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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 June 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)



---

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 July 17, 2006
|Common Stock, $0.001 par value |  | 25,214,812                         



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##### Table of Contents

FOXHOLLOW TECHNOLOGIES, INC.

FORM 10-Q

TABLE OF CONTENTS



|                              |  |                                                                                              |  |     
|----------------------------- |  | -------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                              |  | Page
|Part I: Financial Information
|                              |  |                                                                                             
|Item 1.                       |  | Condensed Financial Statements (unaudited):                                                  |  |     
|                              |  |                                                                                             
|                              |  | Condensed Balance Sheets at June 30, 2006 and December 31, 2005                              |  | 3   
|                              |  |                                                                                             
|                              |  | Condensed Statements of Operations for the Three and Six Months Ended June 30, 2006 and 2005 |  | 4   
|                              |  |                                                                                             
|                              |  | Condensed Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005           |  | 5   
|                              |  |                                                                                             
|                              |  | Notes to Condensed Financial Statements                                                      |  | 6   
|                              |  |                                                                                             
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations        |  | 15  
|                              |  |                                                                                             
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                   |  | 24  
|                              |  |                                                                                             
|Item 4.                       |  | Controls and Procedures                                                                      |  | 24  
|                             
|Part II: Other Information   
|Item 1.                       |  | Legal Proceedings                                                                            |  | 25  
|                              |  |                                                                                             
|Item 1A.                      |  | Risk Factors                                                                                 |  | 25  
|                              |  |                                                                                             
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                    |  | 37  
|                              |  |                                                                                             
|Item 3.                       |  | Defaults Upon Senior Securities                                                              |  | 37  
|                              |  |                                                                                             
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                          |  | 37  
|                              |  |                                                                                             
|Item 5.                       |  | Other Information                                                                            |  | 37  
|                              |  |                                                                                             
|Item 6.                       |  | Exhibits                                                                                     |  | 38  
|                              | 
|Signatures                    |  | 40                                                                                          
|                              | 
|Certifications                |  |                                                                                             



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PART I: FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                       |  |              |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                                                       |  | June 30,2006 |         |   | December 31,2005 |  
|Assets                                                                                                                 |  |              |         |   |                  |   |         |  
|Current assets:                                                                                                        |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                              |  | $            | 24,140  |   |                  | $ | 24,249  |  
|Short-term investments                                                                                                 |  |              | 41,661  |   |                  |   | 35,666  |  
|Accounts receivable, net of allowance for doubtful accounts of $1,358 at June 30, 2006 and $1,002 at December 31,
2005 |  |              | 25,073  |   |                  |   | 21,831  |  
|Inventories                                                                                                            |  |              | 13,463  |   |                  |   | 15,607  |  
|Prepaid expenses and other current assets                                                                              |  |              | 1,583   |   |                  |   | 1,846   |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                   |  |              | 105,920 |   |                  |   | 99,199  |  
|                                                                                                                       |  |             
|Property and equipment, net                                                                                            |  |              | 8,700   |   |                  |   | 8,442   |  
|Other assets                                                                                                           |  |              | 568     |   |                  |   | 564     |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Total assets                                                                                                           |  | $            | 115,188 |   |                  | $ | 108,205 |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Liabilities and Stockholders Equity                                                                                   |  |              |         |   |                  |   |         |  
|Current liabilities:                                                                                                   |  |              |         |   |                  |   |         |  
|Accounts payable                                                                                                       |  | $            | 6,610   |   |                  | $ | 7,072   |  
|Accrued liabilities                                                                                                    |  |              | 12,125  |   |                  |   | 11,163  |  
|Deferred revenue                                                                                                       |  |              | 3,926   |   |                  |   | 6,206   |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Total liabilities                                                                                                      |  |              | 22,661  |   |                  |   | 24,441  |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Commitments and Contingencies (Note 12)                                                                                |  |              |         |   |                  |   |         |  
|                                                                                                                       |  |             
|Stockholders equity:                                                                                                  |  |              |         |   |                  |   |         |  
|Common stock: $0.001 par value per share                                                                               |  |              | 25      |   |                  |   | 24      |  
|Additional paid-in capital                                                                                             |  |              | 195,214 |   |                  |   | 178,011 |  
|Deferred stock-based compensation                                                                                      |  |              | (3,469  | ) |                  |   | (9,066  | )
|Other comprehensive loss                                                                                               |  |              | (31     | ) |                  |   | (99     | )
|Accumulated deficit                                                                                                    |  |              | (99,212 | ) |                  |   | (85,106 | )
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Total stockholders equity                                                                                             |  |              | 92,527  |   |                  |   | 83,764  |  
|                                                                                                                       |  |              |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                             |  | $            | 115,188 |   |                  | $ | 108,205 |  
|                                                                                                                       |  |              |         |   |                  |   |         |  

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



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FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                                                                        |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                                                                                                                        |  | 2006                       |        |   | 2005                     |   |        | 2006 |  |   | 2005    |  
|Revenue:                                                                                                                                                                                |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Product                                                                                                                                                                                 |  | $                          | 47,951 |   |                          | $ | 28,724 |      |  | $ | 92,534  |   |  | $ | 50,202  |  
|Research collaboration                                                                                                                                                                  |  |                            | 216    |   |                          |   |       |      |  |   | 2,280   |   |  |   |        |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net revenue                                                                                                                                                                             |  |                            | 48,167 |   |                          |   | 28,724 |      |  |   | 94,814  |   |  |   | 50,202  |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Costs and expenses:                                                                                                                                                                     |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Product (includes $312, $126, $644, and $299 in stock-based compensation expense for the three and six month periods ended June 30, 2006
and 2005)                                      |  |                            | 10,578 |   |                          |   | 8,863  |      |  |   | 21,735  |   |  |   | 17,754  |  
|Research collaboration                                                                                                                                                                  |  |                            | 708    |   |                          |   |       |      |  |   | 1,828   |   |  |   |        |  
|Research and development (includes $547, $408, $1,074, and $727 in stock-based compensation expense for the three and six month periods ended
June 30, 2006 and 2005)                   |  |                            | 4,818  |   |                          |   | 2,513  |      |  |   | 8,909   |   |  |   | 4,922   |  
|Selling, general and administrative (includes $2,031, $1,332, $15,965, and $2,616 in stock-based compensation expense for the three and six
month periods ended June 30, 2006 and 2005) |  |                            | 32,222 |   |                          |   | 21,272 |      |  |   | 77,738  |   |  |   | 38,392  |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total costs and expenses                                                                                                                                                                |  |                            | 48,326 |   |                          |   | 32,648 |      |  |   | 110,210 |   |  |   | 61,068  |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                                                                                                                                    |  |                            | (159   | ) |                          |   | (3,924 | )    |  |   | (15,396 | ) |  |   | (10,866 | )
|                                                                                                                                                                                        |  |                            |        |  
|Interest and other income and expense, net                                                                                                                                              |  |                            | 691    |   |                          |   | 482    |      |  |   | 1,290   |   |  |   | 901     |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                                                                                                                                       |  | $                          | 532    |   |                          | $ | (3,442 | )    |  | $ | (14,106 | ) |  | $ | (9,965  | )
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income (loss) per common share:                                                                                                                                                     |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Basic                                                                                                                                                                                   |  | $                          | 0.02   |   |                          | $ | (0.15  | )    |  | $ | (0.57   | ) |  | $ | (0.44   | )
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                                                                                                                                 |  | $                          | 0.02   |   |                          | $ | (0.15  | )    |  | $ | (0.57   | ) |  | $ | (0.44   | )
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Weighted-average number of shares used in per common share calculations:                                                                                                                |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Basic                                                                                                                                                                                   |  |                            | 24,847 |   |                          |   | 22,711 |      |  |   | 24,581  |   |  |   | 22,527  |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                                                                                                                                 |  |                            | 25,807 |   |                          |   | 22,711 |      |  |   | 24,581  |   |  |   | 22,527  |  
|                                                                                                                                                                                        |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  

