placed on certain shares of our common stock in connection with our initial public offering.

We expect that marketing, research and development and general and administrative expenses will continue to increase in absolute dollars in connection with the growth of our business and our operations as a public company, including expenses associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002. We also expect to incur additional costs and expenses to expand our manufacturing capacity. We expect to fund these increased costs and expenditures from our cash flows from operations, our existing cash balance and the proceeds from our initial public offering. However, our future capital requirements depend on numerous forward-looking factors. These factors include and are not limited to the following: the revenues generated by sales of our products; the costs associated with expanding our manufacturing, marketing, sales and distribution efforts; the rate of progress and cost of our research and development activities; the costs of obtaining and maintaining Food and Drug Administration and other regulatory clearances of our products and products in development; the effects of competing technological and market developments; the costs associated with being a public company, including the costs associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002; and the number and timing of acquisitions and other strategic transactions.

We believe that our current cash and cash equivalents, and cash we expect to generate from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, we may require additional funds for marketing activities to develop new products and to acquire new products and technologies. We may seek financing of future cash needs through the sale of equity securities and debt. We cannot assure you that additional financing will be available when needed or that, if available, such financing will be obtained on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our business operations or may adversely affect our ability to operate as a going concern. If additional funds are obtained by issuing equity or debt securities, substantial dilution to existing stockholders may result.

Off-Balance Sheet Liabilities

We did not have any off-balance sheet liabilities as of March 31, 2005.

Contractual Obligations and Capital Expenditure Requirements

We lease office space and equipment under non-cancelable operating leases with various expiration dates through 2007. At March 31, 2005, future minimum lease payments are as follows (in thousands):

At March 31, 2005, we had approximately $1.8 million in non-cancelable purchase commitments with suppliers.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 151, “Inventory Costs — an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 amends ARB 43, Chapter 4, to clarify that abnormal

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amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the provisions of SFAS No. 151 is not expected to have a material impact on our financial position and results of operations.

In December 2004, the FASB issued FASB Statement No. 123(R), Share Based Payment (“SFAS 123(R)”). SFAS 123(R) revises FASB Statement No. 123, Accounting for Stock-Based Compensation, and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. The standard is effective for our quarter ending March 31, 2006 and will apply to our employee stock option and stock purchase plans. We are currently evaluating the impact of the adoption of SFAS 123(R) and have not selected a transition method or valuation model. As such, we are unable to estimate the expected effect on our financial statements, but believe it will have a significant adverse impact on our results from operations.

In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB 107 provides guidance for the implementation of SFAS 123(R) with respect to valuation techniques, expected volatility and expected term for valuing employee stock options among other matters. The provisions of SAB 107 will be effective for us at the time we adopt SFAS 123(R).

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Risk Factors

     This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions and expectations. Many factors, including those described below, could cause actual results to differ materially from those discussed in any forward-looking statements. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate” and variations of such words and similar expressions are intended to identify such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

We expect to derive substantially all of our future revenues from sales of our Closure system. If our Closure system fails to achieve substantial market acceptance we may not generate sufficient revenues to continue our operations.

     Currently, our primary product offering is our Closure system, which is comprised of two components, our RF generator and our disposable catheter. We commercially introduced our Closure system in late 1998 in Europe and in 1999 in the United States. We launched a new generation RF generator in the fourth quarter of 2004. We expect that sales of our Closure system will continue to account for substantially all of our revenues for at least the next several years. Vein stripping and ligation surgery is the current standard of care for the treatment of venous reflux disease. This procedure is well established among physicians, has extensive long-term data, is routinely taught to new surgeons and has remained relatively unchanged for the past 50 years. By contrast, our Closure system is a relatively new treatment procedure for venous reflux disease. We cannot assure you that our Closure procedure will compete effectively against vein stripping and ligation surgery. We may have difficulty gaining widespread acceptance of our Closure system among physicians for a number of reasons including:

	•	lack of experience with our Closure procedure;
	•	perceived liability risks associated with the use of new technologies or procedures for venous reflux disease;
	•	the results of any adverse long-term clinical studies relating to the safety or effectiveness of our Closure system;
	•	the cost of our RF generator;
	•	the availability of alternative treatments or procedures that may be, or may be perceived as, more effective, safer, faster, easier to use or less costly than our Closure system; and
	•	if reimbursement from U.S. healthcare payors for the Closure system is reduced or discontinued.

     If physicians do not adopt our Closure system, we will not achieve greater, or maintain our current, revenues or remain profitable.

     Our success also depends on whether physicians view our Closure system as safe, effective and economically beneficial. We believe that physicians will not adopt our Closure system unless they determine, based on experience and other factors, that our Closure system is an attractive alternative to other available treatment methods, including vein stripping and endovenous laser ablation, or EVL. We also believe that recommendations and support of our Closure system by influential physicians and other healthcare providers are important for market acceptance and adoption.

     In addition, we recommend that a physician performing the Closure procedure use noninvasive ultrasound imaging to position the catheter in the vein to be treated. The purchase of ultrasound imaging equipment can cost $25,000 or more. Not all physicians who may be otherwise qualified to perform the Closure procedure have access to this equipment. Accordingly, physicians who do not have access to ultrasound imaging equipment may not find it sufficiently cost effective to begin performing the Closure procedure.

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We may experience significant fluctuations in our quarterly results and we may not maintain our recent profitability.

     As of March 31, 2005, we had an accumulated deficit of approximately $39.6 million. Although we have been profitable for the last six fiscal quarters, we cannot assure you that we will sustain profitability or that losses will not occur in the future. The fluctuations in our quarterly results of operations have and will continue to result from numerous factors, including:

	•	delays or interruptions in manufacturing and shipping of our products;
	•	practices of insurance companies and Medicare with respect to reimbursement for our procedure and our products;
	•	physician and patient acceptance of our products and procedures;
	•	seasonal demand;
	•	pricing of our products;
	•	timing of new product introductions;
	•	timing of orders received;
	•	our ability to train physicians in performing the Closure procedure; and
	•	the effect of competing technological and market developments.

     These factors, some of which are not within our control, may cause the price of our stock to fluctuate substantially. If our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly. We believe the quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

     In addition, we anticipate that our operating expenses will increase substantially in the foreseeable future as we expand our sales and marketing, manufacturing and product development activities and administrative staff. If sales do not continue to grow, we may not be able to maintain profitability. Our expansion efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently to offset these higher expenses. If we fail to do so, the market price for our common stock will likely decline.

Competition from existing and new products and procedures may decrease our market share and cause our revenues to decline.

     The medical device industry, including the market for venous reflux disease treatments, is highly competitive, subject to rapid technological change and significantly affected by new product introductions and market activities of other participants. For example, in 2002 the first EVL product was cleared for marketing in the United States.

     Several companies are marketing EVL systems for the treatment of venous reflux disease. These companies include AngioDynamics, Inc., biolitec AG, Diomed Holdings, Inc., Dornier MedTech GmbH, New Star Lasers, Inc., doing business as CoolTouch Inc., and Vascular Solutions, Inc. These or other competitors may succeed in developing additional products that are superior to our Closure system or that otherwise render our Closure system obsolete or noncompetitive. Some of these companies are larger than VNUS or may enjoy competitive advantages, including:

	•	established distribution networks;
	•	established relationships with physicians;
	•	products and procedures that are less expensive and take less time to perform;
	•	greater experience in launching, marketing, distributing and selling products;
	•	established relationships with healthcare providers and payors; and
	•	greater financial and other resources for product development, sales and marketing and patent litigation.

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     Because of the size of the venous reflux market, we anticipate that new or existing competitors may develop competing products, procedures or clinical solutions. These products, procedures or solutions could prove to be more effective, faster, safer or less costly than the Closure procedure. The introduction of new products, procedures or clinical solutions by competitors may result in price reductions, reduced margins or loss of market share and may render our products obsolete. In addition, we have begun to discount the sales price of our catheters and RF generators to improve our competitive position, which could cause our revenue or profit margins to decline and have an adverse effect on our results of operations.

If we become subject to product liability claims, we may be required to spend significant time and money in litigation or otherwise pay significant damages that may exceed our insurance coverage.

     The manufacture and sale of our products may expose us to product liability claims and product recalls, including those that may arise from the misuse or malfunction of, or design flaws in, our products, or use of our products with components not manufactured by us. Our Closure procedure may result in a variety of complications, some of which are potentially serious. The most serious potential complications include a pulmonary embolism, which is a blood clot that travels to the lungs and may cause shortness of breath or even death, blood clots in deep veins, skin burns and nerve inflammation. Successful results using our Closure system are dependent upon physician technique. Although we inform physicians of the risks associated with failing to follow the proper technique when performing the Closure procedure, we cannot assure you that these efforts will prevent complications. For example, in September 2004, an article published in the Journal of Vascular Surgery reported the preliminary experience of a group of physicians that found a 16% incidence of blood clots extending into deep veins in the first 73 legs they treated with the Closure procedure.

     We carry product liability insurance that is limited in scope and amount and may not be adequate to fully protect us against product liability claims. We could be required to pay damages that exceed our insurance coverage. Any product liability claim, with or without merit, could result in an increase in our product liability insurance rates or our inability to secure coverage on reasonable terms, if at all. Even in the absence of a claim, our insurance rates may rise in the future to a point where we decide not to carry this insurance. Even a meritless or unsuccessful product liability claim would be time consuming and expensive to defend and could result in the diversion of management’s attention from our business. Any of these events could negatively affect our earnings and financial condition.

Our intellectual property rights may not provide meaningful commercial protection for our products, which could enable third parties to use our technology or methods, or very similar technology or methods, and could reduce our ability to compete.

     Our success depends significantly on our ability to protect our proprietary rights to the technologies used in our products. We may need to assert claims or engage in litigation to protect our proprietary rights, which could cause us to incur substantial costs, could place significant strain on our financial resources, and divert the attention of management from our business. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our patent applications may not issue as patents in a form that will be advantageous to us. Our issued patents and those that may be issued in the future may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products. Although we have taken steps to protect our intellectual property and proprietary technology, there is no assurance that third parties will not be able to design around our patents. In addition, although we have entered into confidentiality agreements and intellectual property assignment agreements with our employees, consultants and advisors, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements.

     Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. Foreign countries generally do not allow patents to cover methods for performing surgical procedures. If our intellectual property does not provide significant protection against competition, our competitors could compete more directly with us, which could result in a decrease in our market share. All of these factors may harm our competitive position.

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Inadequate levels of reimbursement for the Closure procedure from governmental or other third-party payors could affect the adoption or use of our Closure system and may cause our revenues to decline.

     Widespread adoption or use of our Closure system by the medical community is unlikely to occur if physicians do not receive sufficient reimbursement from payors for performing our Closure procedure. To date, our Closure procedure typically has been reimbursed by private healthcare insurance, managed care payors and Medicare. Many private payors use reimbursement amounts determined by the Centers for Medicare and Medicaid Services, or CMS, which administers the Medicare program, as a guideline in setting their reimbursement policies. Actions by CMS or other government agencies may diminish reimbursement payments to physicians, hospitals and outpatient surgery centers. Additionally, some private payors do not follow the Medicare guidelines and those payors may reimburse for only a portion of our procedure or not at all. Some private party payors, including PacifiCare, have deemed the Closure procedure experimental and will not provide reimbursement until additional long-term data is available or published. Even to the extent our Closure procedure is reimbursed by private payors and governmental payors, adverse changes in payors’ policies toward reimbursement for the procedure would also harm our ability to market and sell our Closure system.

     We are unable to predict all changes to the reimbursement methodologies that will be employed by private or governmental third-party payors. In November 2004, the codes to be used for 2005 by third-party payors and Medicare to identify and reimburse for our Closure procedure and the disposable catheters and other supplies used in the procedure were published by the American Medical Association, or AMA, and CMS. Due to a wide range of physician payment levels in 2004 for performing the Closure procedure in a hospital setting, the 2005 payment rates as established by CMS will be less for some physicians performing the Closure procedure in a hospital setting than in 2004. As a result, some physicians who currently perform the Closure procedure in a hospital may choose to perform the procedure in an office setting, which may delay catheter purchases, or they may reduce the number of procedures they perform, in which case our business may be harmed. Additionally, the establishment of new procedure codes by the AMA and reimbursement payment rates by CMS does not guarantee the coverage of those codes or procedures by private healthcare insurers. Private healthcare insurers may establish payment rates that are different from Medicare. In May 2005, CMS issued an interim final rule to update the list of covered procedures for ambulatory surgery centers (ASC) and included endovenous RF and laser ablation codes on this list, scheduled to go into effect July 5, 2005. The effect of this is to establish Medicare reimbursement to the ASC at an average national rate of $510. This rate is likely to be inadequate to cover the cost of performing these procedures.

     If doctors do not treat multiple veins during a procedure, or perform varicose vein removal adjunctively with the Closure procedure, some hospitals or ASCs may view the 2005 reimbursement rate as inadequate to support the purchase of our disposable catheter. Furthermore, for some governmental payors, such as the Medicaid program, reimbursement differs from state to state, and some state Medicaid programs may not reimburse for our procedure in an adequate amount, if at all. Any lack of private or governmental third-party payor coverage or inadequate reimbursement for procedures performed using our Closure system could harm our business and reduce our revenues.

     Our international success is dependent upon the availability of reimbursement within prevailing foreign healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government-sponsored healthcare and private insurance. In addition, healthcare cost containment efforts similar to those we face in the United States are prevalent in many of the other countries in which we sell our Closure system, and these efforts are expected to continue. To the extent our Closure system has historically received reimbursement under a foreign healthcare payment system, such reimbursement has typically been significantly less than the reimbursement provided in the United States. If adequate levels of reimbursement from governmental and third-party payors outside of the United States are not attained and maintained, sales of our Closure system outside of the United States may decrease and we may fail to achieve or maintain significant non-U.S. sales.

Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply problems and price fluctuations, which could harm our business.

     In October 2004, we transitioned the manufacture of our RF generators to Byers Peak, Inc. from Stellartech Research Corporation. Byers Peak, Inc. is, and we expect for the foreseeable future will be, a sole-source supplier of our RF generators. We and our contract manufacturers also rely on sole-source suppliers to manufacture some of the components used in our products. Our manufacturers and suppliers may encounter problems during manufacturing due to a variety of reasons, including failure to follow specific protocols and procedures, failure to comply with applicable regulations, including the Food and Drug Administration’s Quality System Regulations, equipment malfunction and environmental factors, any of which could delay or impede our ability to meet demand. Our reliance on these outside manufacturers and suppliers also subjects us to other risks that could harm our business, including:

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	•	suppliers may make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in shipment of our products;
	•	we may not be able to obtain adequate supply in a timely manner or on commercially reasonable terms;
	•	we may have difficulty locating and qualifying alternative suppliers for our disposable catheter components or RF generators;
	•	switching components may require product redesign and submission to the FDA of a pre-market supplement or possibly a separate pre-market approval, either of which could significantly delay production;
	•	our suppliers manufacture products for a range of customers, and fluctuations in demand for the products those suppliers manufacture for others may affect their ability to deliver components for us in a timely manner; and
	•	our suppliers may encounter financial hardships unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements.

     Any interruption or delay in the supply of components or materials, or our inability to obtain components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and cause them to cancel orders or switch to competitive procedures.

     To mitigate the risk of supply interruptions from a sole-source supplier, we may determine to maintain excess inventory of the products or components they supply. Managing our inventory levels is important to our cash position and results of operations. An excessive amount of inventory reduces our cash available for operations and may result in excess or obsolete materials. Inadequate inventory levels may make it difficult for us to meet customer product demand, resulting in decreased revenues. An inability to forecast future revenues or estimated life cycles of products may result in inventory-related charges that would negatively affect our gross margins and results of operations.

We depend on our officers and if we are not able to retain them or recruit additional qualified personnel, our business will suffer.

     We are highly dependent on our President and Chief Executive Officer, Brian E. Farley, and other officers. Due to the specialized knowledge each of our officers possesses with respect to our Closure system and our operations, the loss of service of one or more of these individuals could significantly affect our ability to operate and manage our business. We do not have any insurance in the event of the death or disability of any of these key personnel. Each of our officers may terminate their employment without notice and without cause or good reason. For example, our Vice President, Account and Market Development, terminated his employment by us in the first quarter of 2005. Subsequent to the end of the first quarter of 2005, our Vice President, Worldwide Marketing and International Sales, terminated his employment. We are currently actively recruiting to fill the Worldwide Marketing and International Sales role.

To successfully grow our business, we will need to attract additional qualified management, technical and sales personnel.

     To successfully grow our business, we will need to attract additional qualified management, technical and sales personnel. To succeed in the implementation of our business strategy, our management team must rapidly execute our sales strategy, achieve market acceptance for our Closure system and further develop products, while managing anticipated growth by implementing effective planning, manufacturing and operating processes. Managing this growth will require us to attract and retain additional management and technical personnel. Our offices are located in San Jose, California, where competition for employees with experience in the medical device industry is intensely competitive. We rely on direct sales employees to sell our Closure system in the United States. We plan to expand our sales team and failure to adequately train our employees in the use and benefits of our products will prevent us from achieving our market share and revenue growth goals. We cannot assure you that we will be able to attract and retain the additional personnel necessary to grow and expand our business and operations. If we fail to identify, attract, retain and motivate these highly skilled personnel, we may be unable to continue our development and sales activities.

The medical device industry is characterized by patent litigation and we could become subject to litigation that could be costly, result in the diversion of management’s attention, require us to pay damages and discontinue selling our products.

     The medical device industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that our system or the methods we employ in the use of our system are covered by U.S. or foreign patents held by them. This risk is exacerbated by the fact that there are numerous issued and pending patents relating to the

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use of RF energy in catheter-based procedures in the medical technology field. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware that may later result in issued patents that our Closure system may infringe. There could also be existing patents of which we are unaware that one or more components of our system may inadvertently infringe. As the number of competitors in the market for the treatment of venous reflux disease grows, the possibility of inadvertent patent infringement by us or a patent infringement claim against us increases.

     Any litigation or claim against us may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of management from our business and harm our reputation. If the relevant patents were upheld as valid and enforceable and we were found to infringe, we could be prevented from selling our Closure system unless we can obtain a license to use technology or ideas covered by such patent or are able to redesign our Closure system to avoid infringement. A license may not be available at all or on terms acceptable to us, and we may not be able to redesign our products to avoid any infringement. Modification of our products or development of new products could require us to conduct additional clinical trials and to revise our filings with the Food and Drug Administration and other regulatory bodies, which would be time-consuming and expensive. If we are not successful in obtaining a license or redesigning our products, we may be unable to sell our products and our business could suffer. In addition, our patents are vulnerable to various invalidity attacks, such as those based upon earlier patent applications, patents, publications, products or processes, which might invalidate or limit the scope of the protection that our patents afford.

If we choose to acquire new and complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions or to successfully integrate them in a cost-effective and non-disruptive manner.

     Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and technologies. Accordingly, we may in the future pursue the acquisition of complementary businesses, products or technologies instead of developing them ourselves. We have no current commitments with respect to any acquisition or investment. We do not know if we will be able to successfully complete any acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology or retain any key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, disrupt our ongoing business and distract our management. If we are unable to integrate any acquired businesses, products or technologies effectively, our business will suffer. In addition, any amortization or charges resulting from the costs of acquisitions could increase our expenses.

We lack published long-term randomized trial data comparing the efficacy of our Closure procedure with vein stripping and EVL. If future data proves to be inconsistent with our clinical results, our revenues may decline.

     Currently, there is no randomized trial data beyond two years comparing the long-term efficacy of the Closure procedure to alternative treatments. Additional long-term patient follow-up studies may indicate that the Closure procedure is not as safe and effective as vein stripping or EVL. Currently available published data from a comparative study of the Closure procedure versus vein stripping is limited to the two-year period following treatment. Data from an independent study comparing clinical outcomes between the Closure procedure and EVL has not been published. If new studies or comparative studies generate results that are not as favorable as our clinical results, our revenues may decline. Furthermore, physicians may choose not to purchase our Closure system until they receive additional published long-term clinical evidence and recommendations from prominent physicians that indicate our Closure system effectively treats venous reflux disease.

Any failure in our efforts to train physicians could reduce the market acceptance of our products and reduce our revenues.

     There is a learning process involved for physicians to become proficient in the use of our products. It is critical to the success of our sales efforts to adequately train a sufficient number of physicians and to provide them with adequate instruction in the use of our Closure system and RFS devices. Following completion of training, we rely on the trained physicians to advocate the benefits of our products in the broader marketplace. Convincing physicians to dedicate the time and energy necessary for adequate training is challenging, and we cannot assure you that we will be successful in these efforts. If physicians are not properly trained, they may misuse or ineffectively use our products. This may also result in unsatisfactory patient outcomes, patient injury, negative publicity or lawsuits against us, any of which could negatively affect our reputation and sales of our Closure system or RFS devices.

If we are unable to manufacture an adequate supply of our products, we could lose customers and revenues and our growth could be limited.

     In order for us to maintain and expand our business successfully within the United States and internationally, we must manufacture commercial quantities of components that comprise our Closure system in compliance with regulatory requirements at an acceptable

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cost and on a timely basis. Our anticipated growth may strain our ability to manufacture an increasingly large supply of our products. Manufacturing facilities often experience difficulties in scaling up production, including problems with production yields and quality control and assurance. If we cannot scale our manufacturing operations appropriately, maintain control over expenses or otherwise adapt to anticipated growth, or if we have underestimated our future growth, we may not have the capability to satisfy market demand, which would harm our business.

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or “off-label” uses.

     Although we believe our promotional materials and training methods regarding physicians are conducted in compliance with regulations of the Food and Drug Administration and other applicable regulations, if the Food and Drug Administration determines that our promotional materials or training constitutes promotion of an unapproved use, it could request that we modify our training or promotional materials or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

     Some of our employees were previously employed at universities or other medical device companies. Although there are no claims currently pending against us, we may be subject to future claims that these employees, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of these former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research or sales personnel or their work product could hamper or prevent our ability to improve our products or sell our existing products, which would harm our business.

If we fail to comply with the extensive government regulations relating to our business, we may be subject to fines, injunctions and penalties.

     Our products are classified as medical devices. Medical devices are subject to extensive regulation in the United States by the Food and Drug Administration and numerous other federal, state and foreign governmental authorities. Food and Drug Administration regulations specific to medical devices are wide ranging and govern, among other things:

	•	design, development and manufacturing;
	•	testing;
	•	clinical trials in humans;
	•	electronic product safety;
	•	labeling;
	•	storage;
	•	marketing;
	•	pre-market clearance or approval;
	•	record keeping procedures;
	•	advertising and promotion;

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	•	post-market surveillance and reporting of deaths, serious injuries or malfunctions; and
	•	export.

     Our manufacturing processes are required to comply with the Food and Drug Administration’s Quality System Regulations, which cover the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The Food and Drug Administration enforces its Quality System Regulations through periodic unannounced inspections and if our manufacturing facility fails a Quality System inspection, our operations could be disrupted and our manufacturing interrupted. Failure to take adequate and timely corrective action in response to an adverse Quality System inspection could force a shutdown of our manufacturing operations or a recall of our products.

     Compliance with these regulations can be complex, expensive and time-consuming. While we believe we and our third-party manufacturers and suppliers have complied with these regulations in the past, and continue to do so on an ongoing basis, our failure to comply with such regulations could lead to the imposition of injunctions, suspensions or loss of regulatory approvals, product recalls, orders for repair, replacement or refund, customer notifications, termination of distribution, product seizures or civil penalties. In the most egregious cases, criminal sanctions or closure of our manufacturing facilities or those of our suppliers are possible. If we are required to shut down our manufacturing operations or recall any of our products, we may not be able to provide our customers with the quantity of products they require, and we could lose customers and suffer reduced revenue. If we are unable to obtain sufficient quantities of high quality products to meet customer demand on a timely basis, we could lose customers, our growth could be limited and our business could be harmed.

     We are also subject to medical device reporting (“MDR”) regulations that require us to report to the Food and Drug Administration if our products cause or contribute to a death or serious injury or if they malfunction. As of December 31, 2004, we have submitted 41 medical device reports. In 36 cases, a thrombus, or blood clot, was noticed at varying lengths of time after the Closure procedure was performed. In four cases, the patient developed a pulmonary embolism. In March 2005, we received a report that a patient treated with a motorized varicose vein treatment device and our radiofrequency ablation catheter was admitted to a hospital and diagnosed with a pulmonary embolism 13 days after the procedure and died the following day. We reported this event to the FDA via the MDR process. Information on the events leading to the patient’s death is incomplete. The treating physician’s office has informed us that the patient was free of deep vein thrombosis at a routine ultrasound scan performed two days after the procedure. The next day the patient contacted the physician’s office indicating the patient did not feel well. The patient was then seen by the treating physician seven days after treatment. On the 12th day after treatment the patient reported shortness of breath and saw a primary care physician who referred the patient to a hospital emergency room. The patient was admitted to the hospital and diagnosed with pulmonary emboli. No treatment details are available. We do not have sufficient information to determine which of the two procedures may have caused, or had a major contribution to, the pulmonary emboli. We have not received any report of malfunction of the equipment used in the Closure procedure. This is the first report we have received of a patient death following treatment with our catheter or system. Pulmonary embolism is a known risk from any surgical procedure including our radiofrequency procedure, and is described in our risk factors and product labeling. We believe that none of these incidents were caused by design faults or defects in the product. However, it is possible that claims could be made against us alleging that our products are defective or unsafe. Our failure to comply with applicable regulatory requirements could result in enforcement action by the Food and Drug Administration, which could include any of the above sanctions. In addition, the identification of serious safety risks could result in product recall or withdrawal of our clearance or approval. The imposition of any one or more of these penalties could have a negative effect on our production, product sales and profitability.

     Our third party component manufacturers may also be subject to the same sanctions and, as a result, may be unable to supply components for our products. Any failure to retain governmental clearances or approvals that we currently hold or to obtain additional similar clearances or approvals could prevent us from successfully marketing our products and technology and could harm our operating results. Furthermore, changes in the applicable governmental regulations could prevent further commercialization of our products and technologies and could harm our business.

We spend considerable time and money complying with federal, state and foreign regulations and, if we are unable to fully comply with such regulations, we could face substantial penalties.

     We are directly or indirectly through our customers, subject to extensive regulation by both the federal government and the states and foreign countries in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include, but are not limited to, the following:

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	•	The Federal Food, Drug, and Cosmetic Act, which regulates the design, testing, manufacture, labeling, marketing, distribution and sale of prescription drugs and medical devices;
	•	state food and drug laws;
	•	the federal Anti-Kickback Law, which prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;
	•	Medicare laws and regulations that prescribe the requirements for coverage and payment, including the amount of such payment, and laws prohibiting false claims for reimbursement under Medicare and Medicaid;
	•	the federal physician self-referral prohibition, commonly known as the Stark Law, which, in the absence of a statutory or regulatory exception, prohibits the referral of Medicare patients by a physician to an entity for the provision of designated healthcare services, if the physician or a member of the physician’s immediate family has a direct or indirect financial relationship, including an ownership interest in, or a compensation arrangement with, the entity and also prohibits that entity from submitting a bill to a federal payor for services rendered pursuant to a prohibited referral;
	•	state laws that prohibit the practice of medicine by non-physicians and fee-splitting arrangements between physicians and non-physicians, as well as state law equivalents to the Anti-Kickback Law and the Stark Law, which may not be limited to government reimbursed items; and
	•	the Federal Trade Commission Act and similar laws regulating advertising and consumer protection.

     If our past or present operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. If we are required to obtain permits or licensure under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense. Any penalties, damages, fines, curtailment or restructuring of our operations would adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by applicable regulatory authorities or the courts, and their provisions are open to a variety of interpretations and additional legal or regulatory change. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation.

Product sales or introductions may be delayed or canceled as a result of the Food and Drug Administration regulatory process, which could cause our sales or profitability to decline.

     The process of obtaining and maintaining regulatory approvals and clearances to market a medical device from the Food and Drug Administration and similar regulatory authorities abroad can be costly and time consuming, and we cannot assure you that such approvals and clearances will be granted. Pursuant to Food and Drug Administration regulations, unless exempt, the Food and Drug Administration permits commercial distribution of a new medical device only after the device has received 510(k) clearance or is the subject of an approved pre-market approval application. The Food and Drug Administration will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The pre-market approval application process is more costly, lengthy and uncertain than the 510(k) process, and must be supported by extensive data, including data from preclinical studies and human clinical trials. Because we cannot assure you that any new products, or any product enhancements, that we develop will be subject to the shorter 510(k) clearance process, significant delays in the introduction of any new products or product enhancement may occur. We cannot assure you that the Food and Drug Administration will not require a new product or product enhancement go through the lengthy and expensive pre-market approval application process.

     Delays in obtaining regulatory clearances and approvals may:

	•	delay or eliminate commercialization of products we develop;
	•	require us to perform costly procedures;

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	•	diminish any competitive advantages that we may attain; and
	•	reduce our ability to collect revenues or royalties.

     Although we have obtained 510(k) clearance from the Food and Drug Administration to market the Closure system, we cannot assure you that the clearance of our Closure system will not be withdrawn or that we will not be required to obtain new clearances or approvals for modifications or improvements to our products.

Modifications to our products may require new marketing clearances or approvals or require us to cease marketing or recall the modified products until such clearance or approvals are obtained.

     Any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture, requires a new 510(k) clearance or, possibly, approval of a pre-market approval application. The Food and Drug Administration requires every manufacturer to make this determination in the first instance, but the Food and Drug Administration may review any manufacturer’s decision. We have made modifications to elements of our Closure system and RFS devices for which we have not sought additional 510(k) clearance. The Food and Drug Administration may not agree with our decisions regarding whether new clearances or approvals are required. If the Food and Drug Administration disagrees with us, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval. In addition, we could be subject to significant regulatory fines or penalties. Furthermore, our products could be subject to recall if the Food and Drug Administration determines, for any reason, that our products are not safe or effective. Delays in receipt or failure to receive clearances or approvals, the loss of previously received clearances or approvals, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects.

We sell our products internationally and are subject to various risks relating to such international activities which could harm our international sales and profitability.

     During the years ended December 31, 2003 and December 31, 2004, and the three-month period ended March 31, 2005, 4%, 4%, and 5%, respectively, of our net revenues were attributable to international markets. By doing business in international markets, we are exposed to risks separate and distinct from those we face in our domestic operations. Our international business may be adversely affected by changing economic conditions in foreign countries. Because most of our sales are currently denominated in U.S. dollars, if the value of the U.S. dollar increases relative to foreign currencies, our products could become more costly to the international consumer and therefore less competitive in international markets, which could affect our profitability. Furthermore, while currently only a small percentage of our sales are denominated in non-U.S. currency, this percentage may increase in the future, in which case fluctuations in exchange rates could affect demand for our products. Engaging in international business inherently involves a number of other difficulties and risks, including:

	•	export restrictions and controls relating to technology;
	•	the availability and level of reimbursement within prevailing foreign healthcare payment systems;
	•	pricing pressure that we may experience internationally;
	•	required compliance with existing and changing foreign regulatory requirements and laws;
	•	laws and business practices favoring local companies;
	•	longer payment cycles;
	•	difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;
	•	political and economic instability;
	•	potentially adverse tax consequences, tariffs and other trade barriers;
	•	international terrorism and anti-American sentiment;

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	•	difficulties and costs of staffing and managing foreign operations; and
	•	difficulties in enforcing intellectual property rights.

     Our exposure to each of these risks may increase our costs, lengthen our sales cycle and require significant management attention. We cannot assure you that one or more of these factors will not harm our business.

Our stock price may be volatile which may cause the value of our stock to decline or subject us to a securities class action litigation.

     The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

	•	the depth and liquidity of the market for our common stock;
	•	volume and timing of orders for our products;
	•	developments generally affecting medical device companies;
	•	the announcement of new products or product enhancements by us or our competitors;
	•	changes in earnings estimates or recommendations by securities analysts;
	•	investor perceptions of us and our business, including changes in market valuations of medical device companies;
	•	actions by institutional or other large stockholders;
	•	our results of operations and financial performance; and
	•	general economic, industry and market conditions.

     In addition, the stock market in general, and the NASDAQ National Market and the market for medical devices in particular, have experienced substantial price and volume volatility that is often seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its common stock. We may become involved in this type of litigation in the future. Any securities litigation claims brought against us could result in substantial expense and the diversion of management’s attention from our business.

If there are substantial sales of our common stock, our stock price could decline.

     If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of common stock, the market price of our common stock could decline significantly. As of April 30, 2005, we had 14,479,110 shares of common stock outstanding. All of these shares are freely tradable without restriction or further registration under the federal securities laws, pursuant to Rule 144, 144(k) and 701, unless held by our “affiliates” as that term is defined in Rule 144 under the Securities Act of 1933.

     Additionally, existing stockholders holding an aggregate of approximately 7,800,000 shares of common stock, including shares of common stock underlying warrants, have the right, subject to some conditions, to require us to file a registration statement with the Securities and Exchange Commission or include their shares in registration statements that we may file for ourselves or other stockholders. If we register their shares of common stock following the expiration of the lock-up agreements, they can freely sell those shares in the public market.

If we fail to maintain the adequacy of our internal controls, our ability to provide accurate financial reports could be impaired, and any failure to maintain our internal controls and provide accurate financial reports would cause our market price to decrease substantially.

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     Effective internal controls are necessary for us to provide reliable financial reports and help prevent fraud. We are continuously evaluating and working to improve our internal controls. Our evaluation may conclude that enhancements, modifications or changes to our internal controls are necessary to satisfy the requirements of Sarbanes-Oxley Act of 2002. We cannot be certain that the measures we implement will ensure that we maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our financial reporting obligations. Any failure to maintain the adequacy of our internal controls and provide accurate financial reports could subject us to costly litigation, could make it difficult to attract and retain quality management personnel and could have a negative effect on the market price of our stock.

Our business may be harmed by a natural disaster, terrorist attacks or other unanticipated problems.

     Our manufacturing and office facilities are located in a single building in San Jose, California. Despite precautions taken by us, a natural disaster such as fire or earthquake, a terrorist attack or other unanticipated problems at this building could interrupt our ability to manufacture our products or operate our business. These disasters or problems may also destroy our product inventories. While we carry insurance for certain natural disasters and business interruption, any prolonged or repeated disruption or inability to manufacture our products or operate our business could result in losses that exceed the amount of coverage provided by this insurance, and in such event could harm our business.

Our future capital needs are uncertain; we may need to raise additional funds in the future and such funds may not be available on acceptable terms, if at all.

     We believe that the net proceeds from our initial public offering, completed in October 2004, together with our current cash, cash equivalents and short-term investments, will be sufficient to meet our projected capital requirements for at least the next 12 months. Our capital requirements will depend on many factors, including:

	•	the revenues generated by sales of our products;
	•	the costs associated with expanding our manufacturing, marketing, sales and distribution efforts;
	•	the rate of progress and cost of our research and development activities;
	•	the costs of obtaining and maintaining Food and Drug Administration and other regulatory clearance of our products and products in development;
	•	the effects of competing technological and market developments; and
	•	the number and timing of acquisitions and other strategic transactions.

     As a result of these factors, we may need to raise additional funds, and we cannot be certain that such funds will be available to us on acceptable terms, if at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rights to our future products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to expand our operations, develop new products, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements.

Concentration of ownership among our existing directors, executive officers and principal stockholders may prevent new investors from influencing significant corporate decisions.

     Our executive officers, directors and greater than 10% stockholders directly or indirectly beneficially own or control greater than a majority of our outstanding shares of common stock. These executive officers, directors and significant stockholders, acting as a group, have substantial control over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transactions. Some of these persons or entities may have interests different than our other stockholders. For example, these stockholders may delay or prevent a change of control of us, even if such a change of control would benefit our other stockholders, and these persons or entities may pursue strategies that are different from the wishes of other investors.

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Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change of control, even if an acquisition would be beneficial to our stockholders, which could cause our stock price to decline and prevent attempts by our stockholders to replace or remove our current management.

     In addition to the effect that the concentration of ownership by our officers, directors and significant stockholders may have, our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that may enable our management to resist a change in control. These provisions may discourage, delay or prevent a change in the ownership of our company or a change in our management. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. Such provisions include:

	•	our board of directors is authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as “blank check” preferred stock, with rights senior to those of common stock;
	•	advance notice requirements for stockholders to nominate individuals to serve on our board of directors or for stockholders to submit proposals that can be acted upon at stockholder meetings;
	•	our board of directors is classified so that not all members of our board of directors are elected at one time, which may make it more difficult for a person who acquires control of a majority of our outstanding voting stock to replace our directors;
	•	stockholder action by written consent is prohibited;
	•	special meetings of our stockholders are permitted to be called only by a majority of our board of directors, the chairman of our board of directors or our president;
	•	stockholders are not permitted to cumulate their votes for the election of directors;
	•	newly created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors are to be filled only by majority vote of the remaining directors, even though less than a quorum is then in office;
	•	our board of directors is expressly authorized to modify, alter or repeal our bylaws; and
	•	stockholders are permitted to amend our bylaws only upon receiving at least 75% of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

     We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including delaying or impeding a merger, tender offer or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     To date, substantially all of our sales have been denominated in U.S. dollars. Approximately 2% of total sales for the three-month period ended March 31, 2005 have been denominated in currencies other than U.S. dollars. Accordingly, we believe that there is currently no material exposure to risk from changes in foreign currency exchange rates.

     Our exposure to interest rate risk at March 31, 2005 is related to our investment of our excess cash and cash equivalents in debt instruments of the U.S. government and its agencies, in high-quality corporate issuers, via a large money market fund. This fund maintains an average investment maturity of 90 days or less. Due to the short-term nature of these investments, we believe that there is currently no material exposure to interest rate risk arising from our investments.

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ITEM 4 – CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), our management, including our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures appear to be effective at the reasonable assurance level.

Change in internal control

There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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Part II. Other Information

Item 1. Legal Proceedings

We are not currently involved in any legal proceedings.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

We effected the initial public offering of our common stock pursuant to a Registration Statement on Form S-1 (File No. 333-117640) that was declared effective by the SEC on October 19, 2004. To date, we have used approximately $474,000 of the proceeds from our initial public offering for sales and marketing activities, approximately $78,000 of the proceeds from our initial public offering for clinical research and product developing activities and approximately $2,568,000 of the proceeds from our initial public offering for working capital and other general corporate purposes.

We expect to use the remaining net proceeds from our initial public offering to fund our operations, including sales and marketing activities, clinical research and development and for working capital and other general corporate purposes. In addition, we may use a portion of the remaining net proceeds from our initial public offering to acquire products, technologies or businesses that are complementary to our own.

Item 6. Exhibits

(a) Exhibits.

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SIGNATURE

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.

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EXHIBIT INDEX