##### Table of Contents

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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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x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2005



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 000-51066



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CONOR MEDSYSTEMS, INC.

(Exact Name of Registrant as Specified in its Charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 94-3350973                             
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification Number)



1003 Hamilton Court

Menlo Park, California 94025

(Address of Principal Executive Offices, including Zip Code)



(650) 614-4100

(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 reports), and (2) has been subject to such filing requirements for
the past 90 days.  YES  x  NO ̈



Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).  YES ̈NO  x



The registrant had 33,344,137 shares of Common Stock, $0.001
par value per share, outstanding as of May 2, 2005.



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##### Table of Contents

CONOR MEDSYSTEMS, INC.



FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2005



TABLE OF CONTENTS



|          |  |                                                                                       |  |   
|--------- |  | ------------------------------------------------------------------------------------- |  | --
|          |  |                                                                                      
|PART I.   |  | FINANCIAL INFORMATION                                                                 |  |   
|          |  |                                                                                      
|Item 1.   |  | Financial Statements                                                                  |  |   
|          |  |                                                                                      
|          |  | Condensed Consolidated Balance Sheets                                                 |  | 3 
|          |  |                                                                                      
|          |  | Condensed Consolidated Statements of Operations                                       |  | 4 
|          |  |                                                                                      
|          |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5 
|          |  |                                                                                      
|          |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6 
|          |  |                                                                                      
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 12
|          |  |                                                                                      
|Item 3.   |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 34
|          |  |                                                                                      
|Item 4.   |  | Controls and Procedures                                                               |  | 34
|          |  |                                                                                      
|PART II.  |  | OTHER INFORMATION                                                                     |  |   
|          |  |                                                                                      
|Item 1.   |  | Legal Proceedings                                                                     |  | 34
|          |  |                                                                                      
|Item 2.   |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 35
|          |  |                                                                                      
|Item 6.   |  | Exhibits                                                                              |  | 36
|          |  |                                                                                      
|SIGNATURE |  |                                                                                       |  | 37



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



Conor Medsystems, Inc.

(a development stage company)



Condensed Consolidated Balance Sheets

(In thousands, except per share amounts)



|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                         |  |               
|                                                                                                                                                                                                         |  | March 31, 2005 |         |   | December 31, 2004 |  
|                                                                                                                                                                                                         |  |               
|                                                                                                                                                                                                         |  | (unaudited)    |         |   | (Note 1)          |  
|Assets                                                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|Current assets:                                                                                                                                                                                          |  |                |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                                                                |  | $              | 116,349 |   |                   | $ | 117,676 |  
|Accounts receivable                                                                                                                                                                                      |  |                | 35      |   |                   |   |        |  
|Inventories                                                                                                                                                                                              |  |                | 124     |   |                   |   | 53      |  
|Prepaid expenses and other current assets                                                                                                                                                                |  |                | 1,083   |   |                   |   | 1,039   |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Total current assets                                                                                                                                                                                     |  |                | 117,591 |   |                   |   | 118,768 |  
|Property and equipment, net                                                                                                                                                                              |  |                | 2,942   |   |                   |   | 1,716   |  
|Restricted cash                                                                                                                                                                                          |  |                | 171     |   |                   |   | 170     |  
|Other assets                                                                                                                                                                                             |  |                | 238     |   |                   |   | 235     |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Total assets                                                                                                                                                                                             |  | $              | 120,942 |   |                   | $ | 120,889 |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|                                                                                                                                                                                                         |  |               
|Liabilities and stockholders equity                                                                                                                                                                     |  |                |         |   |                   |   |         |  
|Current liabilities:                                                                                                                                                                                     |  |                |         |   |                   |   |         |  
|Accounts payable                                                                                                                                                                                         |  | $              | 1,972   |   |                   | $ | 1,961   |  
|Accrued compensation                                                                                                                                                                                     |  |                | 721     |   |                   |   | 892     |  
|Accrued clinical development liabilities                                                                                                                                                                 |  |                | 924     |   |                   |   | 729     |  
|Accrued legal liabilities                                                                                                                                                                                |  |                | 605     |   |                   |   |        |  
|Other accrued liabilities                                                                                                                                                                                |  |                | 921     |   |                   |   | 434     |  
|Deferred rent                                                                                                                                                                                            |  |                | 117     |   |                   |   | 124     |  
|Liability for early exercise of stock options  current portion                                                                                                                                          |  |                | 107     |   |                   |   | 107     |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                                                                |  |                | 5,367   |   |                   |   | 4,247   |  
|Liability for early exercise of stock options                                                                                                                                                            |  |                | 219     |   |                   |   | 251     |  
|                                                                                                                                                                                                         |  |               
|Commitments and contingencies (Note 3)                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|                                                                                                                                                                                                         |  |               
|Stockholders equity:                                                                                                                                                                                    |  |                |         |   |                   |   |         |  
|Common stock; $0.001 par value; 150,000 shares authorized at March 31, 2005 and
December 31, 2004; 32,649 and 31,961 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively |  |                | 33      |   |                   |   | 32      |  
|Additional paid-in-capital                                                                                                                                                                               |  |                | 194,153 |   |                   |   | 186,269 |  
|Accumulated other comprehensive loss                                                                                                                                                                     |  |                | (111    | ) |                   |   | (32     | )
|Deferred stock compensation                                                                                                                                                                              |  |                | (22,460 | ) |                   |   | (25,367 | )
|Deficit accumulated during development stage                                                                                                                                                             |  |                | (56,259 | ) |                   |   | (44,511 | )
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                                                               |  |                | 115,356 |   |                   |   | 116,391 |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                               |  | $              | 120,942 |   |                   | $ | 120,889 |  
|                                                                                                                                                                                                         |  |                |         |   |                   |   |         |  



See accompanying notes



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##### Table of Contents

Conor Medsystems, Inc.

(a development stage company)



Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)



|                                                                                                |  |                             |         |   |                                                                 |   |        |   |  |   |         |  
|----------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | --------------------------------------------------------------- | - | ------ | - |  | - | ------- | -
|                                                                                                |  |                            
|                                                                                                |  | Three MonthsEnded March 31, |         |   | Period from Inception (October 25, 1999) Through March
31, 2005 |  
|                                                                                                |  | 2005                        |         |   | 2004                                                            |   |       
|Revenue:                                                                                        |  |                             |         |   |                                                                 |   |        |   |  |   |         |  
|Product sales                                                                                   |  | $                           | 36      |   |                                                                 | $ |       |   |  | $ | 36      |  
|Contract revenue                                                                                |  |                             |        |   |                                                                 |   |       |   |  |   | 67      |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Total revenue                                                                                   |  |                             | 36      |   |                                                                 |   |       |   |  |   | 103     |  
|Cost of sales                                                                                   |  |                             | 238     |   |                                                                 |   |        |   |  |   | 238     |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Gross profit                                                                                    |  |                             | (202    | ) |                                                                 |   |       |   |  |   | (135    | )
|Operating expenses:                                                                             |  |                             |         |   |                                                                 |   |        |   |  |   |         |  
|Research and development (1)                                                                    |  |                             | 7,653   |   |                                                                 |   | 3,280  |   |  |   | 41,106  |  
|General and administrative (1)                                                                  |  |                             | 4,605   |   |                                                                 |   | 740    |   |  |   | 16,234  |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Total operating expenses                                                                        |  |                             | 12,258  |   |                                                                 |   | 4,020  |   |  |   | 57,340  |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Loss from operations                                                                            |  |                             | (12,460 | ) |                                                                 |   | (4,020 | ) |  |   | (57,475 | )
|Interest and other income                                                                       |  |                             | 712     |   |                                                                 |   | 54     |   |  |   | 1,400   |  
|Interest expense                                                                                |  |                             |        |   |                                                                 |   |       |   |  |   | (184    | )
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Net loss                                                                                        |  |                             | (11,748 | ) |                                                                 |   | (3,966 | ) |  |   | (56,259 | )
|Accretion to redemption value of redeemable convertible preferred
stock                         |  |                             |        |   |                                                                 |   | (793   | ) |  |   | (5,039  | )
|Deemed dividend upon issuance of Series E convertible preferred stock                           |  |                             |        |   |                                                                 |   |       |   |  |   | (23,435 | )
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Net loss attributable to common stockholders                                                    |  | $                           | (11,748 | ) |                                                                 | $ | (4,759 | ) |  | $ | (84,733 | )
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Basic and diluted net loss per share attributable to common
stockholders                        |  | $                           | (0.37   | ) |                                                                 | $ | (1.32  | ) |  |   |         |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Shares used to compute basic and diluted net loss per share attributable to common
stockholders |  |                             | 31,974  |   |                                                                 |   | 3,602  |   |  |   |         |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|(1)    Includes non-cash stock-based compensation expense as follows:                           |  |                             |         |   |                                                                 |   |        |   |  |   |         |  
|Research and development                                                                        |  | $                           | 1,247   |   |                                                                 | $ | 173    |   |  | $ | 3,851   |  
|General and administrative                                                                      |  |                             | 1,844   |   |                                                                 |   | 182    |   |  |   | 5,769   |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  
|Total                                                                                           |  | $                           | 3,091   |   |                                                                 | $ | 355    |   |  | $ | 9,620   |  
|                                                                                                |  |                             |         |   |                                                                 |   |        |  











See accompanying notes



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Conor Medsystems, Inc.

(a development stage company)



Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)