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



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FOXHOLLOW TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                          |  |                          |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Six months endedJune 30, |        
|                                                                                          |  | 2006                     |         |   | 2005 |  
|Cash flows from operating activities:                                                     |  |                          |         |   |      |   |         |  
|Net loss                                                                                  |  | $                        | (14,106 | ) |      | $ | (9,965  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                          |         |   |      |   |         |  
|Loss (Gain) on disposal of property and equipment                                         |  |                          | 3       |   |      |   | (57     | )
|Allowance for doubtful accounts                                                           |  |                          | 356     |   |      |   | 466     |  
|Depreciation and amortization                                                             |  |                          | 2,211   |   |      |   | 1,205   |  
|Amortization of deferred stock-based compensation                                         |  |                          | 1,315   |   |      |   | 2,373   |  
|Stock-based compensation expense                                                          |  |                          | 16,368  |   |      |   | 1,269   |  
|Provision for excess and obsolete inventories                                             |  |                          | 983     |   |      |   | 705     |  
|Changes in operating assets and liabilities:                                              |  |                          |         |   |      |   |         |  
|Accounts receivable                                                                       |  |                          | (3,598  | ) |      |   | (6,860  | )
|Inventories                                                                               |  |                          | 1,161   |   |      |   | (4,150  | )
|Prepaid expenses and other current assets                                                 |  |                          | 263     |   |      |   | (813    | )
|Other assets                                                                              |  |                          | (4      | ) |      |   | (1      | )
|Accounts payable                                                                          |  |                          | (462    | ) |      |   | 2,883   |  
|Accrued liabilities                                                                       |  |                          | 1,080   |   |      |   | 3,199   |  
|Deferred revenue                                                                          |  |                          | (2,280  | ) |      |   |        |  
|                                                                                          |  |                          |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                          | 3,290   |   |      |   | (9,746  | )
|                                                                                          |  |                          |         |   |      |   |         |  
|Cash flows from investing activities:                                                     |  |                          |         |   |      |   |         |  
|Acquisition of property and equipment                                                     |  |                          | (2,474  | ) |      |   | (4,276  | )
|Proceeds from disposal of property and equipment                                          |  |                          | 2       |   |      |   | 158     |  
|Sales or maturities of investments                                                        |  |                          | 21,630  |   |      |   | 26,063  |  
|Purchases of investments                                                                  |  |                          | (27,557 | ) |      |   | (22,726 | )
|                                                                                          |  |                          |         |   |      |   |         |  
|Net cash used in investing activities                                                     |  |                          | (8,399  | ) |      |   | (781    | )
|                                                                                          |  |                          |         |   |      |   |         |  
|Cash flows from financing activities:                                                     |  |                          |         |   |      |   |         |  
|Proceeds from exercise of options to purchase common stock                                |  |                          | 1,381   |   |      |   | 202     |  
|Proceeds from issuance of common stock under the Employee Stock Purchase Plan             |  |                          | 3,619   |   |      |   | 1,609   |  
|                                                                                          |  |                          |         |   |      |   |         |  
|Net cash provided by financing activities                                                 |  |                          | 5,000   |   |      |   | 1,811   |  
|                                                                                          |  |                          |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                                 |  |                          | (109    | ) |      |   | (8,716  | )
|                                                                                          |  |                         
|Cash and cash equivalents, beginning of period                                            |  |                          | 24,249  |   |      |   | 27,506  |  
|                                                                                          |  |                          |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                  |  | $                        | 24,140  |   |      | $ | 18,790  |  
|                                                                                          |  |                          |         |   |      |   |         |  
|Supplemental disclosure of noncash investing and financing activities:                    |  |                          |         |   |      |   |         |  
|Changes in net unrealized gains (losses) on investments                                   |  |                          | 68      |   |      |   | (57     | )
|Reversal of deferred stock-based compensation                                             |  |                          | (4,282  | ) |      |   | (193    | )
|Vesting of restricted stock                                                               |  |                          | 118     |   |      |   | 208     |  

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



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FOXHOLLOW TECHNOLOGIES INC.

NOTES TO CONDENSED 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. PAD results from the accumulation of plaque in the arteries.
The Company sells the SilverHawk Plaque Excision System or SilverHawk, a minimally-invasive single-use catheter system designed for removal of plaque from arteries. Plaque removal re-opens previously narrowed arteries, allowing increased blood flow
to tissue and organs. In June 2003, the U.S. Food and Drug Administration or FDA granted 510(k) clearance to market the SilverHawk for treatment of atherosclerosis in the peripheral vasculature. In September 2005, the Company entered into a
Collaboration and License Agreement with Merck & Co., Inc. (the Merck Collaboration Agreement), pursuant to which the Company and Merck agreed to collaborate on the analysis of atherosclerotic plaque removed from patient
arteries. The Company was incorporated in the state of Delaware in September 1996.

Basis of Presentation

The accompanying unaudited condensed 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 six month period ended June 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 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.

NOTE 2Accounting for 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 six months ended June 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 Statement of Operations during the three and six months ended June 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 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.



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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 EndedJune 30,  |  | Six Months EndedJune 30, 
|                                                     |  | 2006                        |  | 2005                      |  | 2006                |  | 2005       
|Stock Options:                                       |  |                             |  |                           |  |                     |  |            
|Expected volatility                                  |  | 47%                         |  | 75%                       |  | 45%-47%             |  | 75%        
|Risk free interest rate                              |  | 5.15%                       |  | 3.96%                     |  | 4.82%-5.15%         |  | 3.71%-3.96%
|Dividend yield                                       |  | 0%                          |  | 0%                        |  | 0%                  |  | 0%         
|Expected life                                        |  | 4.5 years                   |  | 4.0 years                 |  | 4.5 years-4.7 years |  | 4.0 years  
|Weighted average fair value of stock options granted |  | $13.12                      |  | $17.24                    |  | $13.68              |  | $16.81     
|                                                     |  |                            
|                                                     |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|                                                     |  | 2006                        |  | 2005                      |  | 2006                |  | 2005       
|ESPP:                                                |  |                             |  |                           |  |                     |  |            
|Expected volatility                                  |  | 47%                         |  | 75%                       |  | 45%-81%             |  | 75%        
|Risk free interest rate                              |  | 5.29%                       |  | 3.34%                     |  | 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   |  | $9.81                       |  | $16.34                    |  | $9.68               |  | $11.58     

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 averaged 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 alone. 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.

