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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006

or



| ̈ | Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to
.

Commission File Number 000-50998



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FOXHOLLOW
TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3252085                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

740 Bay Road

Redwood City, California 94063-2469

(Address of principal executive offices, including Zip Code)

(650) 421-8400

(Registrants telephone number, including area code)



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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  x    NO ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated
filer ̈Accelerated filer  x    Non-accelerated filer ̈

Indicate by check mark whether Registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x



|                               |  |                                       
|------------------------------ |  | --------------------------------------
|Class                          |  | Shares Outstanding at November 6, 2006
|Common Stock, $0.001 par value |  | 25,901,301                            



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##### Table of Contents

FOXHOLLOW TECHNOLOGIES, INC.

FORM 10-Q

TABLE OF CONTENTS



|                              |  |                                                                                                                 |  |     
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                 |  | Page
|Part I:
Financial Information
|                              |  |                                                                                                                
|Item 1.                       |  | Condensed Consolidated Financial Statements (unaudited):                                                        |  |     
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005                               |  | 3   
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and 2005 |  | 4   
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005           |  | 5   
|                              |  |                                                                                                                
|                              |  | Notes to Condensed Consolidated Financial Statements                                                            |  | 6   
|                              |  |                                                                                                                
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 18  
|                              |  |                                                                                                                
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 28  
|                              |  |                                                                                                                
|Item 4.                       |  | Controls and Procedures                                                                                         |  | 28  
|                              | 
|Part II:
Other Information    |  |                                                                                                                
|                              |  |                                                                                                                
|Item 1.                       |  | Legal Proceedings                                                                                               |  | 28  
|                              |  |                                                                                                                
|Item 1A.                      |  | Risk Factors                                                                                                    |  | 29  
|                              |  |                                                                                                                
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                       |  | 38  
|                              |  |                                                                                                                
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                 |  | 39  
|                              |  |                                                                                                                
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                             |  | 39  
|                              |  |                                                                                                                
|Item 5.                       |  | Other Information                                                                                               |  | 39  
|                              |  |                                                                                                                
|Item 6.                       |  | Exhibits                                                                                                        |  | 39  
|                              | 
|Signatures                    |  | 41                                                                                                             
|                              | 
|Certifications                |  |                                                                                                                



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##### Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                            |  |                   |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                            |  | September 30,2006 |         |   | December 31,2005 |  
|Assets                                                                                                                      |  |                   |         |   |                  |   |         |  
|Current assets:                                                                                                             |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                   |  | $                 | 37,179  |   |                  | $ | 24,249  |  
|Short-term investments                                                                                                      |  |                   | 19,097  |   |                  |   | 35,666  |  
|Accounts receivable, net of allowance for doubtful accounts of $1,156 at September 30, 2006 and $1,002 at December 31,
2005 |  |                   | 27,029  |   |                  |   | 21,831  |  
|Research collaboration receivable                                                                                           |  |                   | 4,100   |   |                  |   |        |  
|Inventories                                                                                                                 |  |                   | 13,122  |   |                  |   | 15,607  |  
|Prepaid expenses and other current assets                                                                                   |  |                   | 2,455   |   |                  |   | 1,846   |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Total current assets                                                                                                        |  |                   | 102,982 |   |                  |   | 99,199  |  
|                                                                                                                            |  |                  
|Property and equipment, net                                                                                                 |  |                   | 8,737   |   |                  |   | 8,442   |  
|Intangibles, net                                                                                                            |  |                   | 12,511  |   |                  |   |        |  
|Goodwill                                                                                                                    |  |                   | 19,181  |   |                  |   |        |  
|Other assets                                                                                                                |  |                   | 1,103   |   |                  |   | 564     |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                |  | $                 | 144,514 |   |                  | $ | 108,205 |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Liabilities and Stockholders Equity                                                                                        |  |                   |         |   |                  |   |         |  
|Current liabilities:                                                                                                        |  |                   |         |   |                  |   |         |  
|Accounts payable                                                                                                            |  | $                 | 9,153   |   |                  | $ | 7,072   |  
|Accrued liabilities                                                                                                         |  |                   | 14,647  |   |                  |   | 11,163  |  
|Deferred revenue                                                                                                            |  |                   | 4,100   |   |                  |   | 6,206   |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                           |  |                   | 27,900  |   |                  |   | 24,441  |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Commitments and Contingencies (Note 15)                                                                                     |  |                   |         |   |                  |   |         |  
|                                                                                                                            |  |                  
|Stockholders equity:                                                                                                       |  |                   |         |   |                  |   |         |  
|Common stock: $0.001 par value per share                                                                                    |  |                   | 26      |   |                  |   | 24      |  
|Additional paid-in capital                                                                                                  |  |                   | 211,481 |   |                  |   | 178,011 |  
|Deferred stock-based compensation                                                                                           |  |                   | (2,401  | ) |                  |   | (9,066  | )
|Other comprehensive loss                                                                                                    |  |                   | (8      | ) |                  |   | (99     | )
|Accumulated deficit                                                                                                         |  |                   | (92,484 | ) |                  |   | (85,106 | )
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                  |  |                   | 116,614 |   |                  |   | 83,764  |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                  |  | $                 | 144,514 |   |                  | $ | 108,205 |  
|                                                                                                                            |  |                   |         |   |                  |   |         |  

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



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FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ---- | ------------------------------ | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                                                                              |  | Three Months EndedSeptember 30, |        |      | Nine Months EndedSeptember 30, |       
|                                                                                                                                                                                              |  | 2006                            |        | 2005 |                                |        | 2006 |  |   | 2005    |  
|Revenue:                                                                                                                                                                                      |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Product                                                                                                                                                                                       |  | $                               | 49,826 |      | $                              | 35,645 |      |  | $ | 142,360 |   |  | $ | 85,847  |  
|Research collaboration                                                                                                                                                                        |  |                                 | 3,926  |      |                                | 431    |      |  |   | 6,206   |   |  |   | 431     |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Net revenue                                                                                                                                                                                   |  |                                 | 53,752 |      |                                | 36,076 |      |  |   | 148,566 |   |  |   | 86,278  |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Costs and expenses:                                                                                                                                                                           |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Product (includes $360, $126, $1,004 and $425 in stock-based compensation expense for the three and nine month periods ended
September 30, 2006 and 2005)                                     |  |                                 | 10,225 |      |                                | 9,821  |      |  |   | 31,960  |   |  |   | 27,575  |  
|Research collaboration                                                                                                                                                                        |  |                                 | 890    |      |                                |       |      |  |   | 2,718   |   |  |   |        |  
|Research and development (includes $693, $197, $1,767 and $924 in stock-based compensation expense for the three and nine month periods ended
September 30, 2006 and 2005)                    |  |                                 | 5,660  |      |                                | 2,759  |      |  |   | 14,569  |   |  |   | 7,681   |  
|Selling, general and administrative (includes $1,885, $1,872, $17,850, and $4,488 in stock-based compensation expense for the three and nine
month periods ended September 30, 2006 and 2005) |  |                                 | 31,095 |      |                                | 25,419 |      |  |   | 108,833 |   |  |   | 63,811  |  
|Amortization of purchased intangible assets                                                                                                                                                   |  |                                 | 79     |      |                                |       |      |  |   | 79      |   |  |   |        |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Total costs and expenses                                                                                                                                                                      |  |                                 | 47,949 |      |                                | 37,999 |      |  |   | 158,159 |   |  |   | 99,067  |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Income (loss) from operations                                                                                                                                                                 |  |                                 | 5,803  |      |                                | (1,923 | )    |  |   | (9,593  | ) |  |   | (12,789 | )
|                                                                                                                                                                                              |  |                                 |        |     
|Interest and other income and expense, net                                                                                                                                                    |  |                                 | 925    |      |                                | 437    |      |  |   | 2,215   |   |  |   | 1,338   |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                                                                                                                                             |  | $                               | 6,728  |      | $                              | (1,486 | )    |  | $ | (7,378  | ) |  | $ | (11,451 | )
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Net income (loss) per common share:                                                                                                                                                           |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Basic                                                                                                                                                                                         |  | $                               | 0.27   |      | $                              | (0.06  | )    |  | $ | (0.30   | ) |  | $ | (0.50   | )
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                                                                                                                                       |  | $                               | 0.26   |      | $                              | (0.06  | )    |  | $ | (0.30   | ) |  | $ | (0.50   | )
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Weighted-average number of shares used in per common share calculations:                                                                                                                      |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Basic                                                                                                                                                                                         |  |                                 | 25,236 |      |                                | 23,189 |      |  |   | 24,799  |   |  |   | 22,748  |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                                                                                                                                       |  |                                 | 25,803 |      |                                | 23,189 |      |  |   | 24,799  |   |  |   | 22,748  |  
|                                                                                                                                                                                              |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  

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



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FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                          |  |                                |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Nine months endedSeptember 30, |        
|                                                                                          |  | 2006                           |         |   | 2005 |  
|Cash flows from operating activities:                                                     |  |                                |         |   |      |   |         |  
|Net loss                                                                                  |  | $                              | (7,378  | ) |      | $ | (11,451 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                |         |   |      |   |         |  
|Loss (gain) on disposal of property and equipment                                         |  |                                | 4       |   |      |   | (33     | )
|Allowance for doubtful accounts                                                           |  |                                | 167     |   |      |   | 586     |  
|Depreciation and amortization                                                             |  |                                | 3,439   |   |      |   | 2,147   |  
|Amortization of deferred stock-based compensation                                         |  |                                | 1,817   |   |      |   | 3,544   |  
|Stock-based compensation expense                                                          |  |                                | 18,804  |   |      |   | 2,293   |  
|Provision for excess and obsolete inventories                                             |  |                                | 1,891   |   |      |   | 810     |  
|Changes in operating assets and liabilities, net of the effect of acquisition:            |  |                                |         |   |      |   |         |  
|Accounts receivable                                                                       |  |                                | (5,025  | ) |      |   | (11,269 | )
|Research collaboration receivable                                                         |  |                                | (4,100  | ) |      |   |        |  
|Inventories                                                                               |  |                                | 1,033   |   |      |   | (7,796  | )
|Prepaid expenses and other current assets                                                 |  |                                | (509    | ) |      |   | (1,111  | )
|Other assets                                                                              |  |                                | (507    | ) |      |   | (3      | )
|Accounts payable                                                                          |  |                                | 748     |   |      |   | 4,179   |  
|Accrued liabilities                                                                       |  |                                | 2,955   |   |      |   | 5,811   |  
|Deferred revenue                                                                          |  |                                | (2,106  | ) |      |   | 8,569   |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                                | 11,233  |   |      |   | (3,724  | )
|                                                                                          |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                     |  |                                |         |   |      |   |         |  
|Acquisition of property and equipment                                                     |  |                                | (3,454  | ) |      |   | (6,749  | )
|Proceeds from disposal of property and equipment                                          |  |                                | 2       |   |      |   | 158     |  
|Sales or maturities of investments                                                        |  |                                | 44,217  |   |      |   | 40,931  |  
|Purchases of investments                                                                  |  |                                | (27,557 | ) |      |   | (33,369 | )
|Acquisition of business, net of cash acquired                                             |  |                                | (18,600 | ) |      |   |        |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                                       |  |                                | (5,392  | ) |      |   | 971     |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                     |  |                                |         |   |      |   |         |  
|Proceeds from exercise of options to purchase common stock                                |  |                                | 3,470   |   |      |   | 859     |  
|Repurchase of common stock                                                                |  |                                |        |   |      |   | (20     | )
|Proceeds from issuance of common stock under the Employee Stock Purchase Plan             |  |                                | 3,619   |   |      |   | 1,609   |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                                 |  |                                | 7,089   |   |      |   | 2,448   |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                                | 12,930  |   |      |   | (305    | )
|                                                                                          |  |                               
|Cash and cash equivalents, beginning of period                                            |  |                                | 24,249  |   |      |   | 27,506  |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                  |  | $                              | 37,179  |   |      | $ | 27,201  |  
|                                                                                          |  |                                |         |   |      |   |         |  
|Supplemental disclosure of noncash investing and financing activities:                    |  |                                |         |   |      |   |         |  
|Changes in net unrealized gains/(losses) on investments                                   |  | $                              | 91      |   |      | $ | (68     | )
|Reversal of deferred stock-based compensation                                             |  |                                | (4,848  | ) |      |   | (350    | )
|Vesting of restricted stock                                                               |  |                                | 139     |   |      |   | 326     |  
|Acquisition of Kerberos Proximal Solutions, Inc. (Note 4)                                 |  |                                | 12,288  |   |      |   |        |  

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



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FOXHOLLOW TECHNOLOGIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1Organization and Basis of
Presentation:

Organization

FoxHollow Technologies, Inc. (the Company) designs, develops, manufactures and sells medical devices primarily for the treatment of peripheral artery disease, or PAD, and other cardiovascular disease. The Company also performs
analysis of atherosclerotic plaque removed from patient arteries with the goal of identifying new biomarkers for atherosclerotic disease progression and new therapies for atherosclerotic disease.

Basis of Presentation

The accompanying unaudited
condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q
and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. The results for the nine month period ended September 30, 2006 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2006, or for any future period. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and the
notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission on March 7, 2006, as amended on March 10, 2006. Certain items in the prior
periods financial statements have been reclassified to conform to the current periods format.

Basis of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All intercompany balances and
transactions have been eliminated.

NOTE 2Significant Accounting Policy Update:

Stock-Based Compensation

Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards or SFAS No. 123 (R), Share-Based Payment (revised 2004), using the modified prospective transition method, which requires the measurement and recognition of compensation expense for all share-based payment awards
made to the Companys employees and directors including stock options and employee stock purchases related to the Employee Stock Purchase Plan. The Companys financial statements as of and for the three and nine months ended
September 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Companys financial statements for prior periods have not been restated to reflect, and do not include, the impact of
SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Share-based compensation expense recognized in the Companys Condensed Consolidated
Statements of Operations during the three and nine months ended September 30, 2006 include compensation expense for share-based payment awards granted subsequent to October 28, 2004, the date of the Companys initial public offering,
but not yet vested as of, December 31, 2005 based on the fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based
on the fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company elected to attribute the value of share-based compensation to expense using the straight-line method, which
was previously used for its pro forma information required under SFAS 123.

Revenue Recognition

The Company recognizes product revenue in accordance with SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. SAB No. 104 requires
that four basic criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; title has transferred; the fee is fixed and determinable; and collectibility is reasonably assured. Transfer of title and risk of
ownership generally occurs when the product is shipped to the customer or when the customer receives the product, depending on the nature of the arrangement. The Company does not offer any rights of return for product sales to direct and indirect
customers.

On September 14, 2005, the Company entered into a Collaboration and License agreement (the Merck Collaboration
Agreement) with Merck & Co., Inc. (Merck) pursuant to which the Company and Merck agreed to collaborate on the analysis of atherosclerotic plaque removed from patient arteries with the goal of identifying new biomarkers of
atherosclerotic disease progression. The Company has recognized revenue related to the Merck Collaboration Agreement in accordance with Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with
Multiple Deliverables. The Merck Collaboration Agreement provided for an initial payment of $9.0 million which covered costs associated with the Companys responsibilities and for the rights granted to Merck during the initial year of the
research collaboration. The initial payment was classified as deferred revenue and the Company has recognized revenue as it fulfilled its obligations and delivered tissue samples under the Merck Collaboration Agreement. On September 15, 2006,
the Merck Collaboration Agreement terminated and the Company recognized the remaining deferred revenue balance as all obligations under the agreement were complete.



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##### Table of Contents

On September 26, 2006, the Company entered into an Amended and Restated Collaboration and License
Agreement (the Amended Merck Collaboration Agreement) as well as a Stock Purchase Agreement (the Stock Purchase Agreement) and a Registration Rights Agreement (the Registration Rights Agreement) with Merck which
will become effective subject to customary closing conditions and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. The Company will recognize revenue related to the Amended Merck Collaboration Agreement in accordance with EITF
00-21 under which management has determined that obligations in the agreement do not meet the requirements for separate units of accounting and therefore will be combined into a single unit of accounting and all payments will be considered as a
whole. The Company will recognize revenue on the minimum payments, adjusted for any discount or premium calculated on the $95.0 million investment, on a straight-line basis over the estimated term of the agreement, or four years, beginning when
the Amended Merck Collaboration Agreement becomes effective. Revenue recognized under the agreement will be limited to cash received and will be adjusted on a prospective basis for amounts received in excess of the total estimated minimum payments
due under the agreements.

Goodwill and Other Intangible Assets.

The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets, whereby goodwill is no longer amortized, but instead is subject to impairment reviews performed periodically during each fiscal year. The Company reviews the carrying amount of goodwill and other intangible assets
whenever events and circumstances indicate that the carrying amount of the goodwill or other intangible assets may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated declines in
revenue or operating profit and adverse legal or regulatory developments. If it is determined that such indicators are present and the review indicates that goodwill or other intangible assets will not be fully recoverable, based upon discounted
estimated cash flows, the carrying value will be reduced to its estimated fair market value. Estimated fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. The
Company is amortizing its acquired intangible assets on a straight line basis over their estimated useful lives, or six to eight years.

NOTE
3Accounting for Stock-Based Compensation:

In connection with the adoption of SFAS 123(R), the Company estimated the fair value of each stock
option on the date of grant using the Black-Scholes option valuation model using the following weighted-average assumptions:



|                                                     |  |                                 |  |                                 |  |                     |  |            
|---------------------------------------------------- |  | ------------------------------- |  | ------------------------------- |  | ------------------- |  | -----------
|                                                     |  | Three Months EndedSeptember 30, |  | Nine Months Ended September 30,
|                                                     |  | 2006                            |  | 2005                            |  | 2006                |  | 2005       
|Stock Options:                                       |  |                                 |  |                                 |  |                     |  |            
|Expected volatility                                  |  | 47%                             |  | 75%                             |  | 45%-47%             |  | 75%        
|Risk free interest rate                              |  | 4.57%                           |  | 3.87%-4.28%                     |  | 4.57%-5.15%         |  | 3.71%-4.28%
|Dividend yield                                       |  | 0%                              |  | 0%                              |  | 0%                  |  | 0%         
|Expected life                                        |  | 4.5                             |  | 4.0 years                       |  | 4.5 years-4.7 years |  | 4.0 years  
|Weighted average fair value of stock options granted |  | $12.59                          |  | $26.92                          |  | $13.28              |  | $18.91     
|                                                     |  |                                
|                                                     |  | Three Months EndedSeptember 30, |  | Nine Months Ended September 30,
|                                                     |  | 2006                            |  | 2005                            |  | 2006                |  | 2005       
|ESPP:                                                |  |                                 |  |                                 |  |                     |  |            
|Expected volatility                                  |  | 62%                             |  | 75%                             |  | 45%-81%             |  | 75%        
|Risk free interest rate                              |  | 4.53%                           |  | 3.88%                           |  | 4.35%-5.29%         |  | 3.34%-3.88%
|Dividend yield                                       |  | 0%                              |  | 0%                              |  | 0%                  |  | 0%         
|Expected life                                        |  | 0.5 years                       |  | 0.5 years                       |  | 0.5 years           |  | 0.5 years  
|Weighed average fair value of ESPP purchase rights   |  | $9.64                           |  | $16.34                          |  | $9.78               |  | $11.58     



7



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##### Table of Contents

The expected term of stock options represents the weighted-average period the stock options are expected
to remain outstanding and is based on the observed and expected time to post-vesting exercise and post-vesting cancellations of options by employees. Upon the adoption of SFAS 123(R), the Company used a combination of historical and peer group
volatility for a blended volatility in deriving its expected volatility assumption as allowed under SFAS 123(R) and SAB 107. Prior to January 1, 2006, the Company used the average volatility of a peer group. The selection of the blended
volatility approach was based upon the Companys assessment that blended volatility is more representative of future stock price trends than just using historical or peer group volatility. The risk-free interest rate assumption is based upon
observed interest rates appropriate for the term of the Companys stock options. The expected dividend assumption is based on the Companys history and expectation of dividend payouts.

The stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2006 is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Companys pro forma information required under SFAS 123(R) for the periods prior to January 1, 2006, the Company accounted for
forfeitures as they occurred.

The effect of recording stock-based compensation expense for the three and nine months ended
September 30, 2006 and 2005 are as follows (in thousands):



|                                                   |  |                                 |       |                                |   |       |  |      |        |  |   |      
|-------------------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ------ |  | - | -----
|                                                   |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                                                   |  | 2006                            |       | 2005                           |   | 2006  |  | 2005
|Stock-based compensation expense by type of award: |  |                                 |       |                                |   |       |  |      |        |  |   |      
|Amortization of deferred stock-based compensation  |  | $                               | 502   |                                | $ | 1,171 |  | $    | 1,817  |  | $ | 3,544
|Employee stock options & employee stock purchases  |  |                                 | 2,239 |                                |   |      |  |      | 6,834  |  |   |     
|Non-employees                                      |  |                                 | 197   |                                |   | 1,024 |  |      | 591    |  |   | 2,293
|Former chief executive officers retirement        |  |                                 |      |                                |   |      |  |      | 11,379 |  |   |     
|                                                   |  |                                 |       |                                |   |       |  |      |        |  |   |      
|Total stock-based compensation expense             |  | $                               | 2,938 |                                | $ | 2,195 |  | $    | 20,621 |  | $ | 5,837
|                                                   |  |                                 |       |                                |   |       |  |      |        |  |   |      
|Effect on income (loss) per common share           |  |                                 |       |                                |   |       |  |      |        |  |   |      
|Basic                                              |  | $                               | 0.12  |                                | $ | 0.09  |  | $    | 0.83   |  | $ | 0.26 
|                                                   |  |                                 |       |                                |   |       |  |      |        |  |   |      
|Diluted                                            |  | $                               | 0.11  |                                | $ | 0.09  |  | $    | 0.83   |  | $ | 0.26 
|                                                   |  |                                 |       |                                |   |       |  |      |        |  |   |      

Prior to the adoption of SFAS 123(R), the Company accounted 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 its interpretations and complied with the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock- Based Compensation-Transition and Disclosurean Amendment of FASB Statement No. 123. Under APB Opinion No. 25, compensation
expense is based on the difference, if any, on the date of the grant between the fair market value of the Companys stock and the exercise price. Employee stock-based compensation is amortized on a straight-line basis over the vesting period of
the underlying options.

The Company continues to amortize deferred stock-based compensation on a straight-line basis over the vesting
period for shares issued prior to the initial public offering. At September 30, 2006, the balance of deferred stock-based compensation was $2.4 million. The remaining balance of deferred employee stock-based compensation will be amortized in
future years as follows assuming no cancellations of the related stock options: $0.5 million for the remainder of 2006, $1.5 million in 2007, and $0.4 million in 2008. The Company recognized compensation expense for all stock-based awards that were
issued subsequent to the initial public offering at fair value on the date of grant.

As of September 30, 2006, the total unamortized
compensation cost related to unvested stock-based awards granted to employees under the Companys stock option plans and stock purchase plan subsequent to the initial public offering was approximately $26.0 million net of forfeitures. This
cost will be amortized on a straight-line basis over the remaining weighted average requisite service period of approximately 3.2 years.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123(R) and Emerging Issues Task Force or EITF Issue No. 96-18, Accounting for Equity Instruments that Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling Goods, or Services, which require that such equity instruments are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject
to periodic adjustment as the underlying equity instruments vest. Non-employee stock-based compensation expense is being recognized over the vesting periods of the related options.



8



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On January 3, 2006 our former chief executive officer, Robert Thomas, retired from the Company. In
connection with Mr. Thomas retirement, the Company entered into a separation agreement and release with Mr. Thomas under which the Company allowed for the continued vesting of shares over a consulting period from January 3, 2006
to December 31, 2006 in return for Mr. Thomas agreement to: i) provide limited transition services to assist our new chief executive officer and the Company, upon request by the Company, ii) refrain from engaging in competitive
activities and iii) provide a general release of claims. The Company determined that the terms of the agreement did not create an in-substance requisite service period and accounted for the continued vesting of shares as a stock award modification
under FAS 123(R) by re-measuring and immediately expensing the fair value of unvested options at January 3, 2006.

SFAS 123(R)
requires the Company to present pro forma information for the comparative period prior to the adoption as if it had accounted for all of its stock options under the fair value method of SFAS 123. The following table illustrates the pro forma
information regarding the effect on net loss and net loss per share if the Company had accounted for the share-based employee compensation under the fair value method of accounting (in thousands, except per share data):



|                                                                                   |  |                                      |        |   |                                     |   |         |  
|---------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ----------------------------------- | - | ------- | -
|                                                                                   |  | Three Months EndedSeptember 30, 2005 |        |   | Nine Months EndedSeptember 30, 2005 |  
|Net loss, as reported                                                              |  | $                                    | (1,486 | ) |                                     | $ | (11,451 | )
|Deduct: Total employee stock-based compensation determined under fair value method |  |                                      | (3,528 | ) |                                     |   | (6,880  | )
|                                                                                   |  |                                      |        |   |                                     |   |         |  
|Pro forma net loss                                                                 |  | $                                    | (5,014 | ) |                                     | $ | (18,331 | )
|                                                                                   |  |                                      |        |   |                                     |   |         |  
|Net loss per common share, basic and diluted:                                      |  |                                      |        |   |                                     |   |         |  
|As reported                                                                        |  | $                                    | (0.06  | ) |                                     | $ | (0.50   | )
|                                                                                   |  |                                      |        |   |                                     |   |         |  
|Pro forma                                                                          |  | $                                    | (0.22  | ) |                                     | $ | (0.81   | )
|                                                                                   |  |                                      |        |   |                                     |   |         |  

Disclosures for the three and nine months ended September 30, 2006 are not presented because
stock-based employee compensation was accounted for under SFAS 123(R)s fair value method during this period. Additionally, the stock-based employee compensation determined under the fair value method for the three and nine months ended
September 30, 2005 has been adjusted to exclude the effect of the options granted prior to the Companys initial public offering in October 2004, as those options were valued for pro forma disclosure purposes using the minimum value
method.

NOTE 4Acquisitions:

Kerberos
Proximal Solutions, Inc.

The Company accounts for business combinations using the purchase method of accounting in accordance with
Statement of Financial Accounting Standards No. 141, Business Combinations. Purchase accounting requires extensive accounting estimates and judgments to allocate the purchase price between in-process research and development, other
identifiable intangible assets, tangible assets and liabilities, and goodwill. To assist in determining the value of any in-process research and development and certain other intangibles, a third party valuation is typically obtained as of the
acquisition date. The amount of the purchase price allocated to purchased in-process research and development and other intangible assets is determined by estimating the future cash flows of each project or technology and discounting the net
cash flows back to their present values. The discount rate used is determined at the time of the acquisition in accordance with standard valuation methods.

On September 12, 2006, the Company completed its acquisition of 100% of the outstanding stock of Kerberos Proximal Solutions, Inc. (Kerberos). Kerberos was a privately-held company that develops and
sells innovative medical devices for the removal of thrombus, or blood clots, from occluded arteries. In connection with the acquisition, the Company issued 389,653 shares of its common stock with a fair market value of approximately $12.3 million
and paid approximately $18.6 million in cash and $1.5 million in acquisition-related transaction fees and expenses for a total purchase price of approximately $32.4 million. The number of shares of common stock issued as initial closing
consideration was determined using the average closing price of the Companys common stock for the ten consecutive day trading period ending on September 12, 2006. The fair market value of the common stock issued was determined based on
the average closing price of the Companys stock for the two days before and two days after August 28, 2006, the date that the terms of the acquisition were agreed to and announced.



9



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##### Table of Contents

In addition to the initial closing payment, the Company may be obligated to make additional earnout
payments contingent on the sales of Kerberos products. The earnout payments would be made in the fourth quarters of 2008 and 2009 in an amount equal to 21/2times sales for the periods from September 1, 2007 to
August 31, 2008 and from September 1, 2008 to August 31, 2009, less the value of all prior payments made by the Company in connection with the acquisition. Such earnout payments are capped at $117.0 million.

The Kerberos acquisition has been accounted for as a purchase business combination. Under the purchase method of accounting, the assets acquired and
liabilities assumed are recorded at the date of acquisition at their respective fair values.

The basis of the acquired goodwill, which is
not deductible for tax purposes, is the market strength of Kerberos existing technology and its existing customer relationships. No in-process research and development was included in the acquisition price of Kerberos.

The results of operations of Kerberos have been included in the accompanying condensed consolidated financial statements from the date of the acquisition
and all intercompany balances have been eliminated upon consolidation. The total estimated cost of the Kerberos acquisition is as follows (in thousands):



|                                          |  |   |        |   |  |   |       
|----------------------------------------- |  | - | ------ | - |  | - | ------
|FoxHollow common stock issued             |  |   |        |   |  | $ | 12,288
|Cash                                      |  |   |        |   |  |   | 18,608
|Direct transaction costs                  |  |   |        |   |  |   | 1,524 
|                                          |  |   |        |   |  |   |       
|Total purchase price                      |  |   |        |   |  | $ | 32,420
|                                          |  |   |        |   |  |   |       
|Assets and liabilities acquired/assumed   |  |   |        |   |  |   |       
|Cash and cash equivalents                 |  | $ | 468    |   |  |   |       
|Accounts receivable                       |  |   | 340    |   |  |   |       
|Inventories                               |  |   | 439    |   |  |   |       
|Prepaid expenses and other current assets |  |   | 133    |   |  |   |       
|Property and equipment                    |  |   | 207    |   |  |   |       
|Accounts payable                          |  |   | (269   | ) |  |   |       
|Accrued liabilities                       |  |   | (669   | ) |  |   |       
|                                          |  |   |        |   |  |   |       
|Net assets acquired                       |  |   |        |   |  |   | 649   
|                                          |  |  
|Intangible assets                         |  |   |        |   |  |   |       
|Existing technology                       |  |   | 12,400 |   |  |   |       
|Customer relationships                    |  |   | 190    |   |  |   |       
|                                          |  |   |        |   |  |   |       
|Total intangible assets acquired          |  |   |        |   |  |   | 12,590
|                                          |  |  
|Goodwill                                  |  |   |        |   |  |   | 19,181
|                                          |  |   |        |   |  |   |       
|Total                                     |  |   |        |   |  | $ | 32,420
|                                          |  |   |        |   |  |   |       

The following unaudited pro forma information assumes the Kerberos acquisition was effective as of
the beginning of each year. These unaudited pro forma results have been prepared for informational purposes only and do not purport to represent what the results of operations would have been had the Kerberos acquisition occurred as of the date
indicated, nor of future results of operations. The unaudited pro forma results for the three months and nine months ended September 30, 2006 and 2005 are as follows (in thousands, except per share data):



|                                    |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|----------------------------------- |  | ------------------------------- | ------ | ---- | ------------------------------ | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                    |  | Three Months EndedSeptember 30, |        |      | Nine Months EndedSeptember 30, |       
|                                    |  | 2006                            |        | 2005 |                                |        | 2006 |  |   | 2005    |  
|Net revenue                         |  | $                               | 54,287 |      | $                              | 36,377 |      |  | $ | 150,264 |   |  | $ | 86,679  |  
|                                    |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Net income (loss)                   |  | $                               | 3,823  |      | $                              | (2,314 | )    |  | $ | (15,525 | ) |  | $ | (17,620 | )
|                                    |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Net income (loss) per common share: |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Basic                               |  | $                               | 0.15   |      | $                              | (0.10  | )    |  | $ | (0.62   | ) |  | $ | (0.76   | )
|                                    |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Diluted                             |  | $                               | 0.15   |      | $                              | (0.10  | )    |  | $ | (0.62   | ) |  | $ | (0.76   | )
|                                    |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  



10



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The unaudited pro forma information for the three and nine months ended September 30, 2006 and 2005
reflects $395,000 and $1.2 million in amortization of the purchased intangible assets, for each three and nine month period, respectively. Purchased intangible assets are being amortized over a six to eight year period.

The unaudited proforma weighted average number of shares outstanding used for the computation of unaudited proforma basic and diluted earnings per share
for the three and nine months ended September 30, 2006 and 2005 include the 389,653 shares issued to Kerberos stockholders in conjunction with the acquisition.

NOTE 5Common Stock:

Each share of common stock has the right to one vote. The holders of
common stock are entitled to dividends when funds are legally available and when declared by the Board of Directors.

2004 Employee Stock Purchase Plan

In July 2004, the Company adopted the 2004 Employee Stock Purchase Plan and made a total of 600,000 shares of common stock available
for sale. In addition, the 2004 Employee Stock Purchase Plan provides for annual increases in the number of shares available for issuance under the Plan on the first day of each fiscal year, beginning with the Companys fiscal year 2005, equal
to the lesser of: 2% of the outstanding shares of the Companys common stock on the first day of the fiscal year; 1,000,000 shares; and such other amount as the Companys Board of Directors may determine. In January 2006 an additional
483,752 shares were automatically reserved for issuance in 2006. All of the Companys employees are eligible to participate if they are customarily employed by the Company or any participating subsidiary for at least 20 hours per week and more
than five months in any calendar year. However, an employee may not be granted an option to purchase stock if such employee: immediately after grant owns stock possessing 5% or more of the total combined voting power or value of all classes of the
Companys capital stock, or whose rights to purchase stock under all of the Companys employee stock purchase plans accrues at a rate that exceeds $25,000 worth of stock for each calendar year.

Offering periods generally start on the first trading day on or after May 1 and November 1 of each year. The Companys 2004 Employee Stock
Purchase Plan permits participants to purchase common stock through payroll deductions of up to 15% of their eligible compensation which includes a participants base salary, wages, overtime pay, commissions, and other compensation remuneration
paid directly to the employee. A participant may purchase a maximum of 5,000 shares during a six-month purchase period. Amounts deducted and accumulated by the participant are used to purchase shares of the Companys common stock at the end of
each six-month purchase period. The price is 85% of the lower of the fair market value of the Companys common stock at the beginning of an offering period or after a purchase period end. If the fair market value at the end of a purchase period
is less than the fair market value at the beginning of the offering period, participants will be withdrawn from the current offering period following their purchase of shares on the purchase date and will be automatically re-enrolled in a new
offering period. Participants may end their participation at any time during an offering period, and will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with the Company. The 2004 Employee
Stock Purchase Plan will automatically terminate in 2024, unless the Company terminates it sooner. Through September 30, 2006, 472,699 shares have been issued in connection with the 2004 Employee Stock Purchase Plan.

NOTE 6 Stock Option Plans:

1997 Stock Plan

In March 1997, the Company adopted the 1997 Stock Plan under which the Board of Directors may issue incentive stock options to employees and
non-qualified stock options to employees, directors and consultants. The Board of Directors has the authority to determine to whom options will be granted, the number of shares, the term and exercise price (which cannot be less than fair market
value at date of grant for incentive stock options or 85% of fair market value for nonqualified



11



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##### Table of Contents

stock options). If an individual owns stock representing more than 10% of the outstanding shares, the price of each
incentive stock option shall be at least 110% of fair market value, as determined by the Board of Directors. The options are exercisable at times and increments as specified by the Board of Directors and generally expire 10 years from the date of
grant. Upon the completion of the initial public offering, the Companys 1997 Stock Plan was terminated and the Board of Directors determined not to grant any additional awards under the 1997 Plan. However, the 1997 Plan will continue to govern
the terms and conditions of the outstanding awards issued thereunder.

2004 Equity Incentive Plan

In July 2004, the Company adopted the 2004 Equity Incentive Plan, or the 2004 Plan, under which the Board of Directors may issue incentive stock options
to employees and non-statutory stock options, restricted stock, stock appreciation rights, performance units and performance shares to employees, directors and consultants. The 2004 Plan provides for annual increases in the number of shares
available for issuance thereunder on the first day of each fiscal year, beginning with fiscal year 2005, equal to the lesser of: 5% of the outstanding shares of the Companys common stock on the first day of the fiscal year; 2,500,000 shares;
and such other amount as the Board of Directors may determine. The number of shares authorized for issuance under the 2004 Equity Incentive Plan will also be increased by any shares returned to the 1997 Stock Plan on or after the completion of the
public offering as a result of the termination of options or the repurchase of unvested shares issued thereunder.

The Board of Directors
has the authority to determine to whom options will be granted, the number of shares, the term and exercise price (which cannot be less than fair market value at date of grant for incentive stock options or 85% of fair market value for nonqualified
stock options). If an individual owns stock representing more than 10% of the outstanding shares, the price of each incentive stock option shall be at least 110% of fair market value, as determined by the Board of Directors. The options are
exercisable at times and increments as specified by the Board of Directors, and generally expire 10 years from the date of grant.

Activity
under our stock option plans are as follows:



|                             |  |                          |                 |  |                     |                        |  |                |             |  |   |             |  
|---------------------------- |  | ------------------------ | --------------- |  | ------------------- | ---------------------- |  | -------------- | ----------- |  | - | ----------- | -
|                             |  | SharesAvailableFor Grant |                 |  | Outstanding Options |                       
|                             |  |                          | Number OfShares |  |                     | Range ofExercisePrices |  | AggregatePrice |            
|Balances, December 31, 2005  |  | 61,306                   |                 |  | 4,055,484           |                        |  | $              | 0.32-53.73  |  | $ | 50,330,000  |  
|                             |  |                          |                 | 
|Reservation of shares        |  | 1,209,380                |                 |  |                     |                        |  |                |             |  |   |             |  
|Options granted              |  | (1,617,525               | )               |  | 1,617,525           |                        |  |                | 22.14-34.28 |  |   | 48,136,193  |  
|Options exercised            |  |                         |                 |  | (1,271,222          | )                      |  |                | 0.32-33.77  |  |   | (3,600,721  | )
|Options cancelled            |  | 896,259                  |                 |  | (896,259            | )                      |  |                | 0.32-51.75  |  |   | (14,588,881 | )
|                             |  |                          |                 |  |                     |                        |  |                |             |  |   |             |  
|Balances, September 30, 2006 |  | 549,420                  |                 |  | 3,505,528           |                        |  | $              | 0.32-53.73  |  | $ | 80,276,591  |  
|                             |  |                          |                 |  |                     |                        |  |                |             |  |   |             |  



12



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##### Table of Contents

The options outstanding and currently exercisable by exercise price at September 30, 2006 are as
follows:



|                       |              |                     |           |                                                   |      |                                |       |                                                   |      |                    |           |                                |   |               |  |                                |  |   |      
|---------------------- | ------------ | ------------------- | --------- | ------------------------------------------------- | ---- | ------------------------------ | ----- | ------------------------------------------------- | ---- | ------------------ | --------- | ------------------------------ | - | ------------- |  | ------------------------------ |  | - | -----
|Options Outstanding    |              | Options Exercisable |           | Options Vested                                   
|Range ofExercise Price |              | NumberOutstanding   |           | Weighted-AverageRemainingContractualLife in Years |      | Weighted-AverageExercise Price |       | Weighted-AverageRemainingContractualLife in Years |      | OptionsExercisable |           | Weighted-AverageExercise Price |   | OptionsVested |  | Weighted-AverageExercise Price
|$                      | 0.32         |                     | 488,684   |                                                   | 6.93 |                                | 0.32  |                                                   | 6.93 |                    | 488,684   |                                | $ | 0.32          |  | 135,629                        |  | $ | 0.32 
|                       | 0.40         |                     | 5,000     |                                                   | 1.21 |                                | 0.40  |                                                   | 1.21 |                    | 5,000     |                                |   | 0.40          |  | 5,000                          |  |   | 0.40 
|                       | 0.84         |                     | 22,507    |                                                   | 5.40 |                                | 0.84  |                                                   | 5.40 |                    | 22,507    |                                |   | 0.84          |  | 22,202                         |  |   | 0.84 
|                       | 2.00         |                     | 81,666    |                                                   | 7.59 |                                | 2.00  |                                                   | 7.59 |                    | 81,666    |                                |   | 2.00          |  | 17,939                         |  |   | 2.00 
|                       | 2.16         |                     | 13,500    |                                                   | 4.04 |                                | 2.16  |                                                   | 4.04 |                    | 13,500    |                                |   | 2.16          |  | 13,500                         |  |   | 2.16 
|                       | 4.00         |                     | 212,646   |                                                   | 7.81 |                                | 4.00  |                                                   | 7.81 |                    | 212,646   |                                |   | 4.00          |  | 41,140                         |  |   | 4.00 
|                       | 11.68        |                     | 252,743   |                                                   | 8.06 |                                | 11.68 |                                                   | 8.06 |                    | 252,743   |                                |   | 11.68         |  | 106,375                        |  |   | 11.68
|                       | 22.14-24.02  |                     | 63,368    |                                                   | 8.41 |                                | 23.88 |                                                   | 8.19 |                    | 24,555    |                                |   | 24.02         |  | 24,555                         |  |   | 24.02
|                       | 24.75-27.72  |                     | 273,300   |                                                   | 9.51 |                                | 26.03 |                                                   |     |                    |          |                                |   |              |  |                               |  |   |     
|                       | 27.93        |                     | 142,164   |                                                   | 8.57 |                                | 27.93 |                                                   | 8.57 |                    | 40,962    |                                |   | 27.93         |  | 40,962                         |  |   | 27.93
|                       | 28.20-29.97  |                     | 830,074   |                                                   | 9.36 |                                | 28.34 |                                                   | 8.34 |                    | 122,153   |                                |   | 28.22         |  | 122,153                        |  |   | 28.22
|                       | 30.00-31.46  |                     | 506,806   |                                                   | 9.33 |                                | 30.69 |                                                   | 8.44 |                    | 29,907    |                                |   | 30.37         |  | 29,907                         |  |   | 30.37
|                       | 32.24-35.86  |                     | 254,775   |                                                   | 9.24 |                                | 34.29 |                                                   | 9.05 |                    | 10,586    |                                |   | 34.52         |  | 10,586                         |  |   | 34.52
|                       | 36.90-39.71  |                     | 148,209   |                                                   | 8.73 |                                | 38.34 |                                                   | 8.72 |                    | 55,865    |                                |   | 38.19         |  | 55,865                         |  |   | 38.19
|                       | 41.88-45.91  |                     | 103,070   |                                                   | 9.00 |                                | 44.50 |                                                   | 8.90 |                    | 7,411     |                                |   | 43.83         |  | 7,411                          |  |   | 43.83
|                       | 46.35-51.43  |                     | 31,100    |                                                   | 8.97 |                                | 48.24 |                                                   | 8.89 |                    | 5,233     |                                |   | 48.80         |  | 5,233                          |  |   | 48.80
|                       | 51.75-53.73  |                     | 75,916    |                                                   | 8.84 |                                | 51.79 |                                                   | 8.84 |                    | 22,648    |                                |   | 51.75         |  | 22,648                         |  |   | 51.75
|                       |              |                     |           |                                                   |      |                                |       |                                                   |      |                    |           |                                |   |               |  |                                |  |   |      
|$                      | 0.32 - 53.73 |                     | 3,505,528 |                                                   | 8.63 |                                | 22.90 |                                                   | 7.59 |                    | 1,396,066 |                                | $ | 10.40         |  | 661,105                        |  | $ | 17.96
|                       |              |                     |           |                                                   |      |                                |       |                                                   |      |                    |           |                                |   |               |  |                                |  |   |      

On May 3, 2004, the board of directors approved a resolution that allows for the early
exercise of all previously granted options and all options to be granted in the future under the Companys 1997 Stock Plan. Under the terms of this amendment, option holders, upon early exercise, must sign a restricted stock purchase agreement
that gives the Company the right to repurchase any unvested shares, at the original exercise price, in the event the optionees employment terminates for any reason. The right to exercise options before they are vested does not change existing
vesting schedules in any way and the early-exercised options may not be sold or transferred before they vest. The repurchase right lapses over time as the shares vest at the same rate as the original option vesting schedule. At September 30,
2006, a total of 142,739 shares of common stock at an aggregate price of $166,000 were subject to repurchase. As such, in accordance with FASB Interpretations No. 44, or FIN No. 44, Accounting for Certain Transactions Involving Stock
Compensation, the unvested shares as of September 30, 2006 are not considered issued for accounting purposes and the options are deemed not to be exercised until the options vest. These options have therefore been excluded from the number
of options exercised as of September 30, 2006 and related balances have been classified as accrued liabilities.

The weighted-average
grant-date fair value of options granted to employees during the nine months ended September 30, 2006 was $13.28 per share. The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $27.2 million. The
aggregate intrinsic value of options outstanding and options exercisable as of September 30, 2006 was $28.1 million and $22.3 million, respectively. The intrinsic value is calculated as the difference between the market value of the Companys
common stock and the exercise price of shares. The market value of the Companys common stock as of September 30, 2006 was $34.19 as reported by NASDAQ.

NOTE 7Net Income (Loss) Per Common Share:

Basic net income (loss) per common share is computed by dividing net income
(loss) by the weighted-average number of common shares outstanding, excluding common shares subject to repurchase, during the period. Diluted net income (loss) per common share is computed by giving effect to all potential dilutive common shares,
including stock options, common stock subject to repurchase, and common stock issued under the employee stock purchase plan. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per common
share is as follows (in thousands):



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|                                                                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                                |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005   |  
|Numerator:                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net income (loss)                                                                                               |  | $                               | 6,728  |   |                                | $ | (1,486 | )    |  | $ | (7,378 | ) |  | $ | (11,451 | )
|                                                                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Denominator:                                                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Basic weighted-average common shares outstanding                                                                |  |                                 | 25,382 |   |                                |   | 23,646 |      |  |   | 25,037 |   |  |   | 23,305  |  
|                                                                                                                |  |                                 |        |  
|Less: Weighted-average unvested common shares subject to repurchase                                             |  |                                 | (146   | ) |                                |   | (457   | )    |  |   | (238   | ) |  |   | (557    | )
|                                                                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average number of common shares outstanding used in computing basic net income (loss) per common share |  |                                 | 25,236 |   |                                |   | 23,189 |      |  |   | 24,799 |   |  |   | 22,748  |  
|                                                                                                                |  |                                 |        |  
|Net effect of dilutive stock options based on the treasury stock method using average market price              |  |                                 | 567    |   |                                |   |       |      |  |   |       |   |  |   |        |  
|                                                                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Diluted weighted-average shares outstanding                                                                     |  |                                 | 25,803 |   |                                |   | 23,189 |      |  |   | 24,799 |   |  |   | 22,748  |  
|                                                                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  

The following outstanding stock options, common stock subject to repurchase and common stock
issued under the employee stock purchase plan were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an antidilutive effect (in thousands):



|                                 |  |                                 |  |                                |  |       |  |      
|-------------------------------- |  | ------------------------------- |  | ------------------------------ |  | ----- |  | -----
|                                 |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                                 |  | 2006                            |  | 2005                           |  | 2006  |  | 2005 
|Options to purchase common stock |  | 1,135                           |  | 4,210                          |  | 3,570 |  | 4,210
|                                 |  |                                 |  |                                |  |       |  |      

NOTE 8Comprehensive Income (Loss):

Comprehensive income (loss) generally represents all changes in stockholders equity except those resulting from investments or contributions by
stockholders. The Companys unrealized gain (loss) on investments represents the only component of other comprehensive loss that is excluded from the Companys net income (loss).

NOTE 9Investments:

Investments consisted of
the following (in thousands):



|                                                         |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|-------------------------------------------------------- |  | --------- | ------ | --------------- | - | ---------------- |  | - | --------- | - |  | - | ------
|                                                         |  | CostBasis |        | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|At September 30, 2006                                    |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|US Government securities (maturities less than one year) |  | $         | 10,137 |                 | $ |                 |  | $ | (8        | ) |  | $ | 10,129
|Corporate bonds (maturities less than one year)          |  |           | 8,968  |                 |   | 3                |  |   | (3        | ) |  |   | 8,968 
|                                                         |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|Total                                                    |  | $         | 19,105 |                 | $ | 3                |  | $ | (11       | ) |  | $ | 19,097
|                                                         |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|                                                         |  |           |        |                
|                                                         |  | CostBasis |        | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|At December 31, 2005                                     |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|US Government securities (maturities less than one year) |  | $         | 17,685 |                 | $ |                 |  | $ | (74       | ) |  | $ | 17,611
|Corporate bonds (maturities less than one year)          |  |           | 18,080 |                 |   |                 |  |   | (25       | ) |  |   | 18,055
|                                                         |  |           |        |                 |   |                  |  |   |           |   |  |   |       
|Total                                                    |  | $         | 35,765 |                 | $ |                 |  | $ | (99       | ) |  | $ | 35,666
|                                                         |  |           |        |                 |   |                  |  |   |           |   |  |   |       

The Company has not experienced any significant realized gains or losses on its investments in the
periods presented in the Condensed Consolidated Statements of Operations.



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NOTE 10Inventories:

Inventories consisted of the following (in thousands):



|                |  |                   |        |                  |   |       
|--------------- |  | ----------------- | ------ | ---------------- | - | ------
|                |  | September 30,2006 |        | December 31,2005
|Raw materials   |  | $                 | 8,190  |                  | $ | 9,808 
|Work in process |  |                   | 1,824  |                  |   | 896   
|Finished goods  |  |                   | 3,108  |                  |   | 4,903 
|                |  |                   |        |                  |   |       
|                |  | $                 | 13,122 |                  | $ | 15,607
|                |  |                   |        |                  |   |       

NOTE 11Warranties:

The Company maintains a warranty allowance for the estimated amount of replacement cost of all products which are found to be defective. The amount of allowance is based upon analyses of historical replacements as
well as changes in design and reliability. Warranty costs are reflected in the Condensed Consolidated Statements of Operations as a component of product costs and expenses. A reconciliation of the changes in the Companys warranty
liability for the nine months ended September 30, 2006 and 2005 follows (in thousands):



|                             |  |      |      |   |      |   |      |  
|---------------------------- |  | ---- | ---- | - | ---- | - | ---- | -
|                             |  | 2006 |      |   | 2005 |  
|Balance at January 1         |  | $    | 217  |   |      | $ | 207  |  
|Add: Accruals for warranties |  |      | 625  |   |      |   | 597  |  
|Less: Cost of replacements   |  |      | (658 | ) |      |   | (566 | )
|                             |  |      |      |   |      |   |      |  
|Balance at September 30      |  | $    | 184  |   |      | $ | 238  |  
|                             |  |      |      |   |      |   |      |  



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NOTE 12Goodwill and Intangible Assets:

The Company recorded approximately $19.2 million of goodwill and approximately $12.6 million of intangible assets in connection with the acquisition of
Kerberos. The components of the Companys intangible assets are as follows (in thousands):



|                        |  |                     |        |                         |   |     |  |   |        |  |        
|----------------------- |  | ------------------- | ------ | ----------------------- | - | --- |  | - | ------ |  | -------
|                        |  | September 30, 2006  |        | AmortizationPeriod     
|                        |  | GrossCarryingAmount |        | AccumulatedAmortization |   | Net | 
|Acquired technology     |  | $                   | 12,400 |                         | $ | 78  |  | $ | 12,322 |  | 8 years
|Customer relationships  |  |                     | 190    |                         |   | 1   |  |   | 189    |  | 6 years
|                        |  |                     |        |                         |   |     |  |   |        |  |        
|Total intangible assets |  | $                   | 12,590 |                         | $ | 79  |  | $ | 12,511 |  |        
|                        |  |                     |        |                         |   |     |  |   |        |  |        

Amortization expense for intangible assets for the three and nine months ended September 30,
2006 was $79,000. Based on the intangible asset balances at September 30, 2006, the Company expects to recognize amortization expense of $395,000 in the remaining three months of 2006, approximately $1.6 million for each year from 2007 to 2013,
and approximately $1.1 million in 2014. There have been no changes to the carrying amount of goodwill.

NOTE 13Deferred Revenue

In September 2005, the Company entered into the Merck Collaboration Agreement pursuant to which the Company and Merck agreed to collaborate on the
analysis of atherosclerotic plaque removed from patient arteries with the goal of identifying new biomarkers of atherosclerotic disease progression. Certain payments made by Merck to the Company thereunder must be recognized as revenue on a deferred
basis. Upon execution of the Merck Collaboration Agreement, the Company received an initial cash payment of $9.0 million to cover costs associated with the Companys responsibilities and for the rights granted to Merck during the initial year
of the research collaboration. On September 15, 2006, the Merck Collaboration Agreement terminated and all obligations under the agreement were completed. In connection with the termination of the Merck Collaboration Agreement, for the three
months ended September 30, 2006, the Company recognized $3.9 million in research collaboration revenue which represented the remaining deferred revenue balance related to the $9.0 million initial cash payment received. On September 26,
2006, the Company entered into the Amended Merck Collaboration Agreement with Merck which will become effective subject to customary closing conditions and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. In connection with these
agreements, Merck agreed to provide the Company with a one-time payment of $4.1 million to cover additional costs incurred under the Merck Collaboration Agreement. The one-time payment has been accounted for as research collaboration receivable and
deferred revenue at September 30, 2006 and will be recognized as research collaboration revenue, together with other estimated future payments to be received under the agreements, on a straight-line basis over the estimated term of the
agreement, or four years, beginning when the Amended Merck Collaboration Agreement becomes effective.

NOTE 14Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48 or FIN 48, Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more
likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the Companys 2007 fiscal year, with the cumulative effect, if any, of the change in
accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting this new standard.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Current Year
Misstatements.SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition
adjustment. SAB No. 108 is effective for the Companys fiscal year 2006 annual financial statements. The Company does not expect the adoption of this standard to have an impact on its financial statements.



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##### Table of Contents

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This standard
defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. This pronouncement applies under other accounting
standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. The Company will be required to adopt SFAS No. 157 in the first quarter of fiscal year 2008. The Company is currently evaluating the requirements of SFAS No. 157 and has not yet determined the impact on its consolidated
financial statements.

NOTE 15Commitments and Contingencies

In July 2006 and August 2006, two separate shareholder class action complaints were filed against the Company and two of its officers in the U.S. District Court for the Northern District of California. The
plaintiffs are seeking to represent a class of purchasers of the Companys common stock from May 13, 2005 to January 26, 2006. The complaint generally alleges that false or misleading statements were made concerning the
Companys management and seeks unspecified monetary damages. Because the outcome of this litigation is undetermined and the Company cannot reasonably estimate the possible loss or range of loss which may arise from the litigation, the
Company has not recorded an accrual for possible damages.

In July 2006, a shareholder derivative complaint was filed against the
Companys directors and certain of its officers in the Superior Court of the State of California, San Mateo County. The complaint is based on substantially similar facts and circumstances as the class action complaints and generally
alleges that the named individuals breached their fiduciary duties to the Company. The complaint seeks unspecified monetary damages. Given the nature of derivative litigation, any recovery in a derivative suit would be to the benefit of the
Company.

In August 2006, a shareholder derivative complaint was filed against the Companys directors and certain of its officers in
the United States District Court for the Northern District of California, San Jose division. The complaint is based on substantially similar facts and circumstances as the class action complaints and generally alleges that the named individuals
breached their fiduciary duties to the Company. The complaint seeks unspecified monetary damages. Similar to the derivative litigation in the Superior Court, any recovery in this derivative suit would be to the benefit of the Company.

NOTE 16Subsequent Events

On November 7,
2006, the Company entered into a lease assignment arrangement under which the Company has assigned the lease of its Mountain View, California facility to a third party. Concurrently and in connection with the lease assignment, the Company has
entered into a new lease agreement with the same landlord for a facility located in Redwood City, California. The term of the new lease is ten years commencing on November 3, 2006 with two options to extend the term each for an additional five year
period. The rental rates applicable during the initial term of the lease range from approximately $101,000 to $137,000 per month, commencing on or about March 1, 2007, plus taxes, insurance and operating expenses, commencing on or about
February 1, 2007. In addition, the Company is entitled to $458,000 in tenant improvements paid by the landlord related to the new lease. Accommodation, brokerage and other transactional fees related to the lease assignment are expected to be
approximately $3.5 million.

In connection with the Amended Merck Collaboration Agreement, on November 9, 2006 the Company issued
3,206,318 shares of its common stock to Merck. The shares were issued under the terms of the Stock Purchase Agreement and the Registration Rights Agreement at $29.629 per share for total proceeds of $95.0 million. In addition, the Amended Merck
Collaboration Agreement became effective upon issuance of the shares to Merck.



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##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Managements discussion and analysis of financial condition and results of operations, or MD&A, is provided as a supplement to
the accompanying condensed consolidated financial statements and footnotes contained in Item 1 of this report to provide an understanding of our results of operations, financial condition, and changes in financial condition. These statements
may relate to, but are not limited to, expectations of future operating results or financial performance, capital expenditures, introduction of new products, regulatory compliance, plans for growth and future operations, as well as assumptions
relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. These risks and other factors include, but are not limited to, those listed under Factors
Affecting Future Operating Results. In some cases, you can identify forward-looking statements by terminology such as may, will, should, could, expect, plan,
anticipate, believe, estimate, predict, intend, potential, continue or the negative of these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. MD&A is organized as follows:



| |  |  | Company description.This section provides a general description and history of our business, including details regarding our organization and customer base and capsule
financial information regarding our results of operations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Results of operations.This section provides our analysis and outlook for the significant line items on our condensed consolidated statements of operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based compensation.This section provides the method and financial reporting of our accounting for stock options granted to employees and to non-employees.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Liquidity and capital resources.This section provides an analysis of our liquidity and cash flows, as well as a discussion of our commitments that existed as of
September 30, 2006.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Recent accounting pronouncements. This section describes the issuance and effects of new accounting pronouncements.
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Critical accounting policies and estimates. This section discusses those accounting policies that both are considered important to our financial condition and results of
operations and require us to exercise subjective or complex judgments in their application.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Company Description

We design, develop, manufacture and sell medical devices primarily for the treatment of peripheral artery disease. PAD results from the accumulation of
plaque in arteries, most commonly occurring in the pelvis and legs. Plaque accumulation, known as atherosclerosis, causes the narrowing of arteries, thereby reducing the flow of oxygenated blood to tissue and organs. Left untreated, PAD increases
the risk of heart attack, stroke, amputation or death. Our first product, the SilverHawk Plaque Excision System, is a minimally-invasive catheter system that treats PAD by removing plaque in order to reopen narrowed or blocked arteries. The
SilverHawk consists of two primary components, a low profile catheter connected to a battery-driven control unit, both of which are disposable. In June 2003, the U.S. Food and Drug Administration, or FDA, granted us 510(k) clearance to market the
SilverHawk in the United States for treatment of atherosclerosis in the peripheral vasculature, which includes arteries outside the heart and brain.

From our inception in 1996 until July 2003, our operations consisted primarily of start-up activities, including developing the SilverHawk, recruiting personnel and raising capital. We received clearance from the FDA
to market the SilverHawk for treatment of atherosclerosis in the peripheral vasculature in June 2003. In July 2003, we began to build our U.S. direct sales organization and initiated sales of the SilverHawk to several large medical centers in the
United States. In January 2004, we commenced full commercial introduction of the SilverHawk in the United States. The SilverHawk is not approved in the United States for use in the coronary or carotid arteries. We received our CE Mark to market the
SilverHawk for coronary applications in October 2002 and for peripheral applications in May 2003. We began commercial sales in Europe in November 2002. To date, our sales outside of the United States have been limited and we expect for the
foreseeable future to rely on third-party distributors to sell our products internationally.

We market the SilverHawk through our direct
sales force in the United States primarily to interventional cardiologists, as well as to vascular surgeons and interventional radiologists. We sell the SilverHawk to over 1,100 current hospital customers in the United States. No single customer
accounted for more than 5% of our net revenue from product sales in the three and nine months ended September 30, 2006. Reimbursement claims for the SilverHawk procedure are typically submitted by the hospital and physician to Medicare or other
third-party payors using established billing codes for atherectomy procedures. We are engaged in several research and development activities to create modifications to our



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##### Table of Contents

SilverHawk device, including: a method for addressing calcified lesions, improvements in the capacity of the nosecone to
collect plaque, and on-board real-time imaging. We can provide no assurance that we will bring these product modifications to market and may choose to discontinue any of these projects at any time.

We manufacture the SilverHawk with parts manufactured in-house and components supplied by vendors, which we then assemble, test and package. We offer
nine different SilverHawk catheters of various diameters and tip lengths to accommodate differing artery sizes and amounts of plaque.

In
September 2005, we entered into a collaboration agreement with Merck (the Merck Collaboration Agreement) through which we collaborated with them on the analysis of atherosclerotic plaque removed from patient arteries with the goal of
identifying new biomarkers for atherosclerotic disease progression. In connection with the Merck Collaboration Agreement, we received $9.0 million for the first year of collaboration and exclusivity. In September 2006, the Merck
Collaboration agreement terminated at the end of its one-year term and we entered into an Amended and Restated Collaboration and License Agreement (the Amended Merck Collaboration Agreement) as well as a Stock Purchase Agreement and a
Registration Rights Agreement with Merck which will become effective subject to customary closing conditions and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. In addition, Merck agreed to provide us with a one-time payment of
$4.1 million to cover additional costs incurred under the Merck Collaboration Agreement. Under the terms of the Amended Collaboration Agreement we will receive $40.0 million over four years in exchange for our agreement to collaborate exclusively
with Merck in specified disease areas. If Merck extends the collaboration program beyond this period, to continue the exclusive collaboration arrangement, Merck would pay $10.0 million per year, which may be offset by potential royalty and milestone
obligations. Merck will also provide a minimum of $60.0 million in funding to us over the first three years of the four year collaboration program term, for research activities to be conducted by us under Mercks direction, including
removal of atherosclerotic plaque from patient arteries for analysis, conduct of clinical trials and drug profiling by Merck. We will receive milestone payments on successful development of drug products or diagnostic tests utilizing results from
the collaboration, as well as royalties on sales by Merck of drugs and diagnostic products developed through the collaboration. In addition, we will receive $95.0 million from Merck for the purchase of approximately 11% of our Companys stock.

Pursuant to an acquisition completed in September 2006, we have one wholly-owned subsidiary, Kerberos Proximal Solutions, Inc., which
manufactures and sells innovative medical devices for the removal of thrombus, or blood clots, from occluded arteries. In connection with the acquisition we issued 389,653 shares of common stock with a fair market value of approximately $12.3
million and paid approximately $18.6 million in cash and $1.5 million in acquisition-related transaction fees and expenses for a total purchase price of approximately $32.4 million. Pursuant to the terms of the acquisition, we may be required to
make certain earnout payments which are capped at $117.0 million.

For the nine months ended September 30, 2006, we generated net
revenue of $148.6 million and a net loss of $7.4 million and as of September 30, 2006, our accumulated deficit was $92.5 million. As of September 30, 2006, our cash, cash equivalents and investment balances totaled $56.3 million.



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##### Table of Contents

Results of Operations

Three Months Ended September 30, 2006 and September 30, 2005

The following table sets forth, for the
periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages of net revenue:



|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | --------------- | ---- | - | ------ | - | ------ | --------------- |  | --- | -
|                                                                                                                                                                          |  | Three Months Ended September 30, |       
|                                                                                                                                                                          |  | 2006                             |        |                 | 2005 |  
|                                                                                                                                                                          |  | Amount                           |        | % of NetRevenue |      |   | Amount |   |        | % of NetRevenue | 
|Revenue:                                                                                                                                                                  |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Product                                                                                                                                                                   |  | $                                | 49,826 |                 | 93   | % |        | $ | 35,645 |                 |  | 99  | %
|Research collaboration                                                                                                                                                    |  |                                  | 3,926  |                 | 7    | % |        |   | 431    |                 |  | 1   | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Net revenue                                                                                                                                                               |  |                                  | 53,752 |                 | 100  | % |        |   | 36,076 |                 |  | 100 | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Costs and expenses:                                                                                                                                                       |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Product (includes $360 and $126 in stock-based compensation expense for the three months ended September 30, 2006 and 2005,
respectively)                                 |  |                                  | 10,225 |                 | 19   | % |        |   | 9,821  |                 |  | 27  | %
|Research collaboration                                                                                                                                                    |  |                                  | 890    |                 | 2    | % |        |   |       |                 |  | 0   | %
|Research and development (includes $693 and $197 in stock-based compensation expense for the three months ended September 30, 2006 and
2005, respectively)                |  |                                  | 5,660  |                 | 11   | % |        |   | 2,759  |                 |  | 8   | %
|Selling, general and administrative (includes $1,885 and $1,872 in stock-based compensation expense for the three months ended
September 30, 2006 and 2005, respectively) |  |                                  | 31,095 |                 | 57   | % |        |   | 25,419 |                 |  | 70  | %
|Amortization of purchased intangible assets                                                                                                                               |  |                                  | 79     |                 | 0    | % |        |   |       |                 |  | 0   | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Total costs and expenses                                                                                                                                                  |  |                                  | 47,949 |                 | 89   | % |        |   | 37,999 |                 |  | 105 | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Income (loss) from operations                                                                                                                                             |  |                                  | 5,803  |                 | 11   | % |        |   | (1,923 | )               |  | -5  | %
|                                                                                                                                                                          |  |                                  |        |                
|Interest and other income and expense, net                                                                                                                                |  |                                  | 925    |                 | 2    | % |        |   | 437    |                 |  | 1   | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  
|Net income (loss)                                                                                                                                                         |  | $                                | 6,728  |                 | 13   | % |        | $ | (1,486 | )               |  | -4  | %
|                                                                                                                                                                          |  |                                  |        |                 |      |   |        |   |        |                 |  |     |  

Revenue:

Our revenue consists of two components: product and research collaboration.

Product. Product
revenue is primarily derived from sales of the SilverHawk Plaque Excision System. Product revenue was $49.8 million for the three months ended September 30, 2006 as compared to $35.6 million for the three months ended September 30, 2005.
The increase of $14.2 million was attributable to an increase in the number of SilverHawk devices sold as well as a 3.0% increase in the average sales price per unit. The increase in the number of devices sold is primarily attributable to an
increase in the number of hospital customers purchasing our devices and more devices purchased per customer as we have expanded our sales force. We expect our product revenue to increase as we continue to increase penetration of existing customer
accounts, penetrate new customer accounts, offer additional products, and enter new international geographies.

Research collaboration.Research collaboration revenue is derived from the Merck Collaboration Agreement. Research collaboration revenue was $3.9 million for the three months ended September 30, 2006 as compared to $431,000 for the three months ended
September 30, 2005. The $3.9 million of revenue was recognized in connection with the completion of our obligations under the Merck Collaboration Agreement which terminated on September 15, 2006. On September 26, 2006 we entered into
the Amended Merck Collaboration Agreement which will become effective subject to customary closing conditions and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. We will begin to recognize research collaboration revenue under the
Amended Merck Collaboration Agreement when it becomes effective. We expect our research collaboration revenue to increase in future quarters as we expand our efforts under the Amended Merck Collaboration Agreement.

Costs and Expenses:

Our costs and expenses
consist of five components: product; research collaboration; research and development; selling, general and administrative; and amortization of purchased intangible assets.



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Product. Product cost consists primarily of material, labor and overhead costs. Product
costs were $10.2 million for the three months ended September 30, 2006 as compared to $9.8 million for the three months ended September 30, 2005. The increase was primarily attributable to the increase in the number of SilverHawk devices
sold. As a percentage of product revenue, product costs were 21% in the three months ended September 30, 2006 as compared to 28% in the three months ended September 30, 2005. Primary factors that contributed to the decrease in product
costs as a percentage of product revenue included an increase in the average sales price per unit, continued improvements related to the absorption of manufacturing overhead costs associated with increased production volumes, efficiencies related to
the purchasing of supplies and materials, and improved labor and manufacturing efficiencies. We expect product costs will increase in absolute dollars but will remain relatively constant as a percentage of product revenue.

Research Collaboration. Research collaboration expenses consist of costs associated with procurement and delivery of tissue samples and
costs of research activities conducted by us under Mercks direction. Research collaboration expenses were $890,000 for the three months ended September 30, 2006 as compared to $0 for the three months ended September 30, 2005. We
expect that research collaboration expenses will increase in absolute dollars as we continue to expand our efforts to collaborate on the analysis of atherosclerotic plaque removed from patient arteries.

Research and Development. Research and development expenses consist primarily of costs associated with personnel, materials, and clinical
studies within our product development, regulatory and clinical organizations. Research and development expenses were $5.7 million for the three months ended September 30, 2006 as compared to $2.8 million for the three months ended
September 30, 2005. The increase was primarily attributable to a $1.8 million increase in personnel related costs, a $535,000 increase in materials and services used in product development, and a $496,000 increase in stock-based compensation.
As a percentage of net revenue, research and development expenses were 11% in the three months ended September 30, 2006 as compared to 8% for the three months ended September 30, 2005. We expect research and development expenses to
increase in absolute terms as we explore new technologies and commence new clinical trials and to remain relatively constant as a percentage of net revenue.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of costs for sales, marketing and administrative personnel, and costs associated with participation in
medical conferences, physician symposia and promotional activities. Selling, general and administrative expenses were $31.1 million for the three months ended September 30, 2006 as compared to $25.4 million for the three months ended
September 30, 2005. The increase was primarily attributable to a $5.9 million increase in personnel costs related to additional hiring of sales, marketing, and administrative personnel and sales commissions paid and a $357,000 increase in
marketing and promotional activities, offset by a $314,000 decrease in bad debt expense, and a $330,000 decrease in consultant expenses. As a percentage of net revenue, selling, general and administrative expenses in the three months ended
September 30, 2006 were 57% as compared to 70% for the three months ended September 30, 2005. We expect selling, general and administrative expenses to increase in absolute terms as we expand our sales and marketing efforts and incur
additional administrative costs, but to decrease as a percentage of net revenue as we leverage our existing selling, general and administrative infrastructure.

Amortization of purchased intangible assets. Amortization of purchased intangible assets was $79,000 for the three months ended September 30, 2006 as compared to $0 for the three months ended
September 30, 2005. The increase in amortization was attributable to the intangible assets purchased in the Kerberos acquisition.

Interest and Other Income and Expense, net. Interest and other income and expense was $925,000 for the three months ended September 30, 2006 as compared to $437,000 for the three months ended September 30, 2005. The
increase in interest and other income and expense is primarily attributable to higher interest rates earned on our investment balances.



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##### Table of Contents

Nine Months Ended September 30, 2006 and September 30, 2005

The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages of net
revenue:



|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | --------------- | --- | - | ------ | - | ------- | --------------- |  | --- | -
|                                                                                                                                                                          |  | Nine Months Ended September 30, |        
|                                                                                                                                                                          |  | 2006                            |         |   | 2005            |    
|                                                                                                                                                                          |  | Amount                          |         |   | % of NetRevenue |     |   | Amount |   |         | % of NetRevenue | 
|Revenue:                                                                                                                                                                  |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Product                                                                                                                                                                   |  | $                               | 142,360 |   |                 | 96  | % |        | $ | 85,847  |                 |  | 100 | %
|Research collaboration                                                                                                                                                    |  |                                 | 6,206   |   |                 | 4   | % |        |   | 431     |                 |  | 0   | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Net revenue                                                                                                                                                               |  |                                 | 148,566 |   |                 | 100 | % |        |   | 86,278  |                 |  | 100 | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Costs and expenses:                                                                                                                                                       |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Product (includes $1,004 and $425 in stock-based compensation expense for the nine months ended September 30, 2006 and 2005,
respectively)                                |  |                                 | 31,960  |   |                 | 22  | % |        |   | 27,575  |                 |  | 32  | %
|Research collaboration                                                                                                                                                    |  |                                 | 2,718   |   |                 | 2   | % |        |   |        |                 |  | 0   | %
|Research and development (includes $1,767 and $924 in stock-based compensation expense for the nine months ended September 30, 2006 and
2005, respectively)               |  |                                 | 14,569  |   |                 | 10  | % |        |   | 7,681   |                 |  | 9   | %
|Selling, general and administrative (includes $17,850 and $4,488 in stock-based compensation expense for the nine months ended
September 30, 2006 and 2005, respectively) |  |                                 | 108,833 |   |                 | 72  | % |        |   | 63,811  |                 |  | 74  | %
|Amortization of purchased intangible assets                                                                                                                               |  |                                 | 79      |   |                 | 0   | % |        |   |        |                 |  | 0   | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Total costs and expenses                                                                                                                                                  |  |                                 | 158,159 |   |                 | 106 | % |        |   | 99,067  |                 |  | 115 | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Loss from operations                                                                                                                                                      |  |                                 | (9,593  | ) |                 | -6  | % |        |   | (12,789 | )               |  | -15 | %
|                                                                                                                                                                          |  |                                 |         |  
|Interest and other income and expense, net                                                                                                                                |  |                                 | 2,215   |   |                 | 1   | % |        |   | 1,338   |                 |  | 2   | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  
|Net loss                                                                                                                                                                  |  | $                               | (7,378  | ) |                 | -5  | % |        | $ | (11,451 | )               |  | -13 | %
|                                                                                                                                                                          |  |                                 |         |   |                 |     |   |        |   |         |                 |  |     |  

Revenue:

Our revenue consists of two components: product and research collaboration.

Product. Product
revenue was $142.4 million for the nine months ended September 30, 2006 as compared to $85.8 million for the nine months ended September 30, 2005. The increase of $56.6 million was attributable to an increase in the number of SilverHawk
devices sold as well as an 11% increase in the average sales price per unit. The increase in the number of devices sold is primarily attributable to an increase in the number of hospital customers purchasing our devices and more devices purchased
per customer as we have expanded our sales force.

Research collaboration.Research collaboration revenue was $6.2 million
for the nine months ended September 30, 2006 as compared to $431,000 for the nine months ended September 30, 2005. The $6.2 million of revenue was recognized in connection with delivery of tissue samples and the completion of our
obligations under the Merck Collaboration Agreement which terminated on September 15, 2006. On September 26, 2006 we entered into the Amended Merck Collaboration Agreement which will become effective subject to customary closing conditions
and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. We will begin to recognize research collaboration revenue under the Amended Merck Collaboration Agreement when it becomes effective.

Costs and Expenses:

Our costs and expenses
consist of five components: product, research collaboration, research and development, selling, general and administrative; and amortization of purchased intangible assets.

Product. Product costs were $32.0 million for the nine months ended September 30, 2006 as compared to $27.6 million for the nine months
ended September 30, 2005. The increase was primarily attributable to an increase in the number of SilverHawk devices sold. As a percentage of product revenue, product costs were 22% in the nine months ended



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##### Table of Contents

September 30, 2006 as compared to 32% in the nine months ended September 30, 2005. Primary factors that
contributed to the decrease in product costs as a percentage of product revenue included an increase in the average sales price per unit, continued improvements related to the absorption of manufacturing overhead costs associated with increased
production volumes, improved purchasing efficiencies of supplies and materials, and improved labor and manufacturing efficiencies.

Research Collaboration. Research collaboration expenses were $2.7 million for the nine months ended September 30, 2006 as compared to $0 for the nine months ended September 30, 2005. As a percentage of research
collaboration revenue, research collaboration costs were 44% for the nine months ended September 30, 2006.

Research and
Development. Research and development expenses were $14.6 million for the nine months ended September 30, 2006 as compared to $7.7 million for the nine months ended September 30, 2005. The increase was primarily attributable to a
$4.0 million increase in personnel related costs, a $1.8 million increase in materials and services used in product development, and an $843,000 increase in stock-based compensation. As a percentage of net revenue, research and development expenses
were 10% for the nine months ended September 30, 2006 as compared to 9% for the nine months ended September 30, 2005.

Selling, General and Administrative. Selling, general and administrative expenses were $108.8 million for the nine months ended September 30, 2006 as compared to $63.8 million for the nine months ended September 30,
2005. The increase was primarily attributable to a $27.4 million increase in personnel costs related to the additional hiring of sales, marketing, and administrative personnel and sales commissions paid, a $13.4 million increase in stock-based
compensation, of which $11.4 million relates to the retirement of our former chief executive officer, a $2.3 million increase in marketing and promotional activities, and a $1.0 million increase in travel and related expenses. As a percentage of net
revenue, selling, general and administrative expenses in the nine months ended September 30, 2006 were 72% as compared to 74% for the nine months ended September 30, 2005.

Amortization of purchased intangible assets. Amortization of purchased intangible assets was $79,000 for the nine months ended
September 30, 2006 as compared to $0 for the nine months ended September 30, 2005. The increase in amortization was attributable to the intangible assets purchased in the Kerberos acquisition.

Interest and Other Income and Expense, net. Interest and other income and expense was $2.2 million for the nine months ended
September 30, 2006 as compared to $1.3 million for the nine months ended September 30, 2005. The increase in interest and other income and expense is primarily attributable to higher interest rates earned on our investment balances.

Stock-Based Compensation

We record
deferred stock-based compensation for financial reporting purposes as the difference between the exercise price of stock options granted to employees and directors and the estimated fair value of our common stock at the time of grant. Deferred
stock-based compensation is amortized on a straight-line basis to product cost, research and development expenses and selling, general and administrative expenses. Deferred stock-based compensation recorded through September 30, 2006 was $14.9
million, net of stock option cancellations, with accumulated amortization of $12.5 million. The remaining $2.4 million will be amortized over the vesting periods of the stock options, generally four years from the date of grant (assuming no
additional cancellations). We currently expect to record amortization expense for deferred stock-based compensation as follows:



|                           |  |        |            
|-------------------------- |  | ------ | -----------
|Period                     |  | Amount
|Remaining 3 months of 2006 |  | $      | 0.5 million
|2007                       |  | $      | 1.5 million
|2008                       |  | $      | 0.4 million

Effective January 1, 2006, the Company adopted SFAS No. 123(R) and recognized
compensation expense for all stock-based awards at fair value on the date of grant and issued subsequent to the initial public offering. For the three and nine months ended September 30, 2006 we recorded $2.7 million and $20.0 million,
respectively, in stock-based compensation expense for employees. The nine month figure includes a charge of $11.4 million related to the retirement of our former chief executive officer. As of September 30, 2006, the total unamortized
compensation cost related to unvested stock-based awards granted to employees under the Companys stock option plans and stock purchase plan subsequent to the initial public offering was approximately $26.0 million, net of forfeitures. This
cost will be amortized on a straight-line basis over the remaining weighted average requisite service period of approximately 3.2 years.



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##### Table of Contents

Stock-based compensation expenses related to stock options granted to non-employees are recognized as the
stock options are earned. The amount of stock-based compensation expenses to be recorded in future periods may decrease if unvested stock options are cancelled. Our stock-based compensation expenses will fluctuate as the fair market value of our
common stock fluctuates. We recorded $197,000 and $1.0 million in stock-based compensation expense for non-employees in the three months ended September 30, 2006 and 2005, respectively, and $591,000 and $2.3 million in the nine months ended
September 30, 2006 and 2005, respectively.

Liquidity and Capital Resources

On October 28, 2004, the Company completed an initial public offering of 4.5 million shares of its common stock; additionally, on
October 29, 2004, the underwriters exercised their over-allotment option of 675,000 shares. Proceeds from the offering, after deducting underwriting discounts and commissions but before expenses, were $67.4 million. From inception through June
2004, we raised $78.3 million through private sales of convertible preferred stock. As of September 30, 2006, we had $37.2 million of cash and cash equivalents, $19.1 million of investments, and $75.1 million of working capital.

Contractual Obligations. The following table discloses aggregate information about our contractual obligations and the periods in which
payments are due as of September 30, 2006:



|                   |  |                        |        |                        |   |       |  |      |        |      |   |       |  |            |       |  |   |       |  |   |       
|------------------ |  | ---------------------- | ------ | ---------------------- | - | ----- |  | ---- | ------ | ---- | - | ----- |  | ---------- | ----- |  | - | ----- |  | - | ------
|                   |  | Payments Due by Period
|                   |  | (in thousands)        
|                   |  | Total                  |        | remaining 3 months2006 |   | 2007  |  | 2008 |        | 2009 |   | 2010  |  | After 2010
|Operating leases   |  | $                      | 44,577 |                        | $ | 310   |  | $    | 4,966  |      | $ | 4,608 |  | $          | 4,678 |  | $ | 4,789 |  | $ | 25,226
|Royalty obligation |  |                        | 21     |                        |   | 21    |  |      |       |      |   |      |  |            |      |  |   |      |  |   |      
|Supplier agreement |  |                        | 11,400 |                        |   | 1,934 |  |      | 6,021  |      |   | 3,445 |  |            |      |  |   |      |  |   |      
|                   |  |                        |        |                        |   |       |  |      |        |      |   |       |  |            |       |  |   |       |  |   |       
|Totals             |  | $                      | 55,998 |                        | $ | 2,265 |  | $    | 10,987 |      | $ | 8,053 |  | $          | 4,678 |  | $ | 4,789 |  | $ | 25,226
|                   |  |                        |        |                        |   |       |  |      |        |      |   |       |  |            |       |  |   |       |  |   |       

The long-term commitments under operating leases shown above consist of payments related to our
real estate lease in Redwood City, California expiring August 2011, our real estate lease in Menlo Park, California expiring May 2007, our real estate lease in Mountain View, California that expires on December 31, 2016, with the first payment
scheduled to commence on January 1, 2007, and our real estate lease in Cupertino, California expiring January 2008.

For 2006 and each
year thereafter, the quarterly minimum patent royalty obligation, related to an agreement with a supplier, equals the prior years minimum royalty adjusted by a percentage equal to the percentage change in the consumer price index for the prior
calendar year as reported by the U.S. Department of Labor. Unless terminated earlier, the term of the royalty obligation will continue until the expiration of the last to expire patent that covers that licensed product in such country or for a
period of 15 years following commercial sales, whichever is longer.

In March 2005, the Company entered into a purchase agreement with one
of its suppliers for certain manufacturing components used in the Companys devices. In September 2006 the Company entered into an amended purchase agreement with the supplier under which the Company will be required to make minimum payments to
the supplier over an eighteen month term.

Net Cash Provided by (Used in) Operating Activities. Net cash provided by
operating activities was $11.2 million for the nine months ended September 30, 2006 as compared to $3.7 million used in operating activities for the nine months ended September 30, 2005. For the nine months ended September 30, 2006,
net cash provided by operating activities was primarily attributable to a net loss of $7.4 million offset by non-cash charges of $20.6 million related to stock-based compensation, which included an $11.4 million charge related to the retirement of
our former chief executive officer, depreciation and amortization of $3.4 million, and an increase in inventory reserves of $1.9 million due to the write-off of excess and defective inventory. Net cash provided by operating activities was also due
to an increase in accrued liabilities and accounts payable of $3.7 million due to our increased operating expenses. Net cash provided by operating activities was partially offset by an increase in accounts receivable and research collaboration
receivable of $9.1 million as we increased our net revenue and a decrease in deferred revenue of $2.1 million as we delivered tissue samples and completed our obligations under the terminated Merck Collaboration Agreement. For the nine months
ended September 30, 2005, net cash used in operating activities was attributable primarily to a net loss of $11.5 million and increases in accounts receivable and inventory balances of $11.3 million and $7.8 million, respectively, as we
increased the number of units produced and shipped. Net cash used in operating activities was partially offset by adjustments for non-cash charges related to stock-based compensation of $5.8 million, depreciation and amortization of $2.1 million,
increases in accrued liabilities and accounts payable of $10.0 million due to our increase operating expenses and $8.6 million in deferred revenue related to the Merck Collaboration Agreement.



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Net Cash Provided by (Used in) Investing Activities. Net cash used in investing activities was $5.4 million
for the nine months ended September 30, 2006 compared to $971,000 provided by investing activities for the nine months ended September 30, 2005. For the nine month period ended September 30, 2006 net cash used in investing activities
was primarily attributable to purchases of investments and the acquisition of Kerberos offset by the sales or maturities of investments. Net cash provided by investing activities for the nine months ended September 30, 2005 was primarily
attributable to sales or maturities of investments offset by purchases of investments and acquisition of property and equipment.

Net
Cash Provided by Financing Activities. Net cash provided by financing activities was $7.1 million for the nine months ended September 30, 2006 compared to $2.4 million for the nine months ended September 30, 2005. For each of the
nine month periods ended September 30, 2006 and 2005, net cash provided by financing activities was attributable to proceeds from issuance of common stock related to stock option exercises and proceeds from the issuance of common stock under
our employee stock purchase plan.

Our future capital requirements depend on numerous factors. These factors include but are not limited to
the following:



| |  |  | revenue generated by sales of the SilverHawk and Rinspirator products;
| | - |  | ----------------------------------------------------------------------



| |  |  | revenue generated by the Amended Merck Collaboration Agreement and its possible renewal beyond the initial four year term.
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | costs associated with our sales and marketing initiatives and manufacturing activities;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | costs associated with performing against our obligations under the Amended Merck Collaboration Agreement;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | rate of progress and cost of our research and development activities;
| | - |  | ---------------------------------------------------------------------



| |  |  | costs of obtaining and maintaining FDA and other regulatory clearances of the SilverHawk;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | effects of competing technological and market developments; and
| | - |  | ---------------------------------------------------------------



| |  |  | size, number and timing of acquisitions and other strategic transactions.
| | - |  | -------------------------------------------------------------------------

Off-Balance-Sheet Arrangements.As of September 30, 2006, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Summary.We believe that our current cash, cash equivalents, and investments, along with the 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. If these sources of cash are insufficient to satisfy our liquidity requirements, we may seek to sell additional
equity or debt securities or obtain a credit facility. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these
securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Additional financing may not be available at all, or in amounts or on terms acceptable to us. If we are
unable to generate sufficient cash from operations or obtain additional financing, we may be required to reduce the scope of our planned research and development and selling and marketing efforts.

We expect to increase capital expenditures consistent with our anticipated growth in manufacturing, infrastructure and personnel. We also may increase
our capital expenditures as we expand our product lines or invest to address new markets. In the event that we acquire complementary businesses, products, or technologies we may have to issue equity or debt.

Recent Accounting Pronouncements

In June 2006, the
FASB issued FASB Interpretation No. 48 or FIN 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48
requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as
of the beginning of our 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting this new standard.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements.SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing
materiality and provides for a one-time cumulative effect transition adjustment. SAB No. 108 is effective for our fiscal year 2006 annual financial statements. We do not expect the adoption of this standard to have an impact on our financial
statements.



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##### Table of Contents

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This standard
defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. This pronouncement applies under other accounting
standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. We will be required to adopt SFAS No. 157 in the first quarter of fiscal year 2008. We are currently evaluating the requirements of SFAS No. 157 and have not yet determined the impact on our consolidated financial
statements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses,
and disclosures of contingent assets and liabilities at the date of the financial statements. On a periodic basis, we evaluate our estimates, including those related to accounts receivable, inventories, warranty reserve, income taxes and stock-based
compensation. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates under different assumptions or conditions. For further information on
our critical accounting policies, see the discussion of critical accounting policies and estimates included in the Companys Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange
Commission on March 7, 2006, as amended on March 10, 2006.

In addition, as of January 1, 2006, we implemented the following
new critical accounting policies:

Stock-Based Compensation.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards or SFAS No. 123 (R), Share-Based Payment (revised 2004), using the modified prospective transition method,
which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Companys employees and directors including stock options and employee stock purchases related to the Employee Stock Purchase
Plan. The Companys financial statements as of and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Companys financial
statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected
to vest. Share-based compensation expense recognized in the Companys Condensed Consolidated Statements of Operations during the three and nine months ended September 30, 2006 included compensation expense for share-based payment awards
granted prior to, but not yet vested as of, December 31, 2005 based on the fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to
December 31, 2005 based on the fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company estimated the fair value of each stock option on the date of grant using the
Black-Scholes option valuation model and elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for its pro forma information required under SFAS 123. The Black-Scholes option
valuation model requires the input of subjective assumptions including expected stock price volatility, expected term of stock option and risk free interest rate. Due to the limited amount of historical data available to us, particularly with
respect to stock-price volatility, employee exercise patterns and forfeitures, actual results could differ from our assumptions.

Prior to
the adoption of SFAS 123(R), the Company accounted 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
its interpretations and complied with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosurean
amendment of FASB Statement No. 123. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair market value of the Companys stock and the exercise price. Employee
stock-based compensation is amortized on a straight-line basis over the vesting period of the underlying options.



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Revenue Recognition

We recognize product revenue in accordance with SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. SAB No. 104 requires that four basic criteria must be met before revenue can be
recognized: persuasive evidence of an arrangement exists; title has transferred; the fee is fixed and determinable; and collectibility is reasonably assured. Transfer of title and risk of ownership generally occurs when the product is shipped to the
customer or when the customer receives the product, depending on the nature of the arrangement. We do not offer any rights of return for product sales to direct and indirect customers.

On September 14, 2005, we entered into the Merck Collaboration Agreement with Merck pursuant to which we agreed to collaborate on the analysis of
atherosclerotic plaque removed from patient arteries with the goal of identifying new biomarkers of atherosclerotic disease progression. We have recognized revenue related to the Merck Collaboration Agreement in accordance with Emerging Issues Task
Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables. The Merck Collaboration Agreement provided for an initial payment of $9.0 million which covered costs associated with our
responsibilities and for the rights granted to Merck during the initial year of the research collaboration. The initial payment was classified as deferred revenue and we have recognized revenue as we fulfilled our obligations and delivered tissue
samples under the Merck Collaboration Agreement. On September 15, 2006, the Merck Collaboration Agreement terminated and we recognized the remaining deferred revenue balance as all obligations under the agreement were complete.

On September 26, 2006, we entered into the Amended Merck Collaboration Agreement as well as a Stock Purchase Agreement and a Registration Rights
Agreement with Merck which will become effective subject to customary closing conditions and clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act. We will recognize revenue related to the Amended Merck Collaboration Agreement in
accordance with EITF 00-21 under which management has determined that obligations in the agreement do not meet the requirements for separate units of accounting and therefore will be combined into a single unit of accounting and all payments will be
considered as a whole. We will recognize revenue on the minimum payments, adjusted for any discount or premium calculated on the $95.0 million investment, on a straight-line basis over the estimated term of the agreement, or four years,
beginning when the Amended Merck Collaboration Agreement becomes effective. Revenue recognized under the agreement will be limited to cash received and will be adjusted on a prospective basis for amounts received in excess of the total
estimated minimum payments due under the agreements.

Basis of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All intercompany balances and
transactions have been eliminated.

Goodwill and Other Intangible Assets.

We account for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, whereby goodwill is no longer amortized, but instead is subject to impairment reviews performed periodically during each fiscal year. We review the carrying amount of goodwill and other intangible assets whenever events and
circumstances indicate that the carrying amount of the goodwill or other intangible assets may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated declines in revenue or operating
profit and adverse legal or regulatory developments. If it is determined that such indicators are present and the review indicates that goodwill or other intangible assets will not be fully recoverable, based upon discounted estimated cash flows,
the carrying value will be reduced to its estimated fair market value. Estimated fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. We are amortizing our acquired
intangible assets on a straight line basis over their estimated useful lives, or six to eight years.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk at
September 30, 2006 is related primarily to our investment portfolio. Our investment portfolio includes fixed rate debt instruments of high quality U.S. government and corporate issuers. A change in prevailing interest rates may cause the fair
value of our investments to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing rate rises, the fair value of the principal amount of our investment will probably
decline. To minimize this risk, investments are generally held to maturity and the weighted average duration of our investments is three months. Due to the short-term nature of these investments, we believe we have no material exposure to interest
rate risk arising from our investments.

We have operated mainly in the United States, and 99.5% and 99.8% of our sales were made in U.S.
dollars for the three and nine months ended September 30, 2006, respectively. All sales in 2005 were made in U.S. dollars. To date, we have not had any material exposure to foreign currency rate fluctuations.

ITEM 4. CONTROLS AND PROCEDURES



|(a) | Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in the Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) required by Exchange Act Rules 13a-15(b) or 15d-15(b), our principal executive officer and principal financial officer have concluded that
as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports
is accumulated and communicated to our management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) | Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In July 2006 and August 2006, two separate shareholder class action complaints
were filed against the Company and two of our officers in the U.S. District Court for the Northern District of California. The plaintiffs are seeking to represent a class of purchasers of our common stock from May 13, 2005 to
January 26, 2006. The complaint generally alleges that false or misleading statements were made concerning our management and seeks unspecified monetary damages. Because the outcome of this litigation is undetermined and we cannot
reasonably estimate the possible loss or range of loss which may arise from the litigation, we have not recorded an accrual for possible damages.

In July 2006, a shareholder derivative complaint was filed against our directors and certain of our officers in the Superior Court of the State of California, San Mateo County. The complaint is based on substantially similar facts and
circumstances as the class action complaints and generally alleges that the named individuals breached their fiduciary duties to the Company. The complaint seeks unspecified monetary damages. Given the nature of derivative litigation, any
recovery in a derivative suit would be to the benefit of the Company.

In August 2006, a shareholder derivative complaint was filed against
our directors and certain of our officers in the United States District Court for the Northern District of California, San Jose division. The complaint is based on substantially similar facts and circumstances as the class action complaints and
generally alleges that the named individuals breached their fiduciary duties to the Company. The complaint seeks unspecified monetary damages. Similar to the derivative litigation in the Superior Court, any recovery in this derivative suit would be
to the benefit of the Company.



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ITEM 1A. RISK FACTORS

Factors Affecting Future Operating Results

Our involvement in arbitration or litigation as a result of the management changes that have taken place and lawsuits related to those changes may
further depress the price of our stock.

We are the subject of litigation by stockholders who have suffered losses in the value of our
stock during this period of transition, and we may become involved in costly arbitration or litigation with former employees in connection with their departure. In any such proceeding we intend to defend ourselves vigorously which may be expensive.
We retain employment practices liability and director and officer liability insurance but there can be no guarantee that such insurance will cover the claims that are made or will insure us fully for all losses on covered claims. Any such
arbitration or litigation may distract our management and consume resources that would otherwise have been directed toward achieving our operating plan and generating increased revenue, which may further cause a decline in our stock price.

We depend substantially on a single product, the SilverHawk, which we commercially launched in the United States at the beginning of 2004. If the
SilverHawk fails to further penetrate the market or loses market acceptance, our business will suffer.

The SilverHawk is our main
product, and we are largely dependent on it. We expect that sales of the SilverHawk in the United States will account for a substantial portion of our revenue for the foreseeable future. Growth in demand for the Silverhawk has slowed and our failure
to generate additional demand may negatively impact our operating revenue. We do not know if the SilverHawk will be successful over the long term. Market acceptance of the SilverHawk may be hindered if physicians are not presented with compelling
data from long-term studies of the safety and efficacy of the SilverHawk compared against alternative procedures, such as angioplasty, stenting or bypass grafting. We recently announced plans to conduct a study comparing treatment with the
SilverHawk to bypass grafting, but it will be more than a year before initial data is available from that study and several years until the study is concluded and final data is available. In addition, demand for the SilverHawk may decline or may not
increase as quickly as we expect. Other reasons that may influence the rate of Silverhawk adoption include the time required to perform the procedure and the lack of on board visualization. If we are unable to make certain design improvements to the
Silverhawk, we may be unable to generate new customers or retain our existing customers. Failure of the SilverHawk to significantly penetrate current or new markets would negatively impact our business, financial condition and results of operations.

There exists limited long-term data regarding the safety and efficacy of the SilverHawk. Future long-term data may not be positive or consistent with
data currently available, which would affect the rate at which our device is adopted.

Our success depends heavily on acceptance of the
SilverHawk by the medical community as safe and effective. Important factors upon which the efficacy of the SilverHawk will be measured are long-term data on the rate of restenosis, or plaque regrowth following our procedure, and the corresponding
duration of patency, or openness of the artery. Another important factor that physicians will consider is the rate of reintervention, or retreatment, following the SilverHawk procedure. Because our technology is relatively new in the treatment of
PAD, to date there have been a limited number of single-center, clinical experiences with limited patient populations that have measured short and mid-term restenosis and patency rates up to one year following treatment. None of these studies were
conducted by us. We are conducting studies designed to measure restenosis rates or patency rates after treatment with the SilverHawk and compare outcomes in a randomized manner to alternative procedures. These studies may be expensive and time
consuming and the results may not prove favorable for the SilverHawk device.

While subset data from the TALON registry regarding
restenosis and patency rates was recently published, we cannot provide any assurance that the published data will be compelling to the medical community, because it may not be scientifically meaningful. In addition, the long-term effects of the
SilverHawk procedure are not known.

The results of limited long-term data and of short-term clinical experience of the SilverHawk do not
necessarily predict long-term clinical benefit. Restenosis rates usually increase over time, and typically two-year restenosis rates are substantially higher than one-year results. We believe that physicians will compare the rates of long-term
restenosis and reintervention for the SilverHawk procedure against alternative procedures, such as angioplasty, stenting and bypass grafting. If long-term rates of restenosis and reintervention do not meet physicians expectations, the
SilverHawk may not become widely adopted and physicians may recommend alternative treatments for their patients. Other significant factors that physicians will consider include acute safety data on complications that occur during the SilverHawk
procedure. If the results obtained from any future clinical studies or clinical or commercial experience indicate that the SilverHawk is not as safe or effective as other treatment options or as prior short-term or long-term data would suggest,
adoption of our product may suffer and our business would be harmed.



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Even if we believe the data collected from clinical studies or clinical experience indicate positive
results, each physicians actual experience with our device will vary. Clinical studies conducted with the SilverHawk, as well as clinical experience recorded in the TALON registry, have involved procedures performed by physicians who are
technically-proficient and high-volume users of the SilverHawk. Consequently, both short and long-term results reported in these studies and the TALON registry may be significantly more favorable than typical results of practicing physicians, which
could negatively impact rates of adoption of the SilverHawk.

If we make acquisitions or divestitures, we could encounter difficulties that harm our
business.

We may acquire companies, products or technologies that we believe to be complementary to the present or future direction of
our business. If we engage in such acquisitions, we may have difficulty integrating the acquired personnel, financials, operations, products or technologies. For example, on September 12, 2006, we acquired Kerberos Proximal Solutions, Inc. and
we are now beginning to sell the Rinspiration System. We may find that we are unable to gain market share or physician acceptance for this product. In addition, we may experience difficulties with transitioning the manufacturing of the Rinspiration
System to our facilities and the Rinspiration System may be subject to regulatory and intellectual property risks that are different from those that we have encountered with the SilverHawk. In addition to the Kerberos acquisition, we may acquire
other companies and product lines or enter into distribution agreements. Acquisitions may dilute our earnings per share, disrupt our ongoing business, distract our management and employees, increase our expenses, subject us to liabilities, and
increase our risk of litigation, all of which could harm our business. If we use cash to acquire companies, products or technologies, it may divert resources otherwise available for other purposes. If we use our common stock to acquire companies,
products or technologies, our stockholders may experience substantial dilution.

We depend on skilled and experienced personnel to operate our business
effectively. If we are unable to recruit, hire and retain these employees, our ability to manage and expand our business will be harmed, which would impair our future revenue and profitability.

Our success largely depends on the skills, experience and efforts of our officers and other key employees. Any of our officers and other key employees may
terminate their employment at any time. In December 2005 our president and chief executive officer retired from our company. Since then, our vice president of sales and vice president of marketing have resigned. In addition, we decided to replace
our chief operating officer. The further loss of any of our senior management team could harm our business. Our ability to retain our skilled labor force and our success in attracting and hiring new skilled employees will be a critical factor in
determining whether we will be successful in the future. We may not be able to meet our future hiring needs or retain existing personnel. We will face particularly significant challenges and risks in hiring, training, managing and retaining
engineering and sales and marketing employees. Failure to attract and retain personnel, particularly technical and sales and marketing personnel, would harm our ability to compete effectively and grow our business. The announcement of the loss of
one of our key employees could further negatively affect our stock price.

We have a limited history of operations and a history of net losses that may
prevent us from sustaining profitability.

We have a limited history of operations upon which you can evaluate our business. In
particular, we incurred net losses of $7.4 million in the nine months ended September 30, 2006 and $11.6 million in 2005. As of September 30, 2006, we had an accumulated deficit of $92.5 million. We commenced full commercial sales of the
SilverHawk in January 2004, and our short commercialization experience makes it difficult for us to predict future performance. Our failure to accurately predict financial performance may lead to volatility in our stock price. In addition, we expect
our operating expenses will increase as we expand our business to meet anticipated growing demand for the SilverHawk and the Rinspiration System and devote resources to our sales and marketing programs and research and development activities. Our
failure to sustain profitability would negatively impact the market price of our common stock.

Our future growth depends on physician adoption of the
SilverHawk and the Rinspiration System, which requires physicians to change their screening and referral practices.

Although there is a
significant correlation between Peripheral Artery Disease (PAD) and coronary artery disease, many physicians do not routinely screen for PAD while screening for coronary artery disease. We target our sales efforts to interventional cardiologists and
vascular surgeons because they are often the primary care physicians diagnosing and treating PAD. However, the initial point of contact for many patients may be general practitioners, podiatrists, nephrologists or endocrinologists, each of whom
commonly treats patients experiencing complications resulting from PAD. If we do not educate referring physicians about PAD in general and the existence of the SilverHawk and Rinspiration System in particular, they may not refer patients to
interventional cardiologists, vascular surgeons or interventional radiologists for the SilverHawk and Rinspiration System procedures, and those patients may instead be surgically treated or treated with an alternative interventional procedure. If we
are not successful in educating physicians about screening for PAD or about referral opportunities, our ability to increase our revenue may be impaired.



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Our ability to market the SilverHawk in the United States is limited to use in peripheral vessels, and if we
want to expand our marketing claims, we will need to file for additional FDA clearances or approvals and conduct further clinical trials, which would be expensive and time-consuming and may not be successful.

We have FDA clearance in the United States for treatment of atherosclerosis in the peripheral vasculature. This general clearance restricts our ability to
market or advertise the SilverHawk for any specific indication within the peripheral arteries, which limits our ability to market the SilverHawk and could affect our growth. Off-label use of the SilverHawk outside the peripheral vasculature, in
coronary and carotid arteries, has occurred and is likely to continue. In addition, off-label use for treatment of in-stent restenosis has occurred and is likely to continue. While off-label uses of medical devices are common and the FDA does not
regulate physicians choice of treatments, the FDA does restrict a manufacturers communications regarding such off-label use. We may not actively promote or advertise the SilverHawk for off-label uses. In addition, we cannot make
comparative claims regarding the use of the SilverHawk against any alternative treatments without conducting head-to-head comparative clinical studies, which would be expensive and time consuming. If our promotional activities fail to comply with
the FDAs regulations or guidelines, we may be subject to FDA warnings or enforcement action.

If we want to market the SilverHawk in
the United States for use in coronary or carotid arteries, we will need to conduct further clinical trials and obtain premarket approval from the FDA. We previously began a clinical trial in support of FDA approval for use of the SilverHawk in the
coronary arteries. Based on 172 patients treated in this trial, we experienced 37 serious adverse events in treating 28 patients, including 10 perforations, two cases of emergency bypass surgery, three cases of stroke, 14 cases of heart attack and
eight patient deaths. We voluntarily halted enrollment so that we could incorporate safety and design improvements into our coronary product. We believe that these serious adverse events resulted from a number of factors, including the
patients overall poor health, the complexity of treating the bifurcated lesions called for under the trial protocol, and the application of our device in the coronary arteries, which are extremely small and constantly move as the heart beats.
We have made several design modifications to the coronary versions of our devices, and we have submitted an application to the FDA for a new Investigational Device Exemption, or IDE. The FDA has responded to our IDE application, and we now expect
that further modifications to our devices will be necessary before the new trial can be started in the U.S. to evaluate the safety and efficacy of the SilverHawk in the coronary arteries. We cannot predict when the trial will be initiated, the
outcome of such a trial or whether the results will adequately demonstrate the safety and efficacy of the SilverHawk for use in coronary arteries.

If
we are unable to manage the anticipated growth of our business, our future revenue and operating results may be adversely affected.

The
growth that we have experienced, and in the future may experience, presents challenges to our company requiring us to rapidly expand our organization. Expansion in our organization may result in less experienced people producing and selling our
product, which could result in unanticipated costs and disruptions to our operations. If we cannot scale and manage our business appropriately, our anticipated growth may be impaired and our financial results will suffer.

We have limited experience manufacturing the SilverHawk and Rinspiration System in commercial quantities which could adversely impact our business.

Because we have only limited experience in manufacturing the SilverHawk and Rinspiration System in commercial quantities, we may encounter unforeseen
situations that would result in delays or shortfalls. For example, in June 2004, we initiated a voluntary recall of two lots of the SilverHawk due to the possibility of improper sterilization at one of two approved sterilization facilities. We may
encounter difficulties and delays in manufacturing our products for the following additional reasons:



| |  |  | we have significantly expanded our manufacturing operations, and our production processes may have to change to accommodate this growth;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | key components of our products are currently provided by a single supplier or limited number of suppliers, and we do not maintain large inventory levels of these components;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | to increase our manufacturing output significantly, we will have to attract and retain qualified employees, who are in short supply, for the assembly and testing operations; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | all of our manufacturing occurs in facilities located in the San Francisco bay area and if we were to lose availability of these facilities due to earthquake, fire, natural disaster
or other disruptions, our operations would be significantly impaired.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If our manufacturing operations are unable to meet
demand for our products, our revenue could be impaired, market acceptance for our products could be adversely affected, and our customers might instead purchase our competitors products. Additionally, although we maintain business interruption
insurance, there can be no assurance that the proceeds of such insurance would be sufficient to offset any loss that we might incur or that we would be able to retain our customer base if operations were disrupted.

We depend on third-party vendors in our manufacturing operations, making us vulnerable to supply shortages and price fluctuations that could harm our business.

We currently rely on third-party vendors for the manufacture of most of the components used in the SilverHawk and the Rinspiration
System. Our reliance on these vendors subjects us to a number of risks that could impact our ability to manufacture our product and harm our business, including:



| |  |  | interruption of supply resulting from modifications to, or discontinuation of, a suppliers operations;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | delays in product shipments resulting from uncorrected defects, reliability issues or a suppliers variation in a component;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | inability to obtain adequate supply in a timely manner or on commercially reasonable terms;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | difficulty identifying and qualifying alternative suppliers for components in a timely manner;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | production delays related to the evaluation and testing of products from alternative suppliers and corresponding regulatory qualifications; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | delays in delivery by our suppliers due to changes in demand from us or their other customers.
| | - |  | ----------------------------------------------------------------------------------------------

Any significant delay or interruption in the supply of components, or our inability to obtain substitute 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 harm our business.

We depend on single and
limited source suppliers for some of the components of the SilverHawk and the Rinspiration System, and if any of those suppliers are unable or unwilling to produce these components or supply them in the quantities that we need, we would experience
manufacturing delays as a result.

We rely on single and limited source suppliers for several of the components of the SilverHawk and
the Rinspiration System. For example, for the SilverHawk, we rely on one vendor for our torque shaft, one vendor for our cutting blade motor, one vendor for our cutter assembly, and one vendor for our tip housing. For the Rinspiration System, we
rely on one vendor for the hub and one vendor for the dual lumen extrusions. These components are critical to the SilverHawk and the Rinspiration System and there are few alternative sources of supply for them. We do not carry a significant
inventory of these components. Identifying and qualifying additional or replacement suppliers for any of the components used in the SilverHawk and the Rinspiration System, if required, may not be accomplished quickly or at all and could involve
significant additional costs. Any supply interruption from our vendors or failure to obtain additional vendors for any of the components used to manufacture the SilverHawk and the Rinspiration System would limit our ability to manufacture our
product and could therefore have a material adverse effect on our business, financial condition and results of operations.

The use, misuse or off-label
use of the SilverHawk and Rinspiration Systems may result in injuries that lead to product liability suits, which could be costly to our business.

We neither provide training for physicians nor require that physicians be trained in the use of the SilverHawk by a third party because we market primarily to physicians who are skilled in the interventional
techniques required to use our device. Although the SilverHawk is cleared by the FDA for the treatment of atherosclerosis in the peripheral vasculature, we have indicated through our marketing efforts that certain treatment locations, such as
arteries below the knee or above the leg, are not suited for physicians with limited experience using the device. There may be increased risk of injury if such physicians attempt SilverHawk procedures in peripheral arteries in these areas of the
body. Not requiring training specific to the use of our device in various parts of the body may expose us to greater risk of product liability if injuries occur during the SilverHawk procedure. If demand for the SilverHawk continues to grow, less
skilled surgeons will likely use the device, potentially leading to more injury and an increased risk of product liability.



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The use or misuse of the SilverHawk in the peripheral and coronary arteries has in the past resulted, and
may in the future result, in complications, including damage to the treated artery, internal bleeding, limb loss and death, potentially leading to a product liability claim. The SilverHawk is not FDA-cleared or approved for treatment of carotid
arteries, which are arteries leading to the brain, coronary arteries, or in-stent restenosis in the United States. Our sales force does not promote the product for off-label uses, and our U.S. instructions for use specify that the SilverHawk is not
intended for use in the coronary arteries or carotid arteries. However, we cannot prevent a physician from using the SilverHawk for these off-label applications. The application of the SilverHawk to coronary arteries, as opposed to peripheral
arteries, is more likely to result in complications that have serious consequences. For example, if excised plaque were not captured properly in our device, it could be carried by the bloodstream to a narrower location, blocking a coronary artery,
leading to a heart attack, or blocking an artery to the brain, leading to a stroke. We have had three reported incidents of stroke in our halted coronary trial, which may have been caused by excised arterial plaque entering the bloodstream. If the
SilverHawk is defectively designed, manufactured or labeled, contains defective components or is misused, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert managements
attention from our core business, be expensive to defend and result in sizable damage awards against us.

The use or misuse of
the Rinspiration System in the peripheral and coronary arteries may in the future result in complications, including damage to the treated artery, internal bleeding, limb loss and death, potentially leading to a product liability claim.
The Rinspiration System is not FDA-cleared or approved for treatment of carotid arteries, which are arteries leading to the brain, in the United States. Our sales force does not promote the product for off-label uses, and our U.S. instructions
for use specify that the Rinspiration System is intended for use in the coronary and peripheral arteries. However, we cannot prevent a physician from using the Rinspiration System for off-label applications. The
application of the Rinspiration System to carotid arteries, as opposed to coronary or peripheral arteries, may result in complications that have serious consequences. For example, if excised plaque were not captured properly in
our device, it could be carried by the bloodstream to a narrower location, blocking a carotid artery, leading to a stroke. If the Rinspiration System is defectively designed, manufactured or labeled, contains defective components or
is misused, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert managements attention from our core business, be expensive to defend and result in sizable damage awards against
us.

We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and regulations and, if we are unable to fully
comply with such laws, could face substantial penalties.

Our operations may be directly or indirectly affected by various broad state
and federal healthcare fraud and abuse laws, including the federal Anti-Kickback Statute, which prohibit any person from knowingly and willfully offering, paying, soliciting or receiving remuneration, directly or indirectly, to induce or reward
either the referral of an individual, or the furnishing or arranging for an item or service, for which payment may be made under federal healthcare programs, such as the Medicare and Medicaid programs. If our past or present operations, including
our consulting arrangements with physicians who use our product, are found to be in violation of these laws, we or our officers may be subject to civil or criminal penalties, including large monetary penalties, damages, fines, imprisonment and
exclusion from Medicare and Medicaid program participation. If enforcement action were to occur, our business and financial condition would be harmed.

We compete against companies that have longer operating histories, more established products and greater resources, which may prevent us from achieving significant market penetration or improved operating results.

With regard to the SilverHawk, we compete against very large and well-known stent and angioplasty device manufacturers, including Abbott Laboratories,
Boston Scientific, Cook, Johnson & Johnson and Medtronic. We also compete against smaller manufacturers, including, among others: ev3, a manufacturer of peripheral vascular stents and angioplasty devices; Spectranetics, a manufacturer of
excimer lasers for the treatment of coronary artery disease and PAD; W. L. Gore, (Medical Products Division), a manufacturer of endoprostheses stent-grafts, and Angioscore, a manufacturer of angioplasty devices. There are also several other
companies that provide products used by surgeons in peripheral bypass procedures. Other competitors include pharmaceutical companies that manufacture drugs for the treatment of mild to moderate PAD. With regard to the Rinspiration System, we compete
against Possis Medical, ev3, Vascular Solutions, and several other manufacturers of aspiration catheters. Many of our competitors have significantly greater financial and human capital resources than we do and have established reputations, as well
as worldwide distribution channels that are more effective than ours. Competition with these companies could result in price-cutting, reduced profit margins and loss of market share, any of which would harm our business, financial condition and
results of operations.

Our ability to compete effectively depends on our ability to distinguish our company and our products from our
competitors and their products, and includes such factors as:



| |  |  | the ability of our products to treat patients safely and effectively;
| | - |  | ---------------------------------------------------------------------



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| |  |  | predictable clinical performance;
| | - |  | ---------------------------------



| |  |  | ease of use;
| | - |  | ------------



| |  |  | price;
| | - |  | ------



| |  |  | adequate third-party reimbursement; and
| | - |  | ---------------------------------------



| |  |  | brand and name recognition.
| | - |  | ---------------------------

Our competitors with greater
financial resources could acquire other companies to gain enhanced name recognition and market share, as well as new technologies or products that could effectively compete with our existing product, which may cause our revenue to decline and would
harm our business.

Our ability to compete also depends on our ability to innovate successfully. If our competitors can compete directly against us or
demonstrate the safety and efficacy of other methods of treatment, our revenue may decline.

The market for medical devices is highly
competitive, dynamic, and marked by rapid and substantial technological development and product innovations. There are few barriers that would prevent new entrants or existing competitors from developing products that compete directly with ours.
Demand for our products could be diminished by equivalent or superior products and technologies offered by competitors. For example, drug-eluting stents have been developed for treating coronary artery disease and have been rapidly adopted. Cook is
currently conducting clinical trials for the use of drug-eluting stents and Edwards is conducting clinical trials for the use of non-drug-eluting stents in the peripheral vasculature, each of which, if successful, may impact future SilverHawk sales.
We are also aware of at least two other companies, Cardiovascular Systems, Inc. and Pathway Medical, developing plaque-removal devices intended for the treatment of PAD. If we are unable to innovate successfully or if new competitors emerge, our
products could become obsolete, and our revenue would decline as our customers purchase our competitors products.

We rely
significantly on our chief executive officer for guidance and direction regarding the development of new products and improvements to existing products. We may choose to acquire complementary products and technologies to augment the number of our
product offerings and add to the diversity of the SilverHawk system. Any acquisitions that we make may divert managements attention from our core programs and may consume necessary resources without generating significant additional revenue.

We may in the future be a party to patent litigation and administrative proceedings that could be costly and could interfere with our ability to sell
our products.

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual
property rights, and companies in the industry have used intellectual property litigation to gain a competitive advantage. We may become a party to patent infringement claims with our competitors or others and litigation or interference proceedings
declared by the U.S. Patent and Trademark Office to determine the priority of inventions. The defense and prosecution of these matters are both costly and time consuming. Additionally, we may need to commence proceedings against others to enforce
our patents, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. These proceedings would result in substantial expense to us and significant diversion of effort by our
technical and management personnel.

An adverse determination in litigation or interference proceedings to which we may become a party
could subject us to significant liabilities or injunctions which would require us to seek licenses. In addition, if we are found to willfully infringe third-party patents, we could be required to pay treble damages in addition to other penalties.
Although patent and intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. We may
be unable to obtain necessary licenses on satisfactory terms, if at all. If we do not obtain necessary licenses, we may not be able to redesign our products to avoid infringement. Adverse determinations in a judicial or administrative proceeding or
failure to obtain necessary licenses could prevent us from manufacturing and selling our products, which would have a significant adverse impact on our business.

We are aware of patents held by Boston Scientific that may be asserted against us in litigation that could be costly and could limit our ability to sell the SilverHawk.

We are aware of patent families related to catheter positioning and atherectomy, or plaque removal, owned or licensed by Boston Scientific. With regard to
atherectomy patents, one of our founders, Dr. John Simpson, founded a company prior to founding our company that developed an atherectomy device that is currently sold by Boston Scientific, and he is a listed inventor on several patents covering
that device. Boston Scientifics device is currently marketed and sold for use in coronary



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arteries. We are not currently aware of any claims Boston Scientific has made or intends to make against us. Because of a
doctrine known as assignor estoppel, if any of Dr. Simpsons earlier patents are asserted against us by Boston Scientific, we may be prevented from asserting an invalidity defense regarding those patents, and our defense may be
compromised. Boston Scientific has significantly greater financial resources than we do to pursue patent litigation and can assert these patent families against us at any time. Adverse determinations in such litigation could prevent us from
manufacturing or selling the SilverHawk, which would have a significant adverse impact on our business.

Intellectual property rights may not provide
adequate protection, which may permit third parties to compete against us more effectively.

We rely on patents, trade secret laws and
confidentiality agreements to protect our technology and products. Our pending patent applications may not issue as patents or, if issued, may not issue in a form that will be advantageous to us. Any patents we have obtained or will obtain in the
future might be invalidated or circumvented by third parties. Should such challenges be successful, competitors might be able to market products and use manufacturing processes that are substantially similar to ours. We may not be able to prevent
the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors or former or current employees, despite the existence generally of confidentiality agreements and other contractual restrictions. Monitoring
unauthorized use and disclosure of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property will be adequate. In addition, the laws of many foreign countries will not protect our
intellectual property rights to the same extent as the laws of the United States. To the extent our intellectual property protection is incomplete, we are exposed to a greater risk of direct competition. In addition, competitors could purchase our
products and attempt to replicate some or all of the competitive advantages we derive from our development efforts or design around our protected technology. If our intellectual property is not adequately protected against competitors products
and methods, our competitive position could be adversely affected, as could our business.

If we fail to obtain and maintain necessary regulatory
clearances or approvals for the SilverHawk and Rinspiration Systems, or if clearances or approvals for future products and indications are delayed or not issued, our commercial operations would be harmed.

The SilverHawk and Rinspiration systems are medical devices that are subject to extensive regulation by the FDA in the United States and by regulatory
agencies in other countries where we do business. Government regulations specific to medical devices are wide-ranging and govern, among other things:



| |  |  | product design, development and manufacture;
| | - |  | --------------------------------------------



| |  |  | product safety, testing, labeling and storage;
| | - |  | ----------------------------------------------



| |  |  | premarketing clearance or approval;
| | - |  | -----------------------------------



| |  |  | record keeping procedures;
| | - |  | --------------------------



| |  |  | product marketing, sales and distribution; and
| | - |  | ----------------------------------------------



| |  |  | post-marketing surveillance, reporting of deaths or serious injuries and medical device reporting.
| | - |  | --------------------------------------------------------------------------------------------------

Before a new medical device or a new use of, or claim for, an existing product can be marketed in the United States, a company must first apply for and
receive either 510(k) clearance or premarketing approval from the FDA, unless an exemption applies. Either process can be expensive, lengthy and unpredictable. Although we have obtained 510(k) clearance to market the SilverHawk for treatment of
atherosclerosis in the peripheral vasculature, our clearance can be revoked if safety or efficacy problems develop. We voluntarily suspended our U.S. clinical trial for the use of the SilverHawk in coronary arteries. To market the SilverHawk in the
United States for this use, we must successfully complete a clinical trial, submit a premarket approval application to the FDA and obtain premarket approval. Therefore, even once we believe we have successfully developed the SilverHawk for use in
the coronary arteries, we may not be permitted to market our device for this indication in the United States for a number of years, if at all. Delays in obtaining approval could adversely affect our future growth.



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We are also subject to medical device reporting regulations that require us to report to the FDA if our
product causes or contributes to a death or serious injury or if a malfunction, were it to occur, might cause or contribute to a death or serious injury. For the third quarter of 2006, the FDA has received forty-four medical device reports
associated with procedures where the SilverHawk was used. Of these filings thirty-five resulted from a reassessment of our filing criteria after a complete review of our entire complaint experience with regard to tip detachments in which the tip
stayed on the guidewire with no adverse clinical result, and these filings represent all such events from our commercialization in June 2003 through September 30, 2006. In addition, two reports resulted from tip detachments due to wire wrap;
five reports resulted from tip detachments with no adverse clinical result; one report resulted from a tip that became wedged in the sheath, and one report resulted from a catheter that became wedged in the sheath requiring the removal of the
Silverhawk.

The FDA and state authorities have broad enforcement powers. Our failure to comply with applicable regulatory requirements
could result in enforcement action by the FDA or state agencies, which may include any of the following sanctions:



| |  |  | warning letters, fines, injunctions, consent decrees and civil penalties;
| | - |  | -------------------------------------------------------------------------



| |  |  | repair, replacement, refunds, recall or seizure of our products;
| | - |  | ----------------------------------------------------------------



| |  |  | operating restrictions, partial suspension or total shutdown of production;
| | - |  | ---------------------------------------------------------------------------



| |  |  | refusing our requests for 510(k) clearance or premarket approval of new products; new intended uses of, or modifications to, existing products;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | withdrawing 510(k) clearance or premarket approvals that have already been granted; and
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | criminal prosecution.
| | - |  | ---------------------

If any of these
events were to occur, our business and financial condition would be harmed.

Modifications to the SilverHawk and Rinspiration System may require new
510(k) clearances or premarket approvals or may require us to recall or cease marketing the SilverHawk until clearances are obtained.

Modifications to the SilverHawk and Rinspiration System may require new 510(k) clearances or premarket approvals or require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. The FDA
requires device manufacturers to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance; however, the FDA can review a manufacturers decision. Any modification to an
FDA-cleared device that would significantly affect its safety or efficacy or that would constitute a major change in its intended use would require a new 510(k) clearance or possibly a premarket approval. We may not be able to obtain additional
510(k) clearances or premarket approvals for new products or for modifications to, or additional indications for, our products in a timely fashion, or at all. Delays in obtaining required future clearances would adversely affect our ability to
introduce new or enhanced products in a timely manner, which in turn would harm our future growth. We have made modifications to the SilverHawk in the past and may make additional modifications in the future that we believe do not or will not
require additional clearances or approvals. If the FDA disagrees and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the SilverHawk as modified, which could harm our operating results
and require us to redesign the SilverHawk. In these circumstances, we may be subject to significant enforcement actions.

If we or our suppliers fail to
comply with the FDAs Quality System Regulation, our manufacturing operations could be delayed and our sales could suffer.

Our
manufacturing processes and those of our suppliers are required to comply with the FDAs Quality System Regulation, which covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling,
packaging, storage and shipping of our products. We are also subject to similar state requirements and licenses. In addition, we must engage in extensive recordkeeping and reporting and must make available our manufacturing facilities and records
for periodic inspections by governmental agencies, including the FDA, state authorities and comparable agencies in other countries. We were inspected by the FDA in June 2006, and four observations were noted. We have submitted documentation to
address these observations. If these corrective actions are not accepted or if we fail a Quality System



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inspection, our operations could be disrupted and our manufacturing interrupted. Failure to take adequate corrective
action in response to an adverse Quality System inspection could result in, among other things, a shut-down of our manufacturing operations, significant fines, suspension of marketing clearances and approvals, seizures or recalls of our device,
operating restrictions and criminal prosecutions, any of which would cause our business to suffer. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements, which
may result in manufacturing delays for our product and cause our revenue to decline.

Our products may in the future be subject to product recalls that
could harm our reputation.

The FDA and similar governmental authorities in other countries have the authority to require the recall of
commercialized products in the event of material regulatory deficiencies or defects in design or manufacture. A government mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design or labeling
defects. In June 2004, we initiated a voluntary recall of two lots of the SilverHawk due to the possibility of improper sterilization. We continue to use both the testing facility and sterilization facility involved in the recall. In October 2004,
we received a formal closure notice from the FDA regarding the recall. Additional recalls of the SilverHawk would divert managerial and financial resources, harm our reputation with customers and have an adverse effect on our financial condition and
results of operations. A recall announcement would negatively affect our stock price.

Changes in coverage and reimbursement for procedures using our
products could affect the adoption of our products and our future revenue.

Currently, the SilverHawk procedure is typically reimbursed
by third-party payors, including Medicare, Medicaid, and private healthcare insurance companies, under existing atherectomy procedure codes, and the Rinspiration System is typically reimbursed by third-party payors, including Medicare, Medicaid, and
private healthcare insurance companies, under existing secondary and coronary thrombectomy codes. These payors may adversely change their coverage and reimbursement policies, as well as payment amounts. In September 2006, the Centers for
Medicare & Medicaid Services, or CMS, released the following 2007 increases for the three in-patient reimbursement codes most frequently used with the SilverHawk procedure, DRGs 479, 553 and 554, increased by 2.8%, 0.1% and 3.2%,
respectively. CMS also released for 2007 an increase of .05% for the reimbursement code APC 0081 which is the out-patient code that is used for the Silverhawk procedure. Also, healthcare reform legislation or regulation may be proposed or enacted in
the future, which may adversely affect such policies and amounts. We cannot predict whether and to what extent existing coverage and reimbursement will continue to be available. If physicians, hospitals and other providers are unable to obtain
adequate coverage and reimbursement for procedures using our products, they are less likely to use them and our business would be adversely impacted.

The expense and potential unavailability of insurance coverage for our company or our customers could adversely affect our ability to sell our products, which would harm our business.

We may not have sufficient insurance coverage for future product liability claims. We may not be able to obtain insurance in amounts or scope sufficient
to provide us with adequate coverage against all potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage,
harm our reputation in the industry and reduce product sales. Product liability claims in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and adversely affecting our financial condition and
operating results.

Some of our customers and prospective customers may have difficulty in procuring or maintaining liability insurance to
cover their operation and use of our products. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using our products and
potential customers may opt against purchasing our products due to the cost or inability to procure insurance coverage.

Compliance with environmental
laws and regulations could be expensive. Failure to comply with environmental laws and regulations could subject us to significant liability.

Our manufacturing operations involve the use of hazardous substances and are subject to a variety of federal, state and local environmental laws and regulations relating to the storage, use, discharge, disposal, remediation of, and human
exposure to, hazardous substances. Our research and development and manufacturing operations produce biological waste materials, such as human and animal tissue, and waste solvents, such as isopropyl alcohol. These operations are permitted by
regulatory authorities, and the resultant waste materials are disposed of in material compliance with environmental laws and regulations. Compliance with these laws and regulations may be expensive and non-compliance could result in substantial
liabilities. In addition, our manufacturing operations may result in the release, discharge, emission or disposal of hazardous substances that could cause us to incur substantial liabilities, including costs for investigation and remediation. Our
leased Redwood City facility was formerly occupied by Rohm & Haas and Occidental Chemical Company and contains residual



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contamination in soil and groundwater from these past industrial operations. Rohm & Haas and Occidental Chemical
Company previously performed soil remediation on the property under the supervision of the California Regional Water Quality Control Board. Rohm & Haas has indemnified the owner of the Bay Road facility and its tenants against costs
associated with the residual contamination, but there can be no assurance that this indemnification will be adequate to cover the extent of the liability. Environmental laws and regulations could become more stringent over time, imposing greater
compliance costs and increasing risks and penalties associated with violations. We cannot assure you that violations of these laws and regulations will not occur in the future or have not occurred in the past as a result of human error, accidents,
equipment failure or other causes. The expense associated with environmental regulation and remediation could harm our financial condition and operating results.

Our directors, officers, and affiliates have significant voting power and may take actions that may not be in the best interests of our other stockholders.

As of November 6, 2006, our directors, officers, and affiliates each holding more than 5% of our common stock collectively controlled approximately 26% our outstanding common stock, assuming the exercise of all
options held by such persons. As a result, these stockholders, if they act together, would be able to exercise significant control over the management and affairs of our company and most matters requiring stockholder approval, including the election
of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control, might adversely affect the market price of our common stock and may not be in the
best interests of our other stockholders.

Anti-takeover provisions in our amended and restated certificate of incorporation and bylaws and Delaware law
could discourage a takeover.

Our amended and restated certificate of incorporation and bylaws and Delaware law contain provisions that
might enable our management to resist a takeover. These provisions include:



| |  |  | a classified board of directors;
| | - |  | --------------------------------



| |  |  | advance notice requirements to stockholders for matters to be brought at stockholder meetings;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | a supermajority stockholder vote requirement for amending certain provisions of our amended and restated certificate of incorporation and bylaws; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

These provisions might discourage, delay or prevent a change in control of our company or a change in our management. The existence of these provisions
could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.

We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our stock.

We have never paid cash dividends and do not anticipate paying cash dividends in the foreseeable future. The payment of dividends will depend on our
earnings, capital requirements, financial condition, prospects and other factors our board of directors may deem relevant. If we do not pay dividends, our stock may be less valuable because a return on your investment will only occur if our stock
price appreciates.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

We registered the initial public offering of our common
stock, par value $0.001 per share, on a Registration Statement on Form S-1, as amended, (Registration No. 333-118191), which was declared effective on October 27, 2004. On October 28, 2004, we completed the initial public offering of
our common stock by selling 4.5 million shares at $14.00 per share, additionally, on October 29, 2004, the underwriters exercised their over-allotment option to purchase 675,000 shares at $14.00 per share. Proceeds from the offering after
deducting underwriting discounts and commissions of $5.1 million, but before expenses were $67.4 million. The managing underwriters of the offering were J.P. Morgan Securities, Inc., Piper Jaffray & Co., Thomas Weisel Partners, LLC and
William Blair & Company, LLC. All of the net proceeds from the initial public offering were spent as of the second quarter of 2005.

We registered the offer and sale of 389,653 shares of our common stock valued at $11.4 million on a registration statement on Form S-3 (the Prospectus) dated September 25, 2006. We issued these shares of our common stock to the selling
stockholders in connection with our acquisition of Kerberos Proximal Solutions, Inc. on September 12, 2006. We will not receive any proceeds from the sale of these shares and we incurred the costs relating to the registration of these shares.
Since the Prospectus has been declared effective by the SEC the selling stockholders may sell their shares on the open market or in private transactions from time-to-time subject to our right to suspend sales under the Prospectus.



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As a condition to entering into the Amended Collaboration Agreement and subject to certain closing
conditions Merck will invest $95.0 million to acquire 3,206,318 newly issued shares of our common stock at $29.629 per share, representing approximately an 11% stake in our company. The 3,206,318 shares are subject to a lock-up agreement restricting
Mercks sale of shares, which terminates upon the earlier of: i) the third anniversary of the Closing Date, ii) the occurrence of a Significant Event, iii) termination of the Amended Collaboration Agreement or iv) failure of Mercks
director designee to be re-elected to our board of directors at our 2009 annual meeting. Following termination of the lock-up we will be obligated to file a shelf registration statement providing for the resale of the shares by Merck.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

In accordance with Section 10A(i)(2) of the Securities Exchange Act of
1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002 (the Act), we are required to disclose the non-audit services approved by our Audit Committee to be performed by PricewaterhouseCoopers LLP, our external accountants.
Non-audit services are defined in the Act as services other than those provided in connection with an audit or a review of the financial statements of a company. PricewaterhouseCoopers LLP no longer provides non-audit services to us.

ITEM 6. EXHIBITS



|               |  |                                                                                                                                                                                        
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                            
|3.2*           |  | Amended and Restated Certificate of Incorporation.                                                                                                                                     
|               | 
|3.4*           |  | Bylaws.                                                                                                                                                                                
|               | 
|4.2*           |  | Amended and Restated Specimen Common Stock certificate.                                                                                                                                
|               | 
|10.1*          |  | Form of Indemnification Agreement for directors and executive officers.                                                                                                                
|               | 
|10.2*          |  | 1997 Stock Plan.                                                                                                                                                                       
|               | 
|10.3*          |  | 2004 Equity Incentive Plan.                                                                                                                                                            
|               | 
|10.4*          |  | 2004 Employee Stock Purchase Plan.                                                                                                                                                     
|               | 
|10.6*          |  | Amended and Restated Investors Rights Agreement, dated February 24, 2004, by and among the Registrant and certain stockholders.                                                       
|               | 
|10.7*          |  | First Amendment to Amended and Restated Investors Rights Agreement, dated May 21, 2004, by and among the Registrant and certain stockholders.                                         
|               | 
|10.10*         |  | Office Building Lease, dated May 3, 2004, by and between the Registrant and Woodside Technology Center, LLC for office space located at 740 Bay Road, Redwood City,
California.        
|               | 
|10.11*        |  | Master License Agreement dated August 24, 1999, by and between the Registrant and Surmodics, Inc., as amended.                                                                         
|               | 
|10.13*         |  | Second Amendment to Amended and Restated Investors Rights Agreement, dated October 25, 2004, by and among the Registrant and certain stockholders.                                    
|               | 
|10.16(A)****   |  | Separation Agreement and Release dated January 3, 2006 by and between FoxHollow Technologies, Inc. and Robert W. Thomas.                                                               
|               | 
|10.16(B)*****  |  | Time-Sharing Agreement dated September 1, 2005, by and between the Registrant and JBS Consulting LLC.                                                                                  
|               | 
|10.17*****     |  | Reimbursement Agreement dated September 1, 2006, by the Registrant, John B. Simpson and JBS Consulting, LLC.                                                                           
|               | 
|10.18*****     |  | Office Building Lease, dated November 1, 2005 by and between the Registrant and Brittania Hacienda VIII LLC for office space located at 2081 Stierlin Court, Mountain View,
California.
|               | 
|10.20******    |  | Original Equipment Manufacturing Agreement dated May 4, 2006 between the Registrant and Cook Medical.                                                                                  
|               | 
|10.21*******   |  | Amended Supplier Agreement, dated as of September 26, 2006, by and between FoxHollow Technologies, Inc. and Norman Noble, Inc.                                                         
|               | 
|10.22         |  | Amended and Restated Collaboration and License Agreement, dated as of September 26, 2006, by and between the Registrant and Merck & Co., Inc.                                          



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|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                       
|31.1           |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|               | 
|31.2           |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|               | 
|32.1           |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|               | 
|32.2           |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---

|* | Incorporated by reference from our Registration Statement on Form S-1 (Registration No. 333-118191), which was declared effective on October 27, 2004.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | Portions of the exhibit have been omitted pursuant to a request for confidential treatment. The confidential portions have been filed with the SEC.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|** | Incorporated by reference from our Form 10-Q for the quarter ended March 31, 2005 filed on May 13, 2005.
|-- | --------------------------------------------------------------------------------------------------------

|*** | Incorporated by reference from our Form 10-Q for the quarter ended September 30, 2005 filed on November 1, 2005.
|--- | ----------------------------------------------------------------------------------------------------------------

|**** | Incorporated by reference from our Form 8-K filed on January 9, 2006.
|---- | ---------------------------------------------------------------------

|***** | Incorporated by reference from our Form 10-K filed on March 7, 2006.
|----- | --------------------------------------------------------------------

|****** | Incorporated by reference from our Form 10-Q for the quarter ended March 31, 2006 filed on May 9, 2006.
|------ | -------------------------------------------------------------------------------------------------------

|******* | Incorporated by reference from our Current Report on Form 8-K filed on September 26, 2006.
|------- | ------------------------------------------------------------------------------------------



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SIGNATURES

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



|                       |  |                              |  |                                                                                         
|---------------------- |  | ---------------------------- |  | ----------------------------------------------------------------------------------------
|                       |  | FOXHOLLOW TECHNOLOGIES, INC.
|                       |  |                             
|Date: November 9, 2006 |  | By:                          |  | /s/ JOHN B. SIMPSON                                                                     
|                       |  |                              |  | John B. Simpson Chief Executive Officer (Principal Executive Officer)                   
|                       |  |                             
|Date: November 9, 2006 |  | By:                          |  | /s/ MATTHEW B. FERGUSON                                                                 
|                       |  |                              |  | Matthew B. Ferguson Chief Financial Officer (Principal Accounting and Financial Officer)



41