|                                                                                  |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------- |  | ----------------------------------- | ------- | - | ------------------------------------------------------------ | - | ------ | - |  | - | ------- | -
|                                                                                  |  |                                    
|                                                                                  |  | For The Three Months EndedMarch 31, |         |   | Period fromInception(October 25, 1999) ThroughMarch 31, 2005 |  
|                                                                                  |  | 2005                                |         |   | 2004                                                         |   |       
|Operating activities                                                              |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Net loss                                                                          |  | $                                   | (11,748 | ) |                                                              | $ | (3,967 | ) |  | $ | (56,259 | )
|Adjustments to reconcile net loss to net cash used in operating
activities:       |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Depreciation and amortization                                                     |  |                                     | 184     |   |                                                              |   | 33     |   |  |   | 716     |  
|Amortization of deferred stock-based compensation                                 |  |                                     | 2,377   |   |                                                              |   | 253    |   |  |   | 7,533   |  
|Loss on disposal of property and equipment                                        |  |                                     |        |   |                                                              |   |       |   |  |   | 47      |  
|Issuance of common stock to consultants for services                              |  |                                     |        |   |                                                              |   |       |   |  |   | 220     |  
|Issuance of stock options to consultants for services                             |  |                                     | 714     |   |                                                              |   | 102    |   |  |   | 2,217   |  
|Accrued interest expense on notes payable                                         |  |                                     |        |   |                                                              |   |       |   |  |   | 60      |  
|Interest expense related to issuance of warrants                                  |  |                                     |        |   |                                                              |   |       |   |  |   | 122     |  
|Accrued interest income on notes receivable                                       |  |                                     |        |   |                                                              |   | (2     | ) |  |   | (11     | )
|Forgiveness of officer loan receivable                                            |  |                                     |        |   |                                                              |   |       |   |  |   | 111     |  
|Changes in operating assets and liabilities:                                      |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Prepaid expenses and other current assets                                         |  |                                     | (44     | ) |                                                              |   | 29     |   |  |   | (1,082  | )
|Accounts receivable                                                               |  |                                     | (35     | ) |                                                              |   |       |   |  |   | (35     | )
|Inventories                                                                       |  |                                     | (71     | ) |                                                              |   |       |   |  |   | (124    | )
|Other assets                                                                      |  |                                     | (3      | ) |                                                              |   | (71    | ) |  |   | (238    | )
|Accounts payable                                                                  |  |                                     | 17      |   |                                                              |   | (504   | ) |  |   | 1,978   |  
|Accrued compensation                                                              |  |                                     | (170    | ) |                                                              |   | 30     |   |  |   | 722     |  
|Accrued clinical development liabilities                                          |  |                                     | 195     |   |                                                              |   | 70     |   |  |   | 924     |  
|Other accrued liabilities                                                         |  |                                     | 1,100   |   |                                                              |   | (118   | ) |  |   | 1,534   |  
|Deferred rent                                                                     |  |                                     | (7      | ) |                                                              |   | 26     |   |  |   | 117     |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Net cash used in operating activities                                             |  |                                     | (7,491  | ) |                                                              |   | (4,119 | ) |  |   | (41,448 | )
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Cash flows from investing activities                                              |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Transfers to restricted cash                                                      |  |                                     | (1      | ) |                                                              |   | (30    | ) |  |   | (171    | )
|Capital expenditures                                                              |  |                                     | (1,379  | ) |                                                              |   | (294   | ) |  |   | (3,680  | )
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Net cash used in investing activities                                             |  |                                     | (1,380  | ) |                                                              |   | (324   | ) |  |   | (3,851  | )
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Financing activities                                                              |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Proceeds from issuance of common stock, including early exercise of stock
options |  |                                     | 7,669   |   |                                                              |   | 19     |   |  |   | 78,954  |  
|Proceeds from issuance of redeemable convertible preferred stock, net             |  |                                     |        |   |                                                              |   |       |   |  |   | 75,441  |  
|Proceeds from issuance of notes payable, net                                      |  |                                     |        |   |                                                              |   |       |   |  |   | 7,500   |  
|Loans receivable from officer                                                     |  |                                     |        |   |                                                              |   |       |   |  |   | (100    | )
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Net cash provided by financing activities                                         |  |                                     | 7,669   |   |                                                              |   | 19     |   |  |   | 161,795 |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Effect of exchange rate changes on cash and cash equivalents                      |  |                                     | (125    | ) |                                                              |   |       |   |  |   | (147    | )
|Net (decrease) increase in cash and cash equivalents                              |  |                                     | (1,327  | ) |                                                              |   | (4,424 | ) |  |   | 116,349 |  
|Cash and cash equivalents at beginning of period                                  |  |                                     | 117,676 |   |                                                              |   | 22,389 |   |  |   |        |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Cash and cash equivalents at end of period                                        |  | $                                   | 116,349 |   |                                                              | $ | 17,965 |   |  | $ | 116,349 |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Supplemental schedule of noncash transactions                                     |  |                                     |         |   |                                                              |   |        |   |  |   |         |  
|Issuance of common stock for services, technology, and equipment                  |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 224     |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Issuance of preferred stock to placement agent                                    |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 258     |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Issuance of common stock for notes payable                                        |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 5,020   |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Issuance of preferred stock to retire notes payable and accrued
interest          |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 2,543   |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Accretion to redemption value of redeemable convertible preferred
stock           |  | $                                   |        |   |                                                              | $ | 793    |   |  | $ | 5,039   |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Deferred stock compensation, net of terminations                                  |  | $                                   | (529    | ) |                                                              | $ | 4,134  |   |  | $ | (29,995 | )
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Deemed dividend to redeemable convertible preferred stockholders                  |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 23,435  |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  
|Conversion of redeemable convertible preferred stock into common stock            |  | $                                   |        |   |                                                              | $ |       |   |  | $ | 83,203  |  
|                                                                                  |  |                                     |         |   |                                                              |   |        |  



See accompanying notes



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##### Table of Contents

Conor Medsystems, Inc.

(a development stage company)



Notes to Condensed Consolidated Financial Statements

(unaudited)



1. Organization and Summary of Significant Accounting Policies



Organization and Business



Conor Medsystems, Inc. (the Company) was incorporated on October 25, 1999 and is developing innovative controlled vascular drug delivery
technologies. Since inception, the Companys activities have consisted primarily of recruiting personnel, raising capital and performing product development. The Company is therefore considered to be in the development stage at March 31, 2005.



Basis of Presentation



The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations and cash flows for the periods indicated.



The condensed consolidated balance sheet as of December 31, 2004 is derived from the Companys audited consolidated
financial statements as of December 31, 2004, included in the Companys Annual Report on Form 10-K for the year ended December 31, 2004, filed with the Securities and Exchange Commission on March 31, 2005, but does not include all of the
information and footnotes required by generally accepted accounting principles for complete financial statements.



The unaudited condensed consolidated financial statements and the accompanying notes should be read in conjunction with the Companys Annual Report
on Form 10-K for the year ended December 31, 2004. Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending
December 31, 2005. Stockholders are encouraged to review the Companys Annual Report on Form 10-K for a broader discussion of the Companys business and the risks inherent therein.



Initial Public Offering



On December 14, 2004, the Company completed its initial public offering of
6,000,000 shares of its common stock at a public offering price of $13.00 per share. Net cash proceeds from the initial public offering were approximately $70.3 million, after deducting underwriting discounts, commissions and other offering
expenses. In connection with the closing of the initial public offering, all of the Companys shares of Series A, B, C, D and E redeemable convertible preferred stock outstanding at the time of the offering were automatically converted into
21,534,150 shares of common stock.



On January 7, 2005, the
underwriters of the Companys initial public offering exercised in full their over-allotment option to purchase 642,000 shares of the Companys common stock. On January 7, 2005, the Company received net cash proceeds of approximately $7.7
million, after deducting underwriting discounts, commissions and other offering expenses.



Risks and Uncertainties Related to Intellectual Property



The Company is aware of patents owned by third parties, to which it does not have licenses, which relate to, among other things, the use of paclitaxel to
treat restenosis, stent structure, catheters used to deliver stents and stent manufacturing processes. For example, Boston Scientific Corporation owns a series of patents that cover the use of paclitaxel to treat restenosis generally and also to
treat restenosis via a stent. In addition, Angiotech Pharmaceuticals, Inc. is the owner of a number of patents, and has licensed from the U.S. government a number of other patents, that also cover the use of paclitaxel coated stents to treat
angiogenesis and restenosis. Boston Scientific, Guidant Corporation and other parties also own other patents that may have a material adverse affect on the Company. On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific
Corporation (as Angiotechs licensee) initiated legal proceedings against the Company in the District Court in the Hague, Netherlands seeking a declaration that the Companys CoStar stent infringes Angiotechs patent rights. In the
suit, Angiotech and Boston Scientific are also seeking orders, among other things,



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preventing the Company from commercializing its CoStar stent in many European countries and requiring the Company to pay damages. Based on the prolific
litigation that has occurred in the stent industry and the fact that the Company may pose a competitive threat to other large and well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, the
Company believes that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use or sale of the Companys CoStar stent. Any lawsuit could seek to enjoin, or prevent, the Company from
commercializing its CoStar stent and may seek damages from the Company, and would likely be expensive for the Company to defend against. The Company has also received letters from third parties, some of whom have been actively involved in coronary
stent litigation, asserting that they may have rights to patents that are relevant to the Companys operations or its stent platform and requesting the initiation of discussions. In the event a court determines that the Company infringes any
valid claim in a patent held by a third party, the Company expects that such a determination would have a material adverse effect on its results of operations, financial condition and liquidity, and that the Company may, among other things, be
required to pay substantial damages, cease the development, manufacture, use and sale of products that infringe the patent rights of others, including its CoStar stent, expend significant resources to redesign the Companys technology so that
it does not infringe others patent rights, or to develop or acquire non-infringing intellectual property, which may not be possible, discontinue manufacturing or other processes incorporating infringing technology, and/or obtain licenses to
the infringed intellectual property. The Company believes that it is unlikely that it would be able to obtain a license to any necessary patent rights controlled by companies, like Boston Scientific, against which it would compete directly. In
addition, the Companys competitors have significant resources to devote to litigation against the Company, and the Company may need to expend significant resources to defend against such litigation. The Company could require significant
additional funds to bear the costs of this litigation, regardless of whether the Company prevails. The Companys ability to continue to operate under its current operating plan could be impaired if such funds are not available. Since the
Companys costs in connection with any such litigation will vary greatly depending on the nature and timing of the litigation, it is not possible for the Company to estimate the effect of such costs on its financial condition and results of
operations. Amounts, ultimately payable, if any, resulting from an adverse outcome of any of these matters cannot be reasonably estimated at this time.



Foreign Currency Translation



The functional currency of the Companys subsidiaries in Ireland is the euro. Foreign assets and liabilities are translated into U.S. dollars at the
quarter-end exchange rates, while components of the statement of operations are translated using average exchange rates in effect throughout the year. Gains and losses from foreign currency transactions are included in the condensed consolidated
statements of operations and were not material for any period presented. Foreign currency translation adjustments are included as a component of stockholders equity.



Revenue Recognition



The Company recognizes revenue from product sales when persuasive evidence of an arrangement exits, delivery has occurred, the fee is fixed and
determinable, and collectibility is reasonably assured. Product sales to date have been to the Companys distributor in India and revenue from such product sales has been recognized in accordance with SEC Staff Accounting Bulletin No. 104,
Revenue Recognition (SAB 104). The Companys distributor in India has no price protection or rights of return. Amounts receivable in connection with these sales have been secured by an irrevocable letter of credit.



Inventories



Inventories are stated at the lower of cost (first in, first out) or market.
At March 31, 2005, inventories consisted primarily of work in process and at December 31, 2004, inventories consisted primarily of raw materials. The Company provides for excess and obsolete inventories based on estimated forecasts of demand.



Stock-Based Compensation



The Company accounts for employee stock options using the intrinsic-value
method in accordance with Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees (APB Opinion No. 25), Financial Accounting Standards Board (FASB) Interpretation
(FIN) No. 44,Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, and related interpretations and has adopted the disclosure-only provisions of Statement of Financial Accounting
Standards (SFAS) No. 123,Accounting for Stock-Based Compensation (SFAS No. 123).



The information regarding net loss as required by SFAS No. 123, as amended, has been determined as if the Company had accounted for its employee stock
options under the fair-value method. The resulting effect on net loss pursuant to SFAS No. 123 is not likely to be representative of the effects on net loss pursuant to SFAS No. 123 in future years, since future years are likely to include
additional grants and the irregular impact of future years vesting.



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##### Table of Contents

The following table illustrates the weighted-average assumptions for the Black-Scholes option pricing
model used in determining the fair value of options granted to employees:



|                        |  |                              |  |        
|----------------------- |  | ---------------------------- |  | -------
|                        | 
|                        |  | Three Months Ended March 31,
|                        |  | 2005                         |  | 2004   
|Dividend yield          |  | 0%                           |  | 0%     
|Risk-free interest rate |  | 4.00%                        |  | 2.96%  
|Volatility              |  | 0.7                          |  | 0.7    
|Expected
life           |  | 5 years                      |  | 5 years



During 2003 and 2004,
stock options were granted at exercise prices that were below the reassessed fair value of the common stock on the date of grant. Accordingly, deferred stock compensation of $30.5 million was recorded during 2003 and 2004 in accordance with APB
Opinion No. 25. The deferred stock compensation will be amortized on a straight-line basis over the vesting period of the related awards, which is generally four years. The related stock-based compensation expense was $2.4 million and $253,000
during the three months ended March 31, 2005 and 2004, respectively.