As stock-based compensation expense recognized in the Condensed Statement of Operations for the three and six months ended June 30, 2006 is based on
awards ultimately expected to vest, it 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 for the periods prior to January 1, 2006, the Company accounted for forfeitures as they occurred.



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



|                                                   |  |                             |       |                           |   |       |  |      |        |  |   |      
|-------------------------------------------------- |  | --------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ------ |  | - | -----
|                                                   |  | Three Months Ended June 30, |       | Six Months Ended June 30,
|                                                   |  | 2006                        |       | 2005                      |   | 2006  |  | 2005
|Stock-based compensation expense by type of award: |  |                             |       |                           |   |       |  |      |        |  |   |      
|Amortization of deferred stock-based compensation  |  | $                           | 596   |                           | $ | 1,171 |  | $    | 1,315  |  | $ | 2,373
|Employee stock options & employee stock purchases  |  |                             | 2,134 |                           |   |      |  |      | 4,595  |  |   |     
|Non-employees                                      |  |                             | 160   |                           |   | 695   |  |      | 394    |  |   | 1,269
|Former chief executive officers retirement        |  |                             |      |                           |   |      |  |      | 11,379 |  |   |     
|                                                   |  |                             |       |                           |   |       |  |      |        |  |   |      
|Total stock-based compensation expense             |  | $                           | 2,890 |                           | $ | 1,866 |  | $    | 17,683 |  | $ | 3,642
|                                                   |  |                             |       |                           |   |       |  |      |        |  |   |      
|Effect on income (loss) per share:                 |  |                             |       |                           |   |       |  |      |        |  |   |      
|Basic                                              |  | $                           | 0.12  |                           | $ | 0.08  |  | $    | 0.72   |  | $ | 0.16 
|                                                   |  |                             |       |                           |   |       |  |      |        |  |   |      
|Diluted                                            |  | $                           | 0.11  |                           | $ | 0.08  |  | $    | 0.72   |  | $ | 0.16 
|                                                   |  |                             |       |                           |   |       |  |      |        |  |   |      

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. The Company recognized compensation expense for all stock-based awards at fair value on the date of grant that were issued subsequent to the initial public offering.

As of June 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 $24.3 million net of forfeitures. This cost will be amortized on a straight-line basis over the remaining weighted average requisite service
period of approximately 3.0 years.

The Company accounts for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123 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, generally two years.

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.



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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 Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                                   |  | 2005                        |        |   | 2005                      |  
|Net loss attributable to common stockholders, as reported                          |  | $                           | (3,442 | ) |                           | $ | (9,965  | )
|Deduct: Employee total stock-based compensation determined under fair value method |  |                             | (2,754 | ) |                           |   | (3,352  | )
|                                                                                   |  |                             |        |   |                           |   |         |  
|Pro forma net loss attributable to common stockholders                             |  | $                           | (6,196 | ) |                           | $ | (13,317 | )
|                                                                                   |  |                             |        |   |                           |   |         |  
|Net loss attributable to common stockholders per common share, basic and diluted:  |  |                             |        |   |                           |   |         |  
|As reported                                                                        |  | $                           | (0.15  | ) |                           | $ | (0.44   | )
|                                                                                   |  |                             |        |   |                           |   |         |  
|Pro forma                                                                          |  | $                           | (0.27  | ) |                           | $ | (0.59   | )
|                                                                                   |  |                             |        |   |                           |   |         |  

Disclosures for the three and six months ended June 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 six months ended
June 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 3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 2004 Employee Stock Purchase 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



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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. As of June 30, 2006, 472,699 shares have been issued to date in connection with the 2004 Employee
Stock Purchase Plan.

NOTE 4 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 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.



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Activity under our stock option plans are as follows:



|                            |  |                          |   |  |                     |   |  |                        |             |                |   |            |  
|--------------------------- |  | ------------------------ | - |  | ------------------- | - |  | ---------------------- | ----------- | -------------- | - | ---------- | -
|                            |  |                          |   |  | Outstanding Options |  
|                            |  | SharesAvailableFor Grant |   |  | 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             |  | (1,053,142               | ) |  | 1,053,142           |   |  |                        | 22.14-34.28 |                |   | 32,216,263 |  
|Options exercised           |  |                         |   |  | (1,017,825          | ) |  |                        | 0.32-33.77  |                |   | (1,498,000 | )
|Options cancelled           |  | 631,668                  |   |  | (631,668            | ) |  |                        | 0.32-51.75  |                |   | (8,755,346 | )
|                            |  |                          |   |  |                     |   |  |                        |             |                |   |            |  
|Balances, June 30, 2006     |  | 849,212                  |   |  | 3,459,133           |   |  | $                      | 0.32-53.73  |                | $ | 72,292,917 |  
|                            |  |                          |   |  |                     |   |  |                        |             |                |   |            |  

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



|                        |  |                     |  |                                                  |  |                               |  |                                                  |  |                    |  |                               |       |               |         |                               |   |      
|----------------------- |  | ------------------- |  | ------------------------------------------------ |  | ----------------------------- |  | ------------------------------------------------ |  | ------------------ |  | ----------------------------- | ----- | ------------- | ------- | ----------------------------- | - | -----
|Options
Outstanding     |  | Options Exercisable |  | Options Vested                                  
|Range of Exercise Price |  | NumberOutstanding   |  | Weighted-AverageRemainingContractualLife inYears |  | Weighted-AverageExercisePrice |  | Weighted-AverageRemainingContractualLife inYears |  | OptionsExercisable |  | Weighted-AverageExercisePrice |       | OptionsVested |         | Weighted-AverageExercisePrice
|$             0.32      |  | 597,941             |  | 7.16                                             |  | 0.32                          |  | 7.16                                             |  | 597,941            |  | $                             | 0.32  |               | 105,301 |                               | $ | 0.32 
|0.40                    |  | 5,000               |  | 1.46                                             |  | 0.40                          |  | 1.46                                             |  | 5,000              |  |                               | 0.40  |               | 5,000   |                               |   | 0.40 
|0.84                    |  | 23,956              |  | 5.67                                             |  | 0.84                          |  | 5.67                                             |  | 23,956             |  |                               | 0.84  |               | 22,316  |                               |   | 0.84 
|2.00                    |  | 186,430             |  | 7.84                                             |  | 2.00                          |  | 7.84                                             |  | 186,430            |  |                               | 2.00  |               | 51,137  |                               |   | 2.00 
|2.16                    |  | 21,750              |  | 4.19                                             |  | 2.16                          |  | 4.19                                             |  | 21,750             |  |                               | 2.16  |               | 21,750  |                               |   | 2.16 
|4.00                    |  | 262,101             |  | 8.06                                             |  | 4.00                          |  | 8.06                                             |  | 262,101            |  |                               | 4.00  |               | 54,154  |                               |   | 4.00 
|11.68                   |  | 272,561             |  | 8.31                                             |  | 11.68                         |  | 8.31                                             |  | 272,561            |  |                               | 11.68 |               | 97,895  |                               |   | 11.68
|22.14-24.02             |  | 73,607              |  | 8.58                                             |  | 23.91                         |  | 8.45                                             |  | 25,553             |  |                               | 24.02 |               | 25,553  |                               |   | 24.02
|24.75-27.34             |  | 241,842             |  | 9.71                                             |  | 26.00                         |  |                                                 |  |                   |  |                               |      |               |        |                               |   |     
|27.93                   |  | 170,250             |  | 8.82                                             |  | 27.93                         |  | 8.82                                             |  | 52,477             |  |                               | 27.93 |               | 52,477  |                               |   | 27.93
|28.20-29.80             |  | 375,150             |  | 8.60                                             |  | 28.23                         |  | 8.59                                             |  | 131,264            |  |                               | 28.22 |               | 131,264 |                               |   | 28.22
|30.12-31.44             |  | 549,800             |  | 9.58                                             |  | 30.69                         |  | 8.68                                             |  | 28,724             |  |                               | 30.35 |               | 28,724  |                               |   | 30.35
|32.24-35.86             |  | 277,400             |  | 9.50                                             |  | 34.29                         |  | 8.90                                             |  | 3,103              |  |                               | 34.94 |               | 3,103   |                               |   | 34.94
|36.90-39.71             |  | 162,200             |  | 8.98                                             |  | 38.30                         |  | 8.95                                             |  | 42,061             |  |                               | 37.60 |               | 42,061  |                               |   | 37.60
|41.88-45.91             |  | 111,820             |  | 9.25                                             |  | 44.53                         |  |                                                 |  |                   |  |                               |      |               |        |                               |   |     
|46.35-51.43             |  | 39,650              |  | 9.22                                             |  | 48.20                         |  |                                                 |  |                   |  |                               |      |               |        |                               |   |     
|51.75-53.73             |  | 87,675              |  | 9.09                                             |  | 51.78                         |  | 9.09                                             |  | 4,436              |  |                               | 51.75 |               | 4,436   |                               |   | 51.75
|                        |  |                     |  |                                                  |  |                               |  |                                                  |  |                    |  |                               |       |               |         |                               |   |      
|$         0.32-53.73    |  | 3,459,133           |  | 8.56                                             |  | 20.90                         |  | 7.76                                             |  | 1,657,357          |  | $                             | 8.11  |               | 645,171 |                               | $ | 15.71
|                        |  |                     |  |                                                  |  |                               |  |                                                  |  |                    |  |                               |       |               |         |                               |   |      

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 June 30, 2006, a
total of 198,831 shares of common stock at an aggregate price of $207,000 were subject to repurchase.



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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 June 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 June 30, 2006 and related balances have been classified as accrued liabilities.

NOTE 5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):



|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|--------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                                                                |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                                                                |  | 2006                        |        |   | 2005                      |   |        | 2006 |  |   | 2005    |  
|Numerator:                                                                                                      |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Net income (loss)                                                                                               |  | $                           | 532    |   |                           | $ | (3,442 | )    |  | $ | (14,106 | ) |  | $ | (9,965 | )
|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Denominator:                                                                                                    |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Basic weighted-average common shares outstanding                                                                |  |                             | 25,108 |   |                           |   | 23,258 |      |  |   | 24,864  |   |  |   | 23,135 |  
|Less: Weighted-average unvested common shares subject to repurchase                                             |  |                             | (261   | ) |                           |   | (547   | )    |  |   | (283    | ) |  |   | (608   | )
|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Weighted-average number of common shares outstanding used in computing basic net income (loss) per common share |  |                             | 24,847 |   |                           |   | 22,711 |      |  |   | 24,581  |   |  |   | 22,527 |  
|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Net effect of dilutive stock options based on the treasury stock method using average market price              |  |                             | 960    |   |                           |   |       |      |  |   |        |   |  |   |       |  
|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Diluted weighted-average shares outstanding                                                                     |  |                             | 25,807 |   |                           |   | 22,711 |      |  |   | 24,581  |   |  |   | 22,527 |  
|                                                                                                                |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  

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 Ended June 30, |  | Six Months Ended June 30,
|                                 |  | 2006                        |  | 2005                      |  | 2006  |  | 2005 
|Options to purchase common stock |  | 1,935                       |  | 4,438                     |  | 3,540 |  | 4,438
|                                 |  |                             |  |                           |  |       |  |      
|                                 |  | 1,935                       |  | 4,438                     |  | 3,540 |  | 4,438
|                                 |  |                             |  |                           |  |       |  |      

NOTE 6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).



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NOTE 7Investments:

Investments consisted of the following (in thousands):



|                                                         |  |           |        |                 |   |                  |  |   |            |   |  |   |       
|-------------------------------------------------------- |  | --------- | ------ | --------------- | - | ---------------- |  | - | ---------- | - |  | - | ------
|                                                         |  | CostBasis |        | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue 
|At June 30, 2006                                         |  |           |        |                 |   |                  |  |   |            |   |  |   |       
|US Government securities (maturities less than one year) |  | $         | 21,614 |                 | $ | 1                |  | $ | (32        | ) |  | $ | 21,583
|Corporate bonds (maturities less than one year)          |  |           | 20,078 |                 |   | 13               |  |   | (13        | ) |  |   | 20,078
|                                                         |  |           |        |                 |   |                  |  |   |            |   |  |   |       
|Total                                                    |  | $         | 41,692 |                 | $ | 14               |  | $ | (45        | ) |  | $ | 41,661
|                                                         |  |           |        |                 |   |                  |  |   |            |   |  |   |       
|                                                         |  |           |        |                
|                                                         |  | CostBasis |        | UnrealizedGains |   | UnrealizedLosses |  |   | Fair Value
|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 Statements of Operations.

NOTE 8Inventories:

Inventories consisted of the following (in thousands):



|                |  |              |        |                  |   |       
|--------------- |  | ------------ | ------ | ---------------- | - | ------
|                |  | June 30,2006 |        | December 31,2005
|Raw materials   |  | $            | 8,317  |                  | $ | 9,808 
|Work in process |  |              | 988    |                  |   | 896   
|Finished goods  |  |              | 4,158  |                  |   | 4,903 
|                |  |              |        |                  |   |       
|                |  | $            | 13,463 |                  | $ | 15,607
|                |  |              |        |                  |   |       

NOTE 9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 Statements of Operations as a component of product costs and expenses. A reconciliation
of the changes in the Companys warranty liability for the six months ended June 30, 2006 and 2005 follows (in thousands):



|                             |  |      |      |   |      |   |      |  
|---------------------------- |  | ---- | ---- | - | ---- | - | ---- | -
|                             |  | 2006 |      |   | 2005 |  
|Balance at January 1         |  | $    | 217  |   |      | $ | 207  |  
|Add: Accruals for warranties |  |      | 567  |   |      |   | 601  |  
|Less: Cost of replacements   |  |      | (486 | ) |      |   | (555 | )
|                             |  |      |      |   |      |   |      |  
|Balance at June 30           |  | $    | 298  |   |      | $ | 253  |  
|                             |  |      |      |   |      |   |      |  



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NOTE 10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. The Company recognized $216,000
and $2.3 million as revenue in the three and six months ended June 30, 2006, respectively, and will continue to recognize plaque analysis revenue as it fulfills its obligations and delivers tissue samples under the Merck Collaboration
Agreement.

NOTE 11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.

NOTE 12Commitments and Contingencies

In July 2006, a purported shareholder class action complaint was filed against the Company and two of our officers in the U.S. District Court for the
Northern District of California. The plaintiff is 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 complaint 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.



14



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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 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 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
June 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 to at least
initially 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 in the three and six months ended June 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 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.



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##### Table of Contents

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 the Merck Collaboration Agreement through which we agreed with Merck to collaborate on the analysis of atherosclerotic
plaque removed from patient arteries with the goal of identifying new biomarkers for atherosclerotic disease progression. The Merck Collaboration Agreement provided for a research collaboration of up to three years and consists of an initial
one-year research term that Merck may, at its discretion, extend for one or two additional years. We are currently in discussions with Merck about extending the Collaboration agreement. As part of this research collaboration, we will provide Merck
with exclusive access to existing atherosclerotic plaque samples collected from patients having vascular disease using the SilverHawk Plaque Excision System as well as new samples to be collected pursuant to agreed upon protocols and criteria. Upon
execution of the Merck Collaboration Agreement, we received an initial cash payment of $9.0 million to cover costs associated with our responsibilities and for the rights granted to Merck during the initial year of the research collaboration. We may
also be entitled to additional payments of at least $7.0 million and up to $31.0 million over the following two years, if Merck elects to extend the research collaboration beyond its initial one-year term and/or exercise an option to maintain
exclusive access to our atherosclerotic plaque samples. We may derive further revenue from the Merck Collaboration Agreement for milestone payments based on the progress of clinical development of any pharmaceutical or diagnostic products arising
from work under the research collaboration, as well as royalties on sales of any such products.

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 of the offering exercised their over-allotment option to purchase 675,000 shares. Proceeds from the
offering after deducting underwriting discounts and commissions but before expenses were $67.4 million.

For the six months ended
June 30, 2006, we generated net revenue of $94.8 million and a net loss of $14.1 million and as of June 30, 2006, our accumulated deficit was $99.2 million. As of June 30, 2006, our cash, cash equivalents and investment balances
totaled $65.8 million.



16



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##### Table of Contents

Results of Operations

Three Months Ended June 30, 2006 and June 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 June 30, |       
|                                                                                                                                                                     |  | 2006                        |        |   | 2005            |    
|                                                                                                                                                                     |  | Amount                      |        |   | % of NetRevenue |     |   | Amount |   |        | % of NetRevenue | 
|Revenue:                                                                                                                                                             |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Product                                                                                                                                                              |  | $                           | 47,951 |   |                 | 100 | % |        | $ | 28,724 |                 |  | 100 | %
|Research collaboration                                                                                                                                               |  |                             | 216    |   |                 | 0   | % |        |   |       |                 |  | 0   | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Net revenue                                                                                                                                                          |  |                             | 48,167 |   |                 | 100 | % |        |   | 28,724 |                 |  | 100 | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Costs and expenses:                                                                                                                                                  |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Product (includes $312 and $126 in stock-based compensation expense for the three months ended June 30, 2006 and 2005,
respectively)                                 |  |                             | 10,578 |   |                 | 22  | % |        |   | 8,863  |                 |  | 31  | %
|Research collaboration                                                                                                                                               |  |                             | 708    |   |                 | 1   | % |        |   |       |                 |  | 0   | %
|Research and development (includes $547 and $408 in stock-based compensation expense for the three months ended June 30, 2006 and 2005,
respectively)                |  |                             | 4,818  |   |                 | 10  | % |        |   | 2,513  |                 |  | 9   | %
|Selling, general and administrative (includes $2,031 and $1,332 in stock-based compensation expense for the three months ended June 30,
2006 and 2005, respectively) |  |                             | 32,222 |   |                 | 67  | % |        |   | 21,272 |                 |  | 74  | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Total costs and expenses                                                                                                                                             |  |                             | 48,326 |   |                 | 100 | % |        |   | 32,648 |                 |  | 114 | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Loss from operations                                                                                                                                                 |  |                             | (159   | ) |                 | 0   | % |        |   | (3,924 | )               |  | -14 | %
|                                                                                                                                                                     |  |                             |        |  
|Interest and other income and expense, net                                                                                                                           |  |                             | 691    |   |                 | 1   | % |        |   | 482    |                 |  | 2   | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  
|Net income (loss)                                                                                                                                                    |  | $                           | 532    |   |                 | 1   | % |        | $ | (3,442 | )               |  | -12 | %
|                                                                                                                                                                     |  |                             |        |   |                 |     |   |        |   |        |                 |  |     |  

Revenue:

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

Product. Product
revenue is derived from sales of the SilverHawk Plaque Excision System. Product revenue was $48.0 million for the three months ended June 30, 2006 as compared to $28.7 million for the three months ended June 30, 2005. The increase of $19.3
million was attributable to an increase in the number of SilverHawk devices sold as well as a 14% 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 and to penetrate
new customer accounts.

Research collaboration.Research collaboration revenue is derived from the Merck Collaboration
Agreement. Research collaboration revenue was $216,000 for the three months ended June 30, 2006 as compared to $0 for the three months ended June 30, 2005. The $216,000 of revenue was recognized in connection with delivery of tissue
samples to Merck under the agreement. The agreement provided for an initial payment of $9.0 million which covers 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 we will recognize revenue as we fulfill our obligations and deliver tissue samples. We expect our research collaboration revenue to increase in future quarters as we expand
enrollment in clinical studies that will allow for the collection and delivery of additional tissue samples and the recognition of the remaining deferred revenue balance of $3.9 million.



17



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##### Table of Contents

Costs and Expenses:

Our costs and expenses consist of four components: product; research collaboration; research and development; and selling, general and administrative.

Product. Product cost consists primarily of material, labor and overhead costs. Product costs were $10.6 million for the three months ended
June 30, 2006 as compared to $8.9 million for the three months ended June 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
22% in the three months ended June 30, 2006 as compared to 31% in the three months ended June 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 be approximately constant as a percentage of product revenue.

Research Collaboration. Research collaboration expenses consist of costs associated with procurement and delivery of tissue samples under the Merck Collaboration Agreement. Research collaboration
expenses were $708,000 for the three months ended June 30, 2006 as compared to $0 for the three months ended June 30, 2005. We expect that research collaboration expenses will increase in absolute dollars and decrease as a percentage of
research collaboration revenue 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 $4.8 million for the three months ended June 30, 2006 as compared to $2.5 million for the three months ended June 30, 2005. The increase was primarily attributable to a $1.3 million
increase in personnel related costs, a $783,000 increase in materials and services used in product development, a $139,000 increase in stock-based compensation, and a $74,000 increase in clinical research studies. As a percentage of net revenue,
research and development expenses were 10% in the three months ended June 30, 2006 as compared to 9% for the three months ended June 30, 2005. We expect research and development expenses to increase in absolute terms as we explore new
technologies and commence new clinical trials.

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
$32.2 million for the three months ended June 30, 2006 as compared to $21.3 million for the three months ended June 30, 2005. The increase was primarily attributable to an $8.7 million increase in personnel costs related to additional
hiring of sales, marketing, and administrative personnel and sales commissions paid, an $845,000 increase in marketing and promotional activities, and a $699,000 increase in stock-based compensation. As a percentage of net revenue, selling, general
and administrative expenses in the three months ended June 30, 2006 were 67% as compared to 74% for the three months ended June 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.

Interest and Other Income and Expense, net. Interest and other income and expense were $691,000 for the three months ended June 30,
2006 as compared to $482,000 for the three months ended June 30, 2005. The increase in interest and other income is primarily attributable to higher interest rates earned on our investment balances.



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##### Table of Contents

Six Months Ended June 30, 2006 and June 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:



|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | --------------- | --- | - | ------ | - | ------- | --------------- |  | --- | -
|                                                                                                                                                                    |  | Six Months Ended June 30, |        
|                                                                                                                                                                    |  | 2006                      |         |   | 2005            |    
|                                                                                                                                                                    |  | Amount                    |         |   | % of NetRevenue |     |   | Amount |   |         | % of NetRevenue | 
|Revenue:                                                                                                                                                            |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Product                                                                                                                                                             |  | $                         | 92,534  |   |                 | 98  | % |        | $ | 50,202  |                 |  | 100 | %
|Research collaboration                                                                                                                                              |  |                           | 2,280   |   |                 | 2   | % |        |   |        |                 |  | 0   | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Net revenue                                                                                                                                                         |  |                           | 94,814  |   |                 | 100 | % |        |   | 50,202  |                 |  | 100 | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Costs and expenses:                                                                                                                                                 |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Product (includes $644 and $299 in stock-based compensation expense for the six months ended June 30, 2006 and 2005,
respectively)                                  |  |                           | 21,735  |   |                 | 23  | % |        |   | 17,754  |                 |  | 35  | %
|Research collaboration                                                                                                                                              |  |                           | 1,828   |   |                 | 2   | % |        |   |        |                 |  | 0   | %
|Research and development (includes $1,074 and $727 in stock-based compensation expense for the six months ended June 30, 2006 and 2005,
respectively)               |  |                           | 8,909   |   |                 | 9   | % |        |   | 4,922   |                 |  | 10  | %
|Selling, general and administrative (includes $15,965 and $2,616 in stock-based compensation expense for the six months ended June 30,
2006 and 2005, respectively) |  |                           | 77,738  |   |                 | 82  | % |        |   | 38,392  |                 |  | 77  | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Total costs and expenses                                                                                                                                            |  |                           | 110,210 |   |                 | 116 | % |        |   | 61,068  |                 |  | 122 | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Loss from operations                                                                                                                                                |  |                           | (15,396 | ) |                 | -16 | % |        |   | (10,866 | )               |  | -22 | %
|                                                                                                                                                                    |  |                           |         |  
|Interest and other income and expense, net                                                                                                                          |  |                           | 1,290   |   |                 | 1   | % |        |   | 901     |                 |  | 2   | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  
|Net loss                                                                                                                                                            |  | $                         | (14,106 | ) |                 | -15 | % |        | $ | (9,965  | )               |  | -20 | %
|                                                                                                                                                                    |  |                           |         |   |                 |     |   |        |   |         |                 |  |     |  

Revenue:

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

Product. Product
revenue was $92.5 million for the six months ended June 30, 2006 as compared to $50.2 million for the six months ended June 30, 2005. The increase of $42.3 million was attributable to an increase in the number of SilverHawk devices sold as
well as a 16% 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 $2.3 million for the six months
ended June 30, 2006 as compared to $0 for the six months ended June 30, 2005. The $2.3 million of revenue was recognized in connection with delivery of tissue samples under the Merck Collaboration Agreement. The agreement provided for an
initial payment of $9.0 million which covers 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 will recognize revenue as it fulfills its obligations and delivers tissue samples.



19



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##### Table of Contents

Costs and Expenses:

Our costs and expenses consist of four components: product, research collaboration, research and development, and selling, general and administrative.

Product. Product costs were $21.7 million for the six months ended June 30, 2006 as compared to $17.8 million for the six months ended
June 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 23% in the six months ended June 30, 2006 as compared to 35% in the six
months ended June 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 $1.8 million for the six months ended June 30, 2006 as compared to $0 for
the six months ended June 30, 2005. As a percentage of research collaboration revenue, research collaboration costs were 80% for the six months ended June 30, 2006.

Research and Development. Research and development expenses were $8.9 million for the six months ended June 30, 2006 as compared to
$4.9 million for the six months ended June 30, 2005. The increase was primarily attributable to a $2.2 million increase in personnel related costs, a $1.3 million increase in materials and services used in product development, and a $347,000
increase in stock-based compensation. As a percentage of net revenue, research and development expenses were 9% for the six months ended June 30, 2006 as compared to 10% for the six months ended June 30, 2005.

Selling, General and Administrative. Selling, general and administrative expenses were $77.7 million for the six months ended June 30,
2006 as compared to $38.4 million for the six months ended June 30, 2005. The increase was primarily attributable to a $21.4 million increase in personnel costs related to additional hiring of sales, marketing, and administrative personnel and
sales commissions paid, a $13.3 million increase in stock-based compensation, of which $11.4 million relates to the retirement of our former chief executive officer, a $2.0 million increase in marketing and promotional activities, and a $1.7 million
increase in travel and related expenses. As a percentage of net revenue selling, general and administrative expenses in the six months ended June 30, 2006 were 82% as compared to 77% for the six months ended June 30, 2005.

Interest and Other Income and Expense, net. Interest and other income and expense were $1.3 million for the six months ended June 30,
2006 as compared to $901,000 for the six months ended June 30, 2005. The increase in interest and other income is primarily attributable to higher interest rates earned on our investment balances.



20



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##### Table of Contents

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 June 30, 2006 was $15.5 million, net of stock option cancellations, with accumulated amortization of $12.0 million. The remaining $3.5 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 6 months of 2006 |  | $      | 1.2 million
|2007                       |  | $      | 1.8 million
|2008                       |  | $      | 0.5 million

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 $160,000 and $695,000 in stock-based compensation expense for non-employees in the three months ended June 30, 2006 and 2005, respectively, and $394,000 and $1.3 million in the six months ended
June 30, 2006 and 2005, respectively.

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 six months ended June 30, 2006 we recorded $2.7 million and $17.3 million, respectively,
in stock-based compensation expense for employees. The six month figure includes a charge of $11.4 million related to the retirement of our former chief executive officer.

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 June 30, 2006, we had $24.1 million of cash and cash equivalents, $41.7
million of investments, and $83.3 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 June 30, 2006:



|                        |  |                                       |        |                         |   |       |  |      |       |      |   |       |  |            |       |  |   |       |  |   |       
|----------------------- |  | ------------------------------------- | ------ | ----------------------- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | ---------- | ----- |  | - | ----- |  | - | ------
|                        |  | Payments Due by Period (in thousands)
|Contractual Obligations |  | Total                                 |        | 2006(remaining6 months) |   | 2007  |  | 2008 |       | 2009 |   | 2010  |  | Thereafter
|Operating leases        |  | $                                     | 44,381 |                         | $ | 450   |  | $    | 4,656 |      | $ | 4,582 |  | $          | 4,678 |  | $ | 4,789 |  | $ | 25,226
|Royalty obligation      |  |                                       | 42     |                         |   | 42    |  |      |      |      |   |      |  |            |      |  |   |      |  |   |      
|Purchase agreement      |  |                                       | 4,477  |                         |   | 1,649 |  |      |      |      |   | 2,828 |  |            |      |  |   |      |  |   |      
|                        |  |                                       |        |                         |   |       |  |      |       |      |   |       |  |            |       |  |   |       |  |   |       
|                        |  | $                                     | 48,900 |                         | $ | 2,141 |  | $    | 4,656 |      | $ | 7,410 |  | $          | 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, and 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.



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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. Under the terms of this agreement, the Company will be required to make payments to the supplier for differences between actual purchase quantities and the minimum purchase quantities defined in the agreement. According to the
agreement the purchase quantities are based on two eighteen month terms.

Net Cash Provided by (Used in) Operating
Activities. Net cash provided by operating activities was $3.3 million for the six months ended June 30, 2006 as compared to $9.7 million used in operating activities for the six months ended June 30, 2005. For the six months ended
June 30, 2006, net cash provided by operating activities was primarily attributable to a net loss of $14.1 million offset by non-cash charges of $17.7 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 $2.2 million, and an increase in inventory reserves of $1.0 million. Net cash provided by operating activities was also due to an increase in accrued
liabilities of $1.1 million due to our increased operating expenses, and a decrease in inventories of $1.2 million due to the increase in the number of units shipped. Net cash provided by operating activities was partially offset by an increase in
accounts receivable of $3.6 million as we increased our net revenue and a decrease in deferred revenue of $2.3 million as we delivered tissue samples under the Merck Collaboration Agreement. For the six months ended June 30, 2005, net cash used
in operating activities was primarily attributable to a net loss of $10.0 million and increases in accounts receivable and inventory balances of $6.9 million and $4.2 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 $3.6 million, depreciation and amortization of $1.2 million and increases in accrued liabilities and accounts
payable of $6.1 million due to our increased operating expenses.

Net Cash Used in Investing Activities. Net cash used in
investing activities was $8.4 million for the six months ended June 30, 2006 compared to $781,000 for the six months ended June 30, 2005. For each of the six month periods ended June 30, 2006 and June 30, 2005, net cash used in
investing activities was attributable to purchases of investments and acquisition of property and equipment offset by sales or maturities of investments.

Net Cash Provided by Financing Activities. Net cash provided by financing activities was $5.0 million for the six months ended June 30, 2006 compared to $1.8 million for the six months ended
June 30, 2005. For each of the six month periods ended June 30, 2006 and June 30, 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;
| | - |  | ---------------------------------------------



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



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



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



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



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| |  |  | 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 June 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.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed 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 policy:

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 six months ended June 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 Statement of Operations during the three and six months
ended June 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



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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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk at
June 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 100% of our sales were made in U.S. dollars for the three
and six months ended June 30, 2006 and 2005. 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.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In July 2006, a purported shareholder class action complaint was filed against
the Company and two of our officers in the U.S. District Court for the Northern District of California. The plaintiff is 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 complaint 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.

ITEM 1A. RISK FACTORS

Factors Affecting Future Operating Results

We have a new management team and may experience instability as a result.

In December 2005 our president and chief executive officer retired from our company. Since that time, our vice president of sales and vice president of marketing have resigned and we chose to replace our chief
operating officer. Additionally, we created a leadership committee consisting of our new chief operating officer, our chief financial officer and our president of strategic operations. In June our founder Dr. John Simpson was appointed as chief
executive officer. In the event that this management structure does not stabilize our company, other officers and employees may choose to leave the company and our revenues and stock price may decline as a result.

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

We may become involved in costly arbitration or litigation with former employees in connection with their
departure or by our stockholders who have suffered losses during this period of transition. 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 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 only product, and we are wholly 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. 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. Failure of the SilverHawk to significantly penetrate current or new markets would negatively impact our business, financial condition and results of operations.



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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.

The SilverHawk is
a novel product, and our success depends on its acceptance 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. 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-term restenosis and patency rates up to one year following treatment. None of these studies were conducted by us. We plan to conduct studies designed to measure restenosis rates or patency rates
after treatment with the SilverHawk. These studies may be expensive and time consuming and the results may not prove favorable for the SilverHawk device.

Our TALON registry may produce limited subset data regarding restenosis and patency rates, but such an evaluation is not mandated by the registry protocol. Another important factor that physicians will consider is the
rate of reintervention, or retreatment, following the SilverHawk procedure. In data presented in October 2005, we announced consistent reintervention data on a much larger group of patients from the TALON registry. Patients are no longer being
enrolled in the registry. We cannot provide any assurance that the data from the registry will be compelling to the medical community, because it may not be scientifically meaningful and may not demonstrate that the SilverHawk is an attractive
procedure when compared against data from alternative procedures. 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.

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.

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.



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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 $14.1
million in the six months ended June 30, 2006 and $11.6 million in 2005. As of June 30, 2006, we had an accumulated deficit of $99.2 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 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, which requires physicians to change their screening and
referral practices.

Although there is a significant correlation between 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 both coronary artery
disease and 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 in particular, they may not refer patients to interventional cardiologists, vascular surgeons or interventional radiologists for the SilverHawk procedure, 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.

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



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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 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. 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.

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 in commercial
quantities, which could adversely impact our business.

Because we have only limited experience in manufacturing the SilverHawk 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 the SilverHawk 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 the SilverHawk 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
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | all of our manufacturing occurs at a single facility and if we were to lose availability of this facility 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 the SilverHawk,
our revenue could be impaired, market acceptance for the SilverHawk could be adversely affected, and our customers might instead purchase our competitors products. Additionally, although we maintain business interruption



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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. 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 SilverHawk components, 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 our components. For example, 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. These components are critical to the SilverHawk 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, 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 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 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



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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.

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.

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.

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. 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 the SilverHawk from our
competitors and their products, and includes such factors as:



| |  |  | the SilverHawks ability to treat PAD 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 treating PAD, 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 the SilverHawk 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,
the SilverHawk could become obsolete, and our revenue would decline as our customers purchase our competitors products.

We do not
currently have a vice president of research and development and 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 the SilverHawk.

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 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 the SilverHawk to avoid infringement. Adverse determinations in a
judicial or administrative



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proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling the SilverHawk, 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 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 a SilverHawk device 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.

The Merck Collaboration Agreement may not result in revenue beyond the initial payment we received and many of the factors affecting the likelihood of
generating any such revenue are not within our control.

The Merck Collaboration Agreement may be terminated by Merck at any time in its
sole discretion. Additionally, even if extended beyond the initial one year term, the payments may be reduced if we do not meet certain milestones or if Merck elects to waive its exclusivity rights. As a result, any additional payments for our
services to Merck pursuant to the Merck Collaboration Agreement may be reduced or eliminated. Also, the additional revenue from Merck for milestone payments based on the progress of clinical development of certain pharmaceutical and diagnostic
products arising from work under the research collaboration, as well as royalties on sales of any such products, are substantially or entirely based on Mercks efforts under this Agreement. The development of Mercks drug therapies from
our collaboration are long-term projects with significant research, clinical, development, and execution risks. As a result, the achievement of the milestones and any sales of a product may not happen for many years, or may not happen at all.



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

The SilverHawk is a
medical device that is 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.

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 second quarter of 2006, the FDA has received eight medical device reports associated with procedures where the SilverHawk was used.
These filings included two deaths, one procedurally-related (no device failure) that resulted in post-procedure death due to septic shock stemming from pre-existing gangrene and one in which surgery was performed to remove a detached nosecone that
was later determined to be located in the sheath and not the patient. The patient died five days later due to unrelated cardiac issues. The remaining filings were comprised of one due to the placement of a covered stent to treat a fistula caused
during the retraction of a device into a damaged sheath, two filings due to two devices used in the same case that resulted in surgery to clear an occlusion that resulted from either procedure or device-related emboli, one due to intervention to
remove emboli after treatment of a chronic total occlusion, one due to emboli from a damaged tip, and one due to a cut-down procedure being required to repair a perforation in an artery in the foot.

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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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 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 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, the SilverHawk 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 SilverHawk 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 the SilverHawk. 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 are in the process of submitting documentation to address said observations. If these corrective
action are not accepted or if we fail a Quality System 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.

The SilverHawk has been and 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.



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Changes in coverage and reimbursement for procedures using the SilverHawk could affect the adoption of the SilverHawk
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. These payors may adversely change their coverage and reimbursement policies, as well as payment amounts. In April 2006, the Centers for
Medicare & Medicaid Services, or CMS, released for public comment a recommendation that the three in-patient reimbursement codes most frequently used with the SilverHawk procedure, DRGs 479, 553 and 554, be reduced for the 2007 fiscal year
by 9%, 6% and 3%, respectively. 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 the SilverHawk procedure, they are less likely to use it 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
the SilverHawk, 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 the SilverHawk. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or
worsens, our customers may discontinue using the SilverHawk and potential customers may opt against purchasing the SilverHawk 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 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.



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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 July 17, 2006, our directors, officers, and affiliates each holding more than 5% of our
common stock collectively will control 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.

The cost of public company compliance with the securities laws and regulations is substantial and recently enacted and proposed changes to these laws and regulations will further increase our general and
administrative expenses.

The cost of complying with the reporting requirements under the Securities and Exchange Act of 1934 are
substantial. In addition, the Sarbanes-Oxley Act of 2002, along with other recent and proposed rules from the SEC and NASDAQ, have required further legal and financial compliance costs, and made some corporate actions more difficult. For example,
compliance with the internal control requirements of Sarbanes-Oxley Section 404 requires us to commit significant resources to document and review the adequacy of our internal controls. If we are unable to maintain compliance with the
requirements of Section 404, we will have to issue a report that our internal controls are not effective, which could cause the market price of our stock to decline.

In addition, the changes in securities laws and regulations may make it more difficult and more expensive for us to maintain directors and officers liability insurance, and we may be required to accept reduced
coverage or incur substantially higher costs to obtain coverage. These developments also could make it more difficult for us to attract and retain qualified executive officers and members of our board of directors, particularly with regard to our
audit committee.



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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.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

We held an annual meeting on June 28,
2006 at our corporate headquarters in Redwood City, California. The first item of business was the election of one Class II director. The nominee elected was Jeffrey B. Child. The nominee was elected by a majority of votes present at the meeting as
follows:



|                 |  |            |  |               
|---------------- |  | ---------- |  | --------------
|Name             |  | Votes For  |  | Votes Withheld
|Jeffrey B. Child |  | 21,689,386 |  | 183,782       

The appointment of PricewaterhouseCoopers LLP as the Companys independent registered public accounting firm
for the year ended December 31, 2006 was ratified with 21,767,256 votes in favor, 97,077 against and 8,835 abstentions.

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 the Company.



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ITEM 6. EXHIBITS



|              |  |                                                                                                                                                                                        
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | 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.                                    
|              | 
|10.14**      |  | Supplier Agreement between the Registrant and Norman Noble, Inc. dated March 25, 2005.                                                                                                 
|              | 
|10.15***     |  | Collaboration and License Agreement between the Registrant and Merck & Co. Inc. dated September 14, 2005.                                                                              
|              | 
|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.                                                                                  
|              | 
|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.                                                                                    



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|     |  |                                                                                                                                                   
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|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.
|------ | -------------------------------------------------------------------------------------------------------



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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: August 9, 2006 |  |  |  | By: |  | /s/ John B. Simpson         
|                     |  |  |  |     |  |                              |  | John B. Simpson Chief Executive Officer (Principal Executive Officer)



|                     |  |  |  |     |  |                         |  |                                                                                         
|-------------------- |  |  |  | --- |  | ----------------------- |  | ----------------------------------------------------------------------------------------
|                     |  |  | 
|Date: August 9, 2006 |  |  |  | By: |  | /s/ Matthew B. Ferguson
|                     |  |  |  |     |  |                         |  | Matthew B. Ferguson Chief Financial Officer (Principal Accounting and Financial Officer)



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