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##### Table of Contents

The table below illustrates the effect on net loss attributable to common stockholders and net loss per
share attributable to common stockholders had the Company applied the fair value provisions of SFAS No. 123 to employee stock compensation (in thousands, except per share amounts):



|                                                                                         |  |                              |         |   |                                                               |   |        |   |  |   |         |  
|---------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ------------------------------------------------------------- | - | ------ | - |  | - | ------- | -
|                                                                                         |  |                             
|                                                                                         |  | Three Months Ended March 31, |         |   | Period fromInception(October 25, 1999) through March 31,
2005 |  
|                                                                                         |  | 2005                         |         |   | 2004                                                          |   |       
|Net loss attributable to common stockholders  as reported                               |  | $                            | (11,748 | ) |                                                               | $ | (4,759 | ) |  | $ | (84,733 | )
|Add: Stock-based employee compensation expense included in reported net
loss             |  |                              | 2,377   |   |                                                               |   | 253    |   |  |   | 7,533   |  
|Deduct: Stock-based employee compensation expense determined under the fair value
method |  |                              | (2,753  | ) |                                                               |   | (282   | ) |  |   | (8,071  | )
|                                                                                         |  |                              |         |   |                                                               |   |        |   |  |   |         |  
|Net loss attributable to common stockholders  proforma                                  |  | $                            | (12,124 | ) |                                                               | $ | (4,788 | ) |  | $ | (85,271 | )
|                                                                                         |  |                              |         |   |                                                               |   |        |   |  |   |         |  
|Basic and diluted net loss per share attributable to common stockholders  as
reported   |  | $                            | (0.37   | ) |                                                               | $ | (1.32  | ) |  |   |         |  
|                                                                                         |  |                              |         |   |                                                               |   |        |   |  |   |         |  
|Basic and diluted net loss per share attributable to common stockholders 
proforma      |  | $                            | (0.38   | ) |                                                               | $ | (1.33  | ) |  |   |         |  
|                                                                                         |  |                              |         |   |                                                               |   |        |   |  |   |         |  



Stock compensation
arrangements with non-employees are accounted for in accordance with SFAS No. 123, as amended by SFAS No. 148, and EITF 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, using a fair value approach. The compensation costs of these arrangements are subject to remeasurement over the vesting terms as earned.



The following table illustrates the weighted-average assumption for the Black-Scholes model used at year end in determining
the fair value of options granted to non-employees:



|                        |  |                              |  |        
|----------------------- |  | ---------------------------- |  | -------
|                        | 
|                        |  | Three Months Ended March 31,
|                        |  | 2005                         |  | 2004   
|Dividend yield          |  | 0%                           |  | 0%     
|Risk-free interest rate |  | 4.00%                        |  | 3.90%  
|Volatility              |  | 0.7                          |  | 0.7    
|Expected
life           |  | 9 years                      |  | 9 years



During the three
months ended March 31, 2005, the Company did not grant any options to purchase common stock to consultants. During the period from inception through March 31, 2005, the Company granted options to purchase 1,128,750 shares of common stock to
consultants and other non-employee service providers. The weighted average exercise price of these options was $0.31 per share. These options generally vest over a four-year period. The related stock-based compensation expense was $714,000 and
$102,000 during the three months ended March 31, 2005 and 2004, respectively.



Recent Accounting Pronouncement



In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R) which is a revision of SFAS No. 123, and supersedes APB Opinion 25. SFAS 123R requires all
share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values, beginning with



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##### Table of Contents

the first annual period after June 15, 2005, with early adoption encouraged. On April 14, 2005, the SEC adopted a new rule that amended the compliance dates
for SFAS No. 123R such that the Company is now allowed to adopt the new standard effective January 1, 2006. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. As
permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB Opinion 25s intrinsic value method and, as such, recognizes no compensation cost for employee stock options.



Under SFAS 123R, the Company must determine the appropriate fair value model
and related assumptions to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive
adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all
unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive method would record compensation expense for all unvested stock options and restricted stock beginning with the first
period restated. The Company is currently evaluating the requirements of SFAS 123R as well as option valuation methodologies related to its employee and director stock options and employee stock purchase plan. Although the Company has not yet
determined the method of adoption or the effect of adopting SFAS 123R, it is expected that the adoption of SFAS 123R will have a material impact on the Companys consolidated results of operations. The impact of adoption of SFAS 123R cannot be
predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used. SFAS 123R also requires the benefits of tax deductions in
excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows
in periods after adoption.



2. Net Loss Per Share



Basic net loss per share attributable to common stockholders is calculated
by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding for the period, without consideration of common stock equivalents. Diluted net loss per share attributable to common
stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation,
common stock subject to repurchase by the Company, redeemable convertible preferred stock, stock options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their
effect is dilutive.



The following table presents the
computation of basic and diluted net loss per share attributable to common stockholders (in thousands, except per share amounts):



|                                                                                                                                            |  |                              |         |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------ | -
|                                                                                                                                            | 
|                                                                                                                                            |  | Three Months Ended March 31, |        
|Historical                                                                                                                                  |  | 2005                         |         |   | 2004 |  
|Numerator:                                                                                                                                  |  |                              |         |   |      |   |        |  
|Net loss attributable to common stockholders                                                                                                |  | $                            | (11,748 | ) |      | $ | (4,759 | )
|                                                                                                                                            |  |                              |         |   |      |   |        |  
|Denominator:                                                                                                                                |  |                              |         |   |      |   |        |  
|Weighted average common shares outstanding                                                                                                  |  |                              | 32,453  |   |      |   | 3,767  |  
|Less weighted average shares subject to repurchase                                                                                          |  |                              | (479    | ) |      |   | (165   | )
|                                                                                                                                            |  |                              |         |   |      |   |        |  
|Denominator for basic and diluted net loss per share attributable to common
stockholders                                                    |  |                              | 31,974  |   |      |   | 3,602  |  
|                                                                                                                                            |  |                              |         |   |      |   |        |  
|Basic and diluted net loss per share attributable to common
stockholders                                                                    |  | $                            | (0.37   | ) |      | $ | (1.32  | )
|                                                                                                                                            |  |                              |         |   |      |   |        |  
|Historical outstanding anti-dilutive securities not included in diluted net loss
per share attributable to common stockholders calculation: |  |                              |         |   |      |   |        |  
|Redeemable convertible preferred stock                                                                                                      |  |                              |        |   |      |   | 14,731 |  
|Common shares subject to repurchase                                                                                                         |  |                              | 451     |   |      |   | 646    |  
|Options to purchase common stock                                                                                                            |  |                              | 4,802   |   |      |   | 2,620  |  
|Warrants to purchase common and preferred stock                                                                                             |  |                              | 493     |   |      |   | 504    |  
|                                                                                                                                            |  |                              |         |   |      |   |        |  
|                                                                                                                                            |  |                              | 5,746   |   |      |   | 18,501 |  
|                                                                                                                                            |  |                              |         |   |      |   |        |  



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3. Commitments and Contingencies



Operating Leases



The Company leases certain real and personal property under noncancelable operating leases. Future payments under these leases as of March 31, 2005 were
as follows (in thousands):



|                          |  |   |      
|------------------------- |  | - | -----
|                          | 
|Years ending December 31, |  |  
|2005                      |  | $ | 709  
|2006                      |  |   | 1,092
|2007                      |  |   | 996  
|2008                      |  |   | 828  
|2009                      |  |   | 370  
|Thereafter                |  |   | 1,926
|                          |  |   |      
|                          |  | $ | 5,921
|                          |  |   |      



In addition to these
minimum lease payments, the Company is required to pay its share of operating expenses related to property taxes, insurance and routine maintenance in connection with its facility leases. Rent expense under the operating leases, including
termination fees, was approximately $134,000 and $178,000 for the quarters ended March 31, 2004 and 2005, respectively, and $1.9 million for the period from inception to March 31, 2005.



In February 2005, the Company entered into a ten-year lease, which has an option for an additional ten year term, for an
approximately 27,000 square foot permanent manufacturing facility in Athlone, Ireland. This facility includes an approximately 5,000 square foot clean room. Lease payments are fixed for a period of five years, with provisions for annual adjustments
for market changes, for the duration of the lease. Total future minimum lease payments are $3.7 million and are being expensed on a straight-line basis over the life of the lease. The future minimum lease payments for the manufacturing facilities in
Ireland are denominated in euros and have been converted into U.S. dollars using the exchange rate in effect as of March 31, 2005.



In March 2005, the Company entered into an amendment of the lease agreement for the Companys current headquarters in Menlo Park, California. The
amendment provides for an additional 26,000 square feet of space in a building adjacent to the Companys current headquarters and extends the term of the Companys lease for an additional year to August 2008. Total future minimum lease
payments are $2.2 million.



Legal Contingencies



On February 1, 2005, Angiotech Pharmaceuticals, Inc.
and Boston Scientific Corporation (as Angiotechs licensee) initiated legal proceedings against the Company in the District Court in the Hague, Netherlands, seeking: a declaration that the Companys CoStar stent infringes European Patent
No. (EP) 0 706 376 B1 in the Netherlands and other countries designated in EP 0 706 376 B1; an order that the Company and its affiliates cease any infringement of EP 0 706 376 B1 in the Netherlands and other designated European countries; an order
that the Company not use its CE marketing approval, if obtained by the Company, for three years or for a period of time which the District Court deems appropriate and/or at the choice of Boston Scientific and Angiotech; an order requiring the
Company to withdraw all information and documentation concerning the clinical trials the Company has conducted in the Netherlands from all relevant regulatory authorities worldwide; an order requiring the Company to pay 2,460 euros per sale of its
CoStar stent in Europe or, at the choice of Boston Scientific and Angiotech, 2,460 euros per day that the Company does not comply; an order that the Company indemnify Boston Scientific and Angiotech or surrender its profit on sales of its CoStar
stent in countries covered by EP 0 706 376 B1; and an order that the Company pay the costs of the proceedings.



On February 18, 2005, the Company initiated proceedings against Angiotech and the University of British Columbia in the High Court of Justice in the
United Kingdom requesting that the court invalidate EP 0 706 376 B1 based on the grounds that all claims of the patent either lack novelty or are obvious in light of the state of scientific knowledge at the priority date of the patent. A trial date
for this proceeding has been set for October 4, 2005.



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##### Table of Contents

On March 31, 2005, the Company filed an Application to Revoke Australian Patent Nos. 728873, 771815 and
693797 owned by Angiotech and University of British Columbia in the Federal Court of Australia (Victoria District Registry), on the bases, among others, that the patents are invalid in light of the state of scientific knowledge as of the priority
date of the patents and that they are not enabled for the claimed subject matter. A trial date for this proceeding has been set for June 5, 2006.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the safe harbor created by those sections. Forward-looking statements are based on our managements beliefs and assumptions and on information
currently available to our management. In some cases, you can identify forward-looking statements by terms such as may, will, should,  could,  would,  expect, 
plans,  anticipates,  believes,  estimates,  projects,  predicts,  potential and similar expressions intended to identify forward-looking statements. These statements
involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or
implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading Risk Factors. Given these risks, uncertainties and other
factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q
completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation
to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.



Overview



We develop innovative controlled vascular drug delivery technologies. We have initially focused on the development of drug
eluting stents to treat coronary artery disease. Our clinical efforts are currently focused on the development and commercialization of our CoStar stent, which is a cobalt chromium paclitaxel eluting stent, for the treatment of restenosis. To date,
we have conducted clinical trials involving over 800 patients using our drug eluting stents, including more than 300 patients with our CoStar stent.



Since inception, we have devoted substantially all of our resources to developing our stent platform, raising capital and preparing for the planned
commercialization of our CoStar stent. We have pursued a clinical development strategy of using our stents to demonstrate that the drug inlay design of our stents permits us to control drug release kinetics, to establish the safety of our stent
design, to demonstrate that drug release kinetics can have a direct impact on clinical outcomes and to establish the basis for regulatory approval of our CoStar stent in Europe and the United States.



In early 2003, we initiated our PISCES study to evaluate the safety and
performance of paclitaxel delivered with different release kinetics and doses using our stainless steel stent. We completed enrollment of 191 patients in late 2003 and announced twelve-month follow-up data in March 2005. The two formulations from
our PISCES study that demonstrated the most favorable clinical outcomes are the focus of our subsequent EuroSTAR and COSTAR I trials, as well as our planned U.S. pivotal clinical trial, which are designed to evaluate our CoStar stent. The COSTAR I
trial began in late 2003 and has completed enrollment of the three formulation groups. In September 2004, we announced four-month follow-up data for one of the three formulation groups from the COSTAR I trial, and in January 2005, we presented
four-month follow-up data for a second formulation group. The EuroSTAR trial began in early 2004 and in March 2005, we announced six-month follow-up data from the first arm of our EuroSTAR trial. The EuroSTAR trial served as our pivotal trial to
support our submission in February 2005 of an application to a designated Notified Body in the European Community, which is one of the steps we must undertake prior to marketing our CoStar stent in the European Community. In March 2005, we received
conditional approval of our IDE application from the FDA to permit commencement of our planned U.S. pivotal clinical trial, COSTAR II, which will evaluate our CoStar stent against a conventional drug eluting stent. We have not yet received any
government regulatory approvals necessary to commercialize our CoStar stent. If our clinical trials proceed as scheduled and the outcomes of these clinical trials are favorable, we anticipate receiving regulatory approval for our CoStar stent in the
European Community in late 2005 and in the United States in late 2007. We could be delayed by adverse results or regulatory complications, and we may never achieve regulatory approval. No regulatory approval is currently required to market our
CoStar stent in India.



If we obtain the necessary regulatory
approval, we plan to pursue commercialization in the United States with our own sales force and commercialize our CoStar stent internationally through distribution arrangements. We entered into agreements with Biotronik AG



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##### Table of Contents

in May 2004 and Interventional Technologies, Pvt., Ltd., or IVT, in July 2004 to distribute our products outside of the United States, Japan, Australia, New
Zealand and Korea. In November 2004, we entered into agreements with affiliates of St. Jude Medical, Inc. to distribute our CoStar stent in Japan, Korea, New Zealand and Australia. We recently began selling commercial units of our CoStar stent in
India pursuant to our distribution agreement with IVT. We have recently established limited manufacturing capacity in Athlone, Ireland to manufacture commercial quantities of our CoStar stent, initially for sale outside of the United States, and we
are currently in the process of preparing the facility for full production.



We were incorporated in Delaware in October 1999 and are a development stage company with a limited operating history. To date, we have not generated any significant revenues, and we have incurred net losses in each
year since our inception. We expect these losses to continue and increase as we expand our clinical trial activities. We have financed our operations primarily through private placements of preferred stock and convertible promissory notes, as well
as through our initial public offering of our common stock. In July and August 2004, we raised aggregate net cash proceeds of $38.9 million in a private placement of 6,711,431 shares of our Series E convertible preferred stock. In December 2004 and
January 2005, we raised net proceeds of $78.1 million in our initial public offering of our common stock. We currently have no products approved for sale in the United States.



Critical Accounting Policies and Significant Judgments and Estimates



Our managements discussion and analysis of our financial condition and results of operations are based on our
condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as reported revenues and expenses during the reporting
periods. On an ongoing basis, we evaluate estimates, including those related to stock-based compensation and clinical trial accruals. We base our estimates on historical experience and on various other factors that we believe are reasonable under
the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different
assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the SEC on March 31, 2005.



Financial Operations



Revenues



In March 2005, we began limited commercialization of our CoStar stent in India. Product sales for the three months ended March 31, 2005 were $36,000.
Prior to March 2005, we had not generated any revenues from the sale of our stents. We do not expect sales of our CoStar stent in India to be significant during 2005. Further, we expect that any revenues that we generate from sales of our CoStar
stent will fluctuate from quarter to quarter.



Cost of
Sales



Cost of sales is composed of the material,
labor, overhead and transportation costs of production and variances associated with inefficiencies in manufacturing.



Research and Development Expenses



Our research and development expenses primarily consist of clinical and regulatory expenses, including preclinical and clinical trial costs and the cost
of manufacturing clinical supplies. Research and development costs also consist of employee compensation, supplies and materials, consultant services, facilities, and non-cash stock-based compensation. We expense research and development costs as
they are incurred. For the period from inception through March 31, 2005, we had incurred $41.1 million in research and development expenses, with nearly all of these expenses related to engineering, preclinical and clinical trials related to our
planned commercialization of our CoStar stent. We expect our research and development expenses to increase significantly as we complete the development of our CoStar stent, research new product opportunities, conduct additional clinical trials and
hire additional employees. We anticipate that the cost of completing our EuroSTAR trial will be approximately $2.0 million. If our COSTAR II trial proceeds as currently planned, we anticipate that it will cost at least $15.0 million to complete.



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General and Administrative Expenses



Our general and administrative expenses consist primarily of compensation for
executive, finance and administrative personnel and non-cash stock-based compensation. Other significant costs include professional fees for accounting and legal services, including legal services associated with our efforts to obtain and maintain
protection for the intellectual property related to our stent platform. For the period from inception through March 31, 2005, we had incurred $16.2 million in general and administrative expenses. We expect our general and administrative expenses to
increase substantially due to the costs associated with operating as a publicly-traded company, costs associated with defending patent infringement claims asserted against us, and the costs associated with the infrastructure necessary to support the
potential commercialization of our product candidates.



Results of
Operations



Three Months Ended March 31, 2005 and 2004



Revenues



Revenues from product sales were $36,000 and $0 for the three months ended
March 31, 2005 and 2004, respectively. Product sales in 2005 were the result of our first shipments of our CoStar stent to our distributor in India.



Cost of Sales



Cost of sales was $238,000 and $0 for the three months ended March 31, 2005 and 2004, respectively. During the three months ended March 31, 2005, we began
to transition into early stage production of our CoStar stent for commercial sale. The cost of sales for the first quarter of 2005 is representative of the production costs and variances associated with the early commercialization of our CoStar
stent and included $53,000 worth of production scrap related to the scale-up of manufacturing. The cost of sales for the three months ended March 31, 2005 is not necessarily indicative of production costs in future periods. We expect that as our
production processes mature and volumes increase, our cost of sales as a percent of product sales will decline.



Research and Development Expenses



Research and development expenses were $7.7 million and $3.3 million for the three months ended March 31, 2005 and 2004, respectively. The $4.4 million
increase was primarily due to higher non-payroll related clinical trial costs of $1.6 million for such items as supplies, tooling, consulting and outside services, $1.1 million of higher payroll and related expenses as we increased research and
development personnel by 55 professionals, $0.6 million of non-cash stock-based compensation expense increases, $0.5 million of non-employee stock-based compensation increases, and an increase of $0.6 million on facilities and other expenses related
to research and development.



General and Administrative
Expenses



General and administrative expenses were $4.6
million and $0.7 million for the three months ended March 31, 2005 and 2004, respectively. The $3.9 million increase was primarily attributable to higher payroll of $0.5 million as we added eight management and administrative personnel, non-cash
stock-based compensation expenses of $1.5 million, professional services for legal, audit and other consulting services of $1.3 million, increases in insurance of $0.2 million, and an increase of $0.4 million in trade show, promotional and other
expenses.



Interest and Other Income



Interest and other income was $0.7 million and $54,000 for the three
months ended March 31, 2005 and 2004, respectively. The increase of $0.7 million was due to higher cash balances resulting from our initial public offering of common stock in December 2004 and the exercise of the over-allotment option by the
underwriters of our initial public offering in January 2005.



Liquidity and
Capital Resources



We have incurred losses since our
inception in October 1999, and, as of March 31, 2005, we had a deficit accumulated during the development stage of $56.3 million. We have funded our operations to date principally from our initial public offering of common stock in December 2004 and
private placements of equity securities and convertible promissory notes, raising aggregate net proceeds of $161.9 million through March 31, 2005.



As of March 31, 2005, we did not have any outstanding or available debt financing arrangements, we had working capital of $112.2 million and our primary
source of liquidity was $116.3 million in cash and cash equivalents. Pending their ultimate use, we currently invest our available funds in liquid money market accounts.



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Net Cash Used in Operating Activities



Net cash used in operating activities was $7.5 million during the three
months ended March 31, 2005. The net cash used during the three months ended March 31, 2005 primarily reflects the net loss of $11.7 million, partially reduced by depreciation of $184,000, non-cash stock-based compensation of $2.4 million, the
issuance of stock to consultants as stock-based compensation of $714,000, increases in accrued liabilities for legal expenses of $0.6 million, and changes in other operating assets and liabilities of $382,000.



Net cash used in operating activities was $4.1 million during the three
months ended March 31, 2004. The net cash used during the three months ended March 31, 2004 primarily reflects the net loss of $4.0 million, partially reduced by depreciation of $33,000, non-cash stock-based compensation of $253,000, the issuance of
stock to consultants as stock-based compensation of $102,000, and net changes in operating assets and liabilities of $538,000.



Net Cash Used in Investing Activities



Net cash used in investing activities increased to $1.4 million for the three months ended March 31, 2005, from $294,000 for the three months ended March
31, 2004, primarily as a result of increased purchases of property and equipment.



Net Cash Provided by Financing Activities



Net cash provided by financing activities increased to $7.7 million for the three months ended March 31, 2005, from $19,000 for the three months ended March 31, 2004, primarily as a result of the net proceeds received
from the exercise of the over-allotment option by the underwriters of our initial public offering in January 2005.



Operating Capital and Capital Expenditure Requirements



As of March 31, 2005, we had recognized only minimal amounts of revenue from commercial product sales and we had not
achieved profitability. We anticipate that we will continue to incur net losses for the next several years as we develop our products, expand our clinical development team and corporate infrastructure, and prepare for the potential commercial growth
of our CoStar stent. We expect that our research and development and general and administrative expenses will continue to increase and, as a result, we will need to generate significant product revenues or raise additional capital to achieve
profitability.



We do not expect to generate significant
product sales until we successfully obtain marketing approval for and begin selling our CoStar stent in Europe. We believe that our cash and cash equivalent balances as well as the interest we earn on these balances, and revenues from future limited
product sales will be sufficient to meet our anticipated cash requirements through at least the first half of 2006. If our available cash and cash equivalents are insufficient to satisfy our liquidity requirements, or if we develop additional
products, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity and debt securities may result in additional dilution to our stockholders. If we raise additional funds through the
issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such
required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to liquidate some or all of our assets or reduce the scope of, delay or eliminate some or all of our
planned research, development and commercialization activities, which could harm our business.



We anticipate spending at least $15.0 million over the next two years for clinical trials to complete the development of our CoStar stent. We estimate that the development of any new product candidates will cost
between $15.0 million and $25.0 million per product candidate and will take up to four years to complete. We expect to fund the development of potential product candidates with our existing cash and cash equivalent balances.



Our forecasts of the period of time through which our financial resources
will be adequate to support our operations and the costs to complete development of products are forward-looking statements and involve risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors
discussed under Risk Factors below. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.



Because of the numerous risks and uncertainties associated with the
development of drug eluting stents, such as our CoStar stent, we are unable to estimate the exact amounts of capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding
requirements will depend on many factors, including, but not limited to:



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| |  |  | the scope, rate of progress and cost of our clinical trials and other research and development activities;
| | - |  | ----------------------------------------------------------------------------------------------------------

| |  |  | future clinical trial results;
| | - |  | ------------------------------

| |  |  | the costs of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the cost of defending, in litigation or otherwise, any claims that we infringe third party patent or other intellectual property rights;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop;
| | - |  | -------------------------------------------------------------------------------------------------------------------------

| |  |  | the cost and timing of completion of a commercial scale manufacturing facility;
| | - |  | -------------------------------------------------------------------------------

| |  |  | the costs and timing of regulatory approvals;
| | - |  | ---------------------------------------------

| |  |  | the costs and timing of establishing sales, marketing and distribution capabilities;
| | - |  | ------------------------------------------------------------------------------------

| |  |  | licensing technologies for future development;
| | - |  | ----------------------------------------------

| |  |  | the effect of competing technological and market developments; and
| | - |  | ------------------------------------------------------------------

| |  |  | the terms and timing of any collaborative, licensing and other arrangements that we may establish.
| | - |  | --------------------------------------------------------------------------------------------------



Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products and
technologies, but we currently have no commitments or agreements relating to any of these types of transactions.



On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific Corporation (as Angiotechs licensee) initiated legal proceedings against
us in the District Court in the Hague, Netherlands seeking a declaration that our CoStar stent infringes Angiotechs patent rights. In the suit, Angiotech and Boston Scientific are also seeking orders, among other things, preventing us from
commercializing our CoStar stent in many European countries and requiring us to pay damages. Based on the prolific litigation that has occurred in the stent industry and the fact that we may pose a competitive threat to some large and
well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, we believe that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use
or sale of our CoStar stent. A number of these patents are owned by very large and well-capitalized companies that are active participants in the stent market, such as Boston Scientific and Guidant Corporation. Several of these third party patents
have been or are being asserted in litigation against purported infringers, including against us, demonstrating a willingness by the patent owners to litigate their claims. Any lawsuit could seek to enjoin, or prevent, us from commercializing our
CoStar stent and may seek damages from us, and would likely be expensive for us to defend. We have also received letters from third parties, some of whom have been actively involved in coronary stent litigation, asserting that they may have rights
to patents that are relevant to our operations or our stent platform and requesting the initiation of discussions. A court may determine that these patents are valid and infringed by us. A finding that we infringe any valid claim in a patent held by
a third party would have a material adverse effect on our results of operations, financial condition and liquidity, and we may, among other things, be required to:



| |  |  | pay damages, including up to treble damages and the other partys attorneys fees, which may be substantial;
| | - |  | ------------------------------------------------------------------------------------------------------------

| |  |  | cease the development, manufacture, use and sale of products that infringe the patent rights of others, including our CoStar stent, through a court-imposed sanction called an
injunction;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | expend significant resources to redesign our technology so that it does not infringe others patent rights, or to develop or acquire non-infringing intellectual property, which
may not be possible;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | discontinue manufacturing or other processes incorporating infringing technology; and/or
| | - |  | ----------------------------------------------------------------------------------------

| |  |  | obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



An award of damages against us would adversely affect our results of
operations and liquidity, and any delays or restrictions with respect to our commercialization plans resulting from such litigation would adversely affect our ability to generate revenues. In addition, our competitors have significant resources to
devote to litigation against us, and we may need to expend significant resources to defend such litigation. We could require significant additional funds to bear the costs of this litigation, regardless of whether we prevail. Our ability to continue
to operate under our current operating plan could be impaired if such funds are not available. Since our costs in connection with any such litigation will vary greatly depending on the nature and timing of the litigation, it is not possible to
estimate the effect of any such costs on our financial condition and results of operations. Amounts, if any, that may be incurred in connection with these matters cannot be reasonably estimated at this time.



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Contractual Obligations



The following table summarizes our outstanding contractual obligations as of March 31, 2005 and the effect those obligations
are expected to have on our liquidity and cash flows in future periods (in thousands):



|                 |  |       |       |                        |   |           |  |           |       |                  |   |       |  |   |      
|---------------- |  | ----- | ----- | ---------------------- | - | --------- |  | --------- | ----- | ---------------- | - | ----- |  | - | -----
|                 |  |      
|                 |  |       |       | Payments due by period
|                 |  | Total |       | Less than1 Year        |   | 1-3 Years |  | 3-5 Years |       | More than5 Years
|Operating Leases |  | $     | 5,921 |                        | $ | 989       |  | $         | 2,015 |                  | $ | 1,082 |  | $ | 1,835
|                 |  |       |       |                        |   |           |  |           |       |                  |   |       |  |   |      



The table above
reflects only payment obligations that are fixed and determinable. Our commitments for operating leases relate to the lease for our headquarters in Menlo Park, California and for our facility in Athlone, Ireland.



In February 2005, we entered into a ten-year operating lease, which has an
option for an additional ten years, for manufacturing facilities in Athlone, Ireland. Total future minimum lease payments are $3.7 million. The lease payments for our facilities in Ireland are denominated in euros and have been converted into U.S.
dollars using the exchange rate in effect as of the date we entered into the lease.



In March 2005, we entered into an amendment of the lease agreement for our current headquarters in Menlo Park, California. The amendment provides for an additional 26,000 square feet of space in a building adjacent to
our current headquarters and extends the term of our lease for an additional year to August 2008. Total future minimum lease payments are $2.2 million.



Recent Accounting Pronouncement



In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R) which is a revision of SFAS No.
123, and supersedes APB Opinion 25. SFAS 123R requires all share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values, beginning with the first
annual period after June 15, 2005, with early adoption encouraged. On April 14, 2005, the SEC adopted a new rule that amended the compliance dates for SFAS No. 123R such that the Company is now allowed to adopt the new standard effective January 1,
2006. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion
25s intrinsic value method and, as such, recognize no compensation cost for employee stock options.



Under SFAS 123R, we must determine the appropriate fair value model and related assumptions to be used for valuing share-based payments, the amortization
method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of
the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption
of SFAS 123R, while the retroactive method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are currently evaluating the requirements of SFAS 123R as well as option
valuation methodologies related to our employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the effect of adopting SFAS 123R, it is expected that the adoption of SFAS
123R will have a material impact on our consolidated results of operations. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future,
the method of adoption and the option valuation method used. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required
under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.



Risk Factors



We have identified the following additional risks and uncertainties that may have a material adverse effect on our business, financial condition or
results of operations. Investors should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently
believe are immaterial may also significantly impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and investors may lose all or part of
their investment.



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Risks Related to Our Intellectual Property



Intellectual property rights, including in particular patent rights, play a
critical role in the drug eluting stent sector of the medical device industry, and therefore in our business. We face significant risks relating to patents, both as to our own patent position as well as to patents held by third parties. These risks
are summarized below. We have described in greater detail our patent position, and patents held by third parties that could impact our business, under Item 1. BusinessPatents and Proprietary Rights in our Annual Report on Form 10-K
for the year ended December 31, 2004, filed with the SEC on March 31, 2005. You should consider carefully the matters discussed under that caption and in the risk factors below in considering an investment in our common stock.



If any patent infringement or other intellectual property claims
asserted against us are successful, we could be enjoined, or prevented, from commercializing our CoStar stent or other product candidates.



There are numerous U.S. and foreign issued patents and pending patent applications owned by third parties with patent claims in areas that are the focus
of our product development efforts. We are aware of patents owned by third parties, to which we do not have licenses that relate to, among other things:



| |  |  | use of paclitaxel (in general or on a stent) to treat restenosis;
| | - |  | -----------------------------------------------------------------

| |  |  | stent structure;
| | - |  | ----------------

| |  |  | catheters used to deliver stents; and
| | - |  | -------------------------------------

| |  |  | stent manufacturing processes.
| | - |  | ------------------------------



A number of these patents are owned by very large and well-capitalized companies that are active participants in the stent market, such as Boston
Scientific Corporation and Guidant Corporation. Several of these third party patents have been or are being asserted in litigation against purported infringers, including against us, demonstrating a willingness by the patent owners to litigate their
claims. On February 1, 2005, Angiotech Pharmaceuticals and Boston Scientific (as Angiotechs licensee) initiated legal proceedings against us in the District Court in the Hague, Netherlands seeking a declaration that our CoStar stent infringes
European Patent No. 0 706 376 B1, one of the Hunter patents owned by Angiotech and licensed to Boston Scientific. In the suit, Angiotech and Boston Scientific are also seeking orders, among other things, preventing us from commercializing our CoStar
stent in many European countries and requiring us to pay damages. Based on the prolific litigation that has occurred in the stent industry and the fact that we may pose a competitive threat to other large and well-capitalized companies who own or
control patents relating to stents and their use, manufacture and delivery, we believe that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use or sale of our CoStar stent based on
one or more of these or other patents. We have also received letters from third parties who have intellectual property rights in, or who have been actively involved in litigation or oppositions relating to, coronary stents, asserting that they may
have rights to patents that are relevant to our operations or our stent platform and requesting the initiation of discussions. Any lawsuit could seek to enjoin, or prevent, us from commercializing our CoStar stent and may seek damages from us, and
would likely be expensive for us to defend. A court may determine that these patents are valid and infringed by us. For a description of patents that we consider to pose a material litigation risk to us, see the discussion under the caption
Business-Patents and Proprietary Rights-Third-Party Patent Rights in our Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC on March 31, 2005. There may be patents in addition to those described under
that caption that relate to aspects of our technology and that may materially and adversely affect our business. Moreover, because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which
may later result in issued patents that pose a material risk to us.



The stent and related markets have experienced rapid technological change and obsolescence in the past, and our competitors have strong incentives to stop or delay the introduction of new products and technologies. Some of the companies in
these markets, such as Boston Scientific and Guidant Corporation, have been able to capture significant market share by introducing new technologies. These companies have maintained their position in the market by, among other things, establishing
intellectual property rights relating to their products and enforcing these rights aggressively against their competitors and potential new entrants into the market. All of the major companies in the stent and related markets, including Boston
Scientific Corporation, Johnson & Johnson, Guidant Corporation and Medtronic, have been repeatedly involved in patent litigation relating to stents since at least 1997. Ongoing patent litigation includes litigation between Boston Scientific and
Johnson & Johnson relating to Boston Scientifics drug eluting and Johnson & Johnsons drug eluting stent, as well as patent litigation by Advanced Cardiovascular Systems, a subsidiary of Guidant, against Boston Scientific relating
to stent structure. Each company is claiming that the other company infringes its intellectual property. We may pose a competitive threat to many of the companies in the stent and related markets. Accordingly, many of these companies, especially
Boston Scientific and others against which we would compete directly, have a strong incentive to take steps,



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through patent litigation or otherwise, to prevent us from commercializing our CoStar stent and as indicated above, Angiotech and Boston Scientific have
initiated legal proceedings in the Netherlands against us seeking to prevent us from commercializing our CoStar stent in certain European countries. Boston Scientific also owns a series of patents, known as the Kunz patents, which cover
the use of paclitaxel to treat restenosis generally and also to treat restenosis via a stent. Boston Scientific asserted three of the Kunz patents in a patent infringement lawsuit in the Federal District Court in Delaware against Johnson &
Johnson and Cordis Corporation, a subsidiary of Johnson & Johnson, and it is possible that Boston Scientific could assert a patent infringement claim against us based on these patents. On March 11, 2005, the Federal District Court in Delaware
dismissed all claims relating to the patents without the right to bring claims in the future, and dismissed all counterclaims by Johnson & Johnson, Cordis and Guidant with the right to assert counterclaims in the future.



Angiotech is the owner of a number of patents, sometimes referred to as the
Hunter patents, and has licensed from the U.S. government a number of other patents, sometimes referred to as the Kinsella patents, that also cover the use of paclitaxel coated stents to treat angiogenesis and restenosis. The
legal proceedings initiated by Angiotech and Boston Scientific against us in the Netherlands allege that the CoStar stent infringes one of the Hunter patents. We understand that, in a 1997 license agreement, Angiotech granted co-exclusive
sublicenses to Boston Scientific and Cook Inc. under these patents. On September 24, 2004, Angiotech announced that Cook elected to exit the coronary vascular field and focus on the development of paclitaxel-eluting peripheral vascular and
gastrointestinal stents. Angiotech also announced that Cook returned all of its rights in the coronary vascular field under the 1997 license agreement to Angiotech. On November 23, 2004, Boston Scientific announced that they had become the only
license holder of these rights in the coronary vascular field of use and had obtained the right to sublicense these rights. Angiotech announced that Cook will maintain its rights in the Angiotech patents in the field of paclitaxel-eluting peripheral
vascular and gastrointestinal stents.



Boston Scientific owns
other patents that may have a material adverse affect on us. These include a stent structure patent with claims covering an expanded stent with a plurality of cavities which are micro-holes or micro-slits that extend from the outer surface through
the inner surface and which act as reservoirs for a substance.



In addition, Guidant owns a number of patents that could have a material adverse effect on us. These include the Yock family of patents that are directed to rapid exchange catheters, the Lau family of patents which
claim rapid exchange catheters for stent delivery, another Lau family of patents directed to stent structures and the Castro patents, which are directed to a manufacturing process involving the application of a material to a
stent.



While our products are in clinical trials, and prior to
commercialization, we believe our activities in the United States related to the submission of data to the FDA fall within the scope of the exemptions that cover activities related to developing information for submission to the FDA and fall under
general investigational use or similar laws in other countries. However, the U.S. exemptions would not cover our stent manufacturing or other activities in the United States that support overseas clinical trials if those activities are not also
reasonably related to developing information for submission to the FDA.



Whether we would, upon commercialization, infringe any patent claim will not be known with certainty unless and until a court interprets the patent claim in the context of litigation. If an infringement allegation is made against us, we may
seek to invalidate the asserted patent claim and/or to allege non-infringement of the asserted patent claim. In February 2005, we initiated legal proceedings in the High Court of Justice in the United Kingdom requesting that the court invalidate EP
0 706 376, which is one of the Hunter patents owned by Angiotech and licensed to Boston Scientific that is the subject of the legal proceedings asserted against us in the Netherlands. In Europe, individual country laws control the standard for
patent invalidation, and the burden of proof to invalidate a particular claim can vary among countries. In order for us to invalidate a U.S. patent claim, we would need to rebut the presumption of validity afforded to issued patents in the United
States with clear and convincing evidence of invalidity, which is a high burden of proof.



In the event that we are found to infringe any valid claim in a patent held by a third party, we may, among other things, be required to:



| |  |  | pay damages, including up to treble damages and the other partys attorneys fees, which may be substantial;
| | - |  | ------------------------------------------------------------------------------------------------------------

| |  |  | cease the development, manufacture, use and sale of products that infringe the patent rights of others, including our CoStar stent, through a court-imposed sanction called an
injunction;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | expend significant resources to redesign our technology so that it does not infringe others patent rights, or to develop or acquire non-infringing intellectual property, which
may not be possible;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | discontinue manufacturing or other processes incorporating infringing technology; and/or
| | - |  | ----------------------------------------------------------------------------------------

| |  |  | obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



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Any development or acquisition of non-infringing products or technology or licenses could require the
expenditure of substantial time and other resources and could have a material adverse effect on our business and financial results. If we are required to, but cannot, obtain a license to valid patent rights held by a third party, we would likely be
prevented from commercializing the relevant product. We believe that it is unlikely that we would be able to obtain a license to any necessary patent rights controlled by companies, like Boston Scientific, against which we would compete directly.
This would include, for example, a license to the Kunz, Hunter or Kinsella patents. If we need to redesign products to avoid third-party patents, we may suffer significant regulatory delays associated with conducting additional studies or submitting
technical, manufacturing or other information related to the redesigned product and, ultimately, in obtaining approval.



In addition, some of our agreements, including our agreement with Phytogen International LLC for the supply of paclitaxel, our distribution agreements
with Biotronik AG and the St. Jude Medical affiliates and our supply agreements for laser-cut stents and catheters, require us to indemnify the other party in certain circumstances where our products have been found to infringe a patent or other
proprietary rights of others. An indemnification claim against us may require us to pay substantial sums to our supplier, including its attorneys fees.



If we are unable to obtain and maintain intellectual property protection covering our products, others may be able to make, use or sell our
products, which would adversely affect our market share, and, therefore, our revenues.



Our ability to protect our drug eluting stent technology from unauthorized or infringing use by third parties depends substantially on our ability to obtain and maintain valid and enforceable patents. Due to evolving
legal standards relating to the patentability, validity and enforceability of patents covering medical devices and pharmaceutical inventions and the scope of claims made under these patents, our ability to obtain and enforce patents is uncertain and
involves complex legal and factual questions. Accordingly, rights under any of our issued patents may not provide us with commercially meaningful protection for our drug eluting stents or afford us a commercial advantage against our competitors or
their competitive products or processes. In addition, patents may not issue from any pending or future patent applications owned by or licensed to us, and moreover, patents that have issued to us or may issue in the future may not be valid or
enforceable. Further, even if valid and enforceable, our patents may not be sufficiently broad to prevent others from marketing stents like ours, despite our patent rights.



The validity of our patent claims depends, in part, on whether prior art references described or rendered obvious our
inventions as of the filing date of our patent applications. We may not have identified all prior art, such as U.S. and foreign patents or published applications or published scientific literature, that could adversely affect the validity of our
issued patents or the patentability of our pending patent applications. For example, patent applications in the United States are maintained in confidence for up to 18 months after their filing. In some cases, however, patent applications remain
confidential in the U.S. Patent and Trademark Office, which we refer to as the U.S. Patent Office, for the entire time prior to issuance as a U.S. patent. Patent applications filed in countries outside the United States are not typically published
until at least 18 months from their first filing date. Similarly, publication of discoveries in the scientific or patent literature often lags behind actual discoveries. Therefore, we cannot be certain that we were the first to invent, or the first
to file patent applications relating to, our stent technologies. In the event that a third party has also filed a U.S. patent application covering our stents or a similar invention, we may have to participate in an adversarial proceeding, known as
an interference, declared by the U.S. Patent Office to determine priority of invention in the United States. It is possible that we may be unsuccessful in an interference, resulting in a loss of some portion or all of our U.S. position. We have
filed an application seeking to provoke an interference with a patent owned by MicroCHIPS, Inc. with claims directed to an implantable stent having reservoirs and a release system contained in the reservoirs for releasing drugs, as the priority date
of the MicroCHIPS patent is after the priority date of our patent. The laws of some foreign jurisdictions do not protect intellectual property rights to the same extent as in the United States, and many companies have encountered significant
difficulties in protecting and defending such rights in foreign jurisdictions. If we encounter such difficulties or we are otherwise precluded from effectively protecting our intellectual property rights in foreign jurisdictions, our business
prospects could be substantially harmed.



We may initiate
litigation to enforce our patent rights, which may prompt our adversaries in such litigation to challenge the validity, scope or enforceability of our patents. If a court decides that our patents are not valid, not enforceable or of a limited scope,
we will not have the right to stop others from using our inventions.



We also rely on trade secret protection to protect our interests in proprietary know-how and for processes for which patents are difficult to obtain or enforce. We may not be able to protect our trade secrets adequately. In addition, we
rely on non-disclosure and confidentiality agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. These agreements may be breached, and we may not have adequate remedies for any
breach. Moreover, others may independently develop equivalent proprietary information, and third parties may otherwise gain access to our trade secrets and proprietary knowledge. Any disclosure of confidential data into the public domain or to third
parties could allow our competitors to learn our trade secrets and use the information in competition against us.



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We may incur substantial costs as a result of litigation or other proceedings relating to patent
and other intellectual property rights.



There has been
substantial litigation and other proceedings regarding patent and intellectual property rights in the medical device industry generally and the drug eluting stent industry in particular. We are currently defending, and may in the future be forced to
defend, claims of infringement brought by our competitors and others, and we may institute litigation against others who we believe are infringing our intellectual property rights. The outcome of patent litigation is subject to substantial
uncertainties, especially in medical device-related patent cases that may, for example, turn on the interpretation of claim language by the court which may not be to our advantage, and also the testimony of experts as to technical facts upon which
experts may reasonably disagree. Our involvement in intellectual property litigation could result in significant expense. Some of our competitors, such as Boston Scientific and Guidant, have considerable resources available to them and a strong
economic incentive to undertake substantial efforts to stop or delay us from bringing our CoStar stent to market and achieving market acceptance. We, on the other hand, are a development stage company with comparatively few resources available to us
to engage in costly and protracted litigation. Moreover, regardless of the outcome, intellectual property litigation against or by us could significantly disrupt our development and commercialization efforts, divert our managements attention
and quickly consume our financial resources.



If third parties
file patent applications or are issued patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings with the U.S. Patent Office or in other proceedings outside the United
States, including oppositions, to determine priority of invention or patentability. Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be
diverted in pursuit of these proceedings.



Risks Related to
Our Business



We will depend heavily on the success
of our lead product candidate, our CoStar stent, which is still in development. If we are unable to commercialize our CoStar stent in major markets or experience significant delays in doing so, our ability to generate revenue will be significantly
delayed and our business will be harmed.



We have
invested all of our product development time and resources in our drug eluting stent technology, which we commercialized initially in the form of our CoStar stent on a limited basis in India. We do not anticipate that the initial commercialization
of our CoStar stent in India will provide us with significant revenues. We anticipate that in the near term our ability to generate meaningful revenues will depend solely on the successful development, regulatory approval and commercialization of
our CoStar stent in major markets. If we are not successful in the completion of clinical trials for the development, approval and commercialization of our CoStar stent, we may never generate any meaningful revenues and may be forced to cease
operations. Although we are investigating the potential applicability of our stent technology to the treatment of an acute myocardial infarction, or AMI, we do not expect to seek regulatory approval of this product candidate for many years, if at
all.



The commercial success of our CoStar stent will depend
upon successful completion of clinical trials, manufacturing commercial supplies, obtaining marketing approval, successfully launching the product in major markets and acceptance of the product by the medical community and third party payors as
clinically useful, cost-effective and safe. If the data from our clinical trials is not satisfactory, we may not proceed with our planned filing of applications for regulatory approvals or we may be forced to delay the filings. Even if we file an
application for approval with satisfactory clinical data, the FDA or foreign regulatory authorities may not accept our filing, or may request additional information, including data from additional clinical trials. The FDA or foreign regulatory
authorities may also approve our CoStar stent for very limited purposes with many restrictions on its use, may delay approval, or ultimately, may not grant marketing approval for our CoStar stent. Even if we do receive FDA or foreign regulatory
approval, we may be unable to gain market acceptance by the medical community and third party payors.



We do not have the necessary regulatory approvals to market our CoStar stent or any other product candidates, and we may never obtain regulatory
approval.



We do not have the necessary regulatory
approvals to market our CoStar stent or any other product in the United States or in any foreign market. The regulatory approval process for our CoStar stent involves, among other things, successfully completing clinical trials and obtaining FDA
approval of a premarket approval application, or PMA, and obtaining equivalent foreign market approvals, including taking the steps necessary for our CoStar stent to bear CE marking in the European Community. We cannot assure you that we will obtain
the necessary regulatory approvals to market our CoStar stent in the United States or abroad. No regulatory approval is currently required to market our stent in India.



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Our CoStar stent is a combination product that will be regulated primarily as a class III medical device
in the United States, which cannot be commercially distributed until the FDA approves our PMA. The premarket approval process can be expensive and uncertain, requires detailed and comprehensive scientific and other data, generally takes several
years and may never result in the FDA granting premarket approval. We will also have to obtain similar, or in some cases more stringent, foreign marketing approval in order to commercialize our product candidates outside of the United States. If we
do not obtain the requisite regulatory or marketing approvals, we will be unable to market our CoStar stent and may never recover any of the substantial costs we have invested in the development of our CoStar stent.



If our pre-clinical tests or clinical trials for our CoStar stent or
other product candidates do not meet safety or efficacy endpoints, or if we experience significant delays in these tests or trials, our ability to commercialize our CoStar stent or other product candidates and our financial position will be
impaired.



Before marketing our CoStar stent or any
other product candidate, we must successfully complete pre-clinical studies and clinical trials that demonstrate that the product is safe and effective. Product development, including pre-clinical studies and clinical testing, is a long, expensive
and uncertain process and is subject to delays. It may take us several years to complete our testing, if at all, and a trial may fail at any stage. For example, we discovered that the dosage formulations for our SCEPTER trial were not ideal.



The results of pre-clinical or clinical studies do not
necessarily predict future clinical trial results, and acceptable results in early studies might not be seen in later studies. For example, the four- and six-month follow-up data from our COSTAR I and EuroSTAR studies, respectively, may not be
sustained in later follow-up of patients in the trials, and we may discover unanticipated side effects. Any pre-clinical or clinical tests may fail to produce results satisfactory to the FDA or foreign regulatory authorities. Pre-clinical and
clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval.



We have designed the protocol of our planned pivotal U.S. clinical trial for our CoStar stent based in part on prior clinical trials that used
different stents. The results of these prior clinical trials may not be indicative of the clinical results we would obtain for our U.S. pivotal clinical trial.



We intend to commercialize our drug eluting stent technology in the form of our CoStar stent, which is a cobalt chromium,
paclitaxel eluting stent. We have only limited clinical data on our CoStar stent, which we derived from the EuroSTAR and COSTAR I studies. Our other prior clinical trials used either a bare metal stainless steel stent or a stainless steel,
paclitaxel eluting stent. In addition to using a different metal than used in our CoStar stent, the stainless steel stent had slightly different dimensions than our CoStar stent. We have designed the protocol, including the dosage formulations, for
our planned U.S. pivotal clinical trial based on the results of these prior clinical trials. This trial has been designed in large part based on the results of our PISCES study, which used a stainless steel, paclitaxel eluting form of our stent
technology, as well as on the results of our COSTAR I and EuroSTAR studies. Although we have twelve-month follow-up data from the PISCES study, we have only four-month follow-up data from the COSTAR I study and only six-month follow-up data from the
EuroSTAR study.



The results of these prior trials may not be
indicative of the behavior of, and therefore the clinical results we will obtain with, our CoStar stent. If results at least as favorable as the four- and twelve-month results in our PISCES study and the four-and six-month results in our COSTAR I
and EuroSTAR studies, respectively, are not observed in our planned U.S. pivotal clinical trial, our development efforts will be delayed or halted and our business may be harmed.



The clinical results we have reported to date may not be indicative of future clinical results.



The clinical results that we have reported to date are limited to four- and
twelve-month follow-up data from our PISCES study, six-month follow-up data from our EuroSTAR study, and four-month follow-up data from our COSTAR I study. Our planned U.S. pivotal clinical trial, COSTAR II, will require at least eight-month
follow-up data. The four-and six-month results from our COSTAR I and EuroSTAR studies, respectively, may not be indicative of the clinical results obtained when we examine the patients at a later date. While the stainless steel, paclitaxel eluting
stent has shown favorable results after twelve months in our PISCES study, it is possible that the long-term results we obtain with our CoStar stent may not show similar effectiveness.



Our current and planned clinical trials may not begin on time, or at all, and may not be completed on schedule, or at
all.



The commencement or completion of any of our
clinical trials may be delayed or halted for numerous reasons, including, but not limited to, the following:



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| |  |  | the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

| |  |  | patients do not enroll in clinical trials at the rate we expect;
| | - |  | ----------------------------------------------------------------

| |  |  | patients are not followed-up at the rate we expect;
| | - |  | ---------------------------------------------------

| |  |  | patients experience adverse side effects or events related to our products;
| | - |  | ---------------------------------------------------------------------------

| |  |  | patients die during a clinical trial for a variety of reasons, including the advanced stage of their disease and medical problems, which may not be related to our product
candidates;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | third party clinical investigators do not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices, or
other third party organizations do not perform data collection and analysis in a timely or accurate manner;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our
clinical trials if investigators find us not to be in compliance with regulatory requirements;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | third party suppliers fail to provide us with critical components, including stent delivery catheters, cobalt chromium tubing and precision laser-cut stents, which conform to design
and performance specifications;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the failure of our manufacturing process to produce finished products which conform to design and performance specifications;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------

| |  |  | changes in governmental regulations or administrative actions;
| | - |  | --------------------------------------------------------------

| |  |  | the interim results of the clinical trial are inconclusive or negative; or
| | - |  | --------------------------------------------------------------------------

| |  |  | our trial design, although approved, is inadequate to demonstrate safety and/or efficacy.
| | - |  | -----------------------------------------------------------------------------------------



Before we can commence our planned U.S. pivotal clinical trial for our CoStar stent, an investigational device exemption, or
IDE, application must be approved by the FDA. Although we have received conditional approval of our IDE application from the FDA, the FDAs conditional approval of our IDE application allows us to begin only a limited enrollment in our COSTAR
II trial. We are required to provide additional information to the FDA prior to the FDA granting full approval of our IDE application, including information that will be reviewed prior to the FDA approving full enrollment in our COSTAR II trial.
While we anticipate that we will be able to provide the additional information that the FDA has requested, there can be no assurance that we will receive full approval of our IDE application on a timely basis, if at all. If we are unable to provide
the additional information to the FDA, or if the FDA does not believe that the additional information we provide is sufficient, the FDA may require us to cease enrollment in the trial until adequate information is provided.



Clinical trials may require the enrollment of large numbers of patients, and
suitable patients may be difficult to identify and recruit. For example, our planned U.S. pivotal clinical trial for our CoStar stent is designed to enroll approximately 1,700 patients at up to 75 U.S. sites and 15 international sites. Patient
enrollment in clinical trials and completion of patient follow-up in clinical trials depend on many factors, including the size of the patient population, the nature of the trial protocol, the proximity of patients to clinical sites and the
eligibility criteria for the study and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures to assess the safety and
effectiveness of our CoStar stent, or they may be persuaded to participate in contemporaneous trials of competitive products. In addition, patients participating in our clinical trials may die before completion of the trial or suffer adverse medical
effects unrelated to our CoStar stent. Delays in patient enrollment or failure of patients to continue to participate in a study may cause an increase in costs and delays or result in the failure of the trial.



Our development costs will increase if we have material delays in our
clinical trials or if we need to perform more or larger clinical trials than planned. Adverse events during a clinical trial could cause us to repeat a trial, terminate a trial or cancel the entire program.



Problems with the stent to be used in the control group could adversely
affect our planned U.S. pivotal clinical trial for our CoStar stent.



Our planned U.S. pivotal clinical trial of our CoStar stent could be significantly delayed or harmed if we experience problems with the stent to be used in the control group for this trial. We plan to use Boston
Scientifics TAXUS Express2 stent as the control stent in our planned U.S. pivotal clinical trial. In July 2004, Boston Scientific announced the recall of approximately 85,000
TAXUS Express2 stent systems and approximately 11,000 Express2 stent systems due to characteristics in the delivery
catheters that have the potential to impede balloon deflation during a coronary angioplasty procedure. In August 2004, Boston Scientific announced that it would recall an additional 3,000 TAXUS Express2 stents. If prior to or during the enrollment and treatment period for our planned U.S. pivotal clinical trial, there is a recall of the control stent or the control stent is removed from the market, our trial
would likely be substantially delayed. The FDA could also require us to redesign the trial based on an alternative control stent. Any significant delay or redesign would significantly delay and potentially impair our ability to commercialize our
CoStar stent.



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We may not be successful in our efforts to expand our portfolio of products and develop additional
drug delivery technologies.



A key element of our
strategy is to discover, develop and commercialize a portfolio of new products in addition to our CoStar stent. We are seeking to do so through our internal research programs and intend to explore strategic collaborations for the development of new
products utilizing our stent technology. Research programs to identify new disease targets, product candidates and delivery techniques require substantial technical, financial and human resources, whether or not any product candidates are ultimately
identified. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for many reasons, including the following:



| |  |  | the research methodology used may not be successful in identifying potential product candidates;
| | - |  | ------------------------------------------------------------------------------------------------

| |  |  | competitors may develop alternatives that render our product candidates obsolete;
| | - |  | ---------------------------------------------------------------------------------

| |  |  | our delivery technologies may not safely or efficiently deliver the drugs; and
| | - |  | ------------------------------------------------------------------------------

| |  |  | product candidates may on further study be shown to have harmful side effects or other characteristics that indicate they are unlikely to be effective.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



Our strategy also includes exploring the use of compounds and drugs other
than paclitaxel for the treatment of restenosis and other indications. We may not be able obtain any necessary licenses to promising compounds or drugs on reasonable terms, if at all. In addition, our strategy includes substantial reliance on
strategic collaborations with others to develop new products. If these collaborators do not prioritize and commit substantial resources to these collaborations, or if we are unable to secure successful collaborations on acceptable business terms, we
may be unable to discover suitable potential product candidates or develop additional delivery technologies and our business prospects will suffer.



Pre-clinical development is a long, expensive and uncertain process, and we may terminate one or more of our pre-clinical development programs.



We may determine that certain pre-clinical product
candidates or programs do not have sufficient potential to warrant the allocation of resources, such as the potential development of our stent technology for the treatment of AMI. Accordingly, we may elect to terminate our programs for such product
candidates. If we terminate a pre clinical program in which we have invested significant resources, our prospects will suffer, as we will have expended resources on a program that will not provide a return on our investment and will have missed the
opportunity to have allocated those resources to potentially more productive uses.



We depend on single source suppliers for our CoStar stent components, manufacturing components and the active drug used in our CoStar stent. The loss of these suppliers could delay our clinical trials or prevent
or delay commercialization of our CoStar stent.



We
rely on third parties to supply us with the critical components and the active drug, paclitaxel, used in our CoStar stent. Phytogen International LLC is our sole supplier of paclitaxel. Our agreement with Phytogen restricts our ability to
commercialize products that incorporate paclitaxel we purchase from third parties, and there is a limited number of alternative suppliers that are capable of manufacturing paclitaxel and are willing, or legally able, to do so. In addition, the
agreement permits Phytogen to manufacture and supply paclitaxel to others. If Phytogen is unable or refuses to meet our demand for paclitaxel, if Phytogen terminates its agreement with us or if Phytogens supplies do not meet quality and other
specifications, the development and commercialization of our CoStar stent could be prevented or delayed. If we obtain market approval for our CoStar stent, we anticipate that we will require substantially larger quantities of paclitaxel. Phytogen
may not provide us with sufficient quantities of paclitaxel that meet quality and other specifications, and we may not be able to locate an alternative supplier of paclitaxel in a timely manner or on commercially reasonable terms, if at all.



We do not have long-term contracts with our third party
suppliers of stent delivery catheters, polymers or the cobalt chromium tubing and laser-precision cutting process required to produce our CoStar stent. In addition, we do not have long-term contracts with our third party suppliers of some of the
equipment and components that are used in our manufacturing process. Except for the suppliers of our laser-cut stents and stent delivery catheters, none of our suppliers have agreed to maintain a guaranteed level of production capacity. Furthermore,
suppliers that have guaranteed a level of production capacity may still be unable to satisfy our supply needs. Establishing additional or replacement suppliers for these components may take a substantial amount of time. We may also have difficulty
obtaining similar components from other suppliers that are acceptable to the FDA or foreign regulatory authorities. Furthermore, since some of these suppliers are located outside of the United States, we are subject to foreign export laws and U.S.
import and customs regulations, which complicate and could delay shipments to us. Some of the manufacturers of stent components are also our competitors and may be reluctant to supply components to us on favorable terms, if at all.



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If we have to switch to replacement suppliers, we may face additional regulatory delays and the
manufacture and delivery of our CoStar stent could be interrupted for an extended period of time, which may delay completion of our clinical trials or commercialization of our CoStar stent. In addition, we will be required to obtain regulatory
clearance from the FDA or foreign regulatory authorities to use different suppliers or components that may not be as safe or as effective. As a result, regulatory approval of our CoStar stent may not be received on a timely basis or at all.



We have limited manufacturing capabilities and
manufacturing personnel, and if our manufacturing facilities are unable to provide an adequate supply of products, our growth could be limited and our business could be harmed.



We currently manufacture our CoStar stent at our facilities in Menlo Park, California, and in our manufacturing facility in
Athlone, Ireland. If there were a disruption to our existing manufacturing facilities, we would have no other means of manufacturing our CoStar stent until we were able to restore the manufacturing capability at our current facilities or develop
alternative manufacturing facilities. If we were unable to produce sufficient quantities of our CoStar stent for use in our current and planned clinical trials, or if our manufacturing process yields substandard stents, our development and
commercialization efforts would be delayed.



We currently have
limited resources, facilities and experience to commercially manufacture our product candidates. In order to produce our CoStar stent in the quantities that we anticipate will be required to meet anticipated market demand, we will need to increase,
or scale up, the production process by a significant factor over the current level of production. There are technical challenges to scaling-up manufacturing capacity, and developing commercial-scale manufacturing facilities would require
the investment of substantial additional funds and hiring and retaining additional management and technical personnel who have the necessary manufacturing experience. We may not successfully complete any required scale-up in a timely manner or at
all. If we are unable to do so, we may not be able to produce our CoStar stent in sufficient quantities to meet the requirements for the launch of the product in major markets or to meet future demand, if at all. If we develop and obtain regulatory
approval for our CoStar stent and are unable to manufacture a sufficient supply of our CoStar stent, our revenues, business and financial prospects would be adversely affected. In addition, if the scaled-up production process is not efficient or
produces stents that do not meet quality and other standards, our future gross margins may decline.



In addition, while we have validated our manufacturing process for consistency, we have experienced drug release kinetic variability within and between
manufacturing lots, and we may experience similar issues in the future. Manufacturing lot variability may result in unfavorable clinical trial results.



Additionally, any damage to or destruction of our Menlo Park facilities or our equipment, prolonged power outage or contamination at our facility would
significantly impair our ability to produce our CoStar stents. For example, because our Menlo Park facilities are located in a seismic zone, we face the risk that an earthquake may damage our facilities and disrupt our operations.



Our manufacturing facilities and the manufacturing facilities of our
suppliers must comply with applicable regulatory requirements. If we fail to achieve regulatory approval for these manufacturing facilities, our business and our results of operations would be harmed.



Completion of our clinical trials and commercialization of our product
candidates require access to, or the development of, manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. Although we are currently manufacturing product in our facility in Ireland on
a limited basis, and are in the process of preparing the facility for full production in anticipation of our planned commercial launch in the European Community, our manufacturing facility may not meet applicable foreign regulatory requirements or
standards at acceptable cost and on a timely basis. In addition, the FDA must approve facilities that manufacture our products for U.S. commercial purposes, as well as the manufacturing processes and specifications for the product. Suppliers of
components of, and products used to manufacture, our products must also comply with FDA and foreign regulatory requirements, which often require significant time, money and record-keeping and quality assurance efforts and subject us and our
suppliers to potential regulatory inspections and stoppages. Our suppliers may not satisfy these requirements. If we or our suppliers do not achieve required regulatory approval for our manufacturing operations, our commercialization efforts could
be delayed, which would harm our business and our results of operations.



Quality issues in our manufacturing processes could delay our clinical development and commercialization efforts.



The production of our CoStar stent must occur in a highly controlled, clean environment to minimize particles and other yield- and quality-limiting
contaminants. In spite of stringent quality controls, weaknesses in process control or minute impurities in materials may cause a substantial percentage of defective products in a lot. If we are not able to maintain stringent quality controls, or if
contamination problems arise, our clinical development and commercialization efforts could be delayed, which would harm our business and our results of operations.



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Our CoStar stent may never achieve market acceptance even if we obtain regulatory approvals.



Even if we obtain regulatory approval, our CoStar
stent, or any other drug delivery device that we may develop, may not gain market acceptance among physicians, patients, health care payors and the medical community. The degree of market acceptance of any of our drug delivery devices that we may
develop will depend on a number of factors, including:



| |  |  | the perceived effectiveness of the product;
| | - |  | -------------------------------------------

| |  |  | the prevalence and severity of any side effects;
| | - |  | ------------------------------------------------

| |  |  | potential advantages over alternative treatments;
| | - |  | -------------------------------------------------

| |  |  | the strength of marketing and distribution support; and
| | - |  | -------------------------------------------------------

| |  |  | sufficient third party coverage or reimbursement.
| | - |  | -------------------------------------------------



If our CoStar stent, or any other drug delivery device that we may develop, is approved but does not achieve an adequate level of acceptance by
physicians, healthcare payors and patients, we may not generate meaningful product revenue and we may not become profitable.



If we fail to obtain an adequate level of reimbursement for our products by third party payors, there may be no commercially viable markets for our
product candidates or the markets may be much smaller than expected.



The availability and levels of reimbursement by governmental and other third party payors affect the market for our product candidates. The efficacy, safety, performance and cost-effectiveness of our product
candidates and of any competing products will determine the availability and level of reimbursement. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored
healthcare and private insurance. To obtain reimbursement or pricing approval in some countries, we may be required to produce clinical data, which may involve one or more clinical trials, that compares the cost-effectiveness of our products to
other available therapies. We may not obtain international reimbursement or pricing approvals in a timely manner, if at all. Our failure to receive international reimbursement or pricing approvals would negatively impact market acceptance of our
products in the international markets in which those approvals are sought. Although we recently launched our CoStar stent in India, India does not currently have a reimbursement infrastructure, and we do not anticipate that the initial
commercialization of our CoStar stent in India will provide us with significant revenues.



We believe that future reimbursement may be subject to increased restrictions both in the United States and in international markets. Future legislation, regulation or reimbursement policies of third party payors may
adversely affect the demand for our products currently under development and limit our ability to sell our product candidates on a profitable basis. In addition, third party payors continually attempt to contain or reduce the costs of healthcare by
challenging the prices charged for healthcare products and services. If reimbursement for our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels, market acceptance of our products would be impaired
and our future revenues would be adversely affected.



If
we are unable to establish sales and marketing capabilities or enter into and maintain arrangements with third parties to sell and market our CoStar stent, our business may be harmed.



We do not have a sales organization and have no experience as a company in
the sales, marketing and distribution of drug eluting stents or other medical devices. To market and sell our CoStar stent internationally, we have entered into distribution agreements with third parties and anticipate that we will have to enter
into additional distribution arrangements. Our existing distribution agreements are generally short-term in duration, and we will have to pursue alternative distributors if the other parties to these distribution agreements terminate or elect not to
renew their agreements with us. If our relationships with our distributors do not progress as anticipated, or if their sales and marketing strategies fail to generate sales of our products in the future, our business, financial condition and results
of operations would be harmed.



If our CoStar stent is approved
for commercial sale in the United States, we currently plan to establish our own sales force to market it in the United States. If we develop our own marketing and sales capabilities, our sales force will be competing with the experienced and
well-funded marketing and sales operations of our competitors. Developing a sales force is expensive and time consuming and could delay or limit the success of any product launch. We may not be able to develop this capacity on a timely basis or at
all. If we are unable to establish sales and marketing capabilities, we will need to contract with third parties to market and sell our CoStar stent in the United States. To the extent that we enter into arrangements with third parties to perform
sales, marketing and



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distribution services in the United States, our product revenues could be lower than if we directly marketed and sold our CoStar stent, or any other drug
delivery device that we may develop. Furthermore, to the extent that we enter into co-promotion or other marketing and sales arrangements with other companies, any revenues received will depend on the skills and efforts of others, and we do not know
whether these efforts will be successful. Some of our existing or future distributors may have products or product candidates that compete with ours, and they may have an incentive not to devote sufficient efforts to marketing our products. For
example, Biotronik AG, with whom we have an agreement that primarily covers European distribution, is developing an absorbable magnesium alloy stent. If we are unable to establish and maintain adequate sales, marketing and distribution capabilities,
independently or with others, we may not be able to generate product revenue and may not become profitable.



The medical device industry is highly competitive and subject to rapid technological change. If our competitors are better able to develop and
market products that are safer and more effective than any products that we may develop, our commercial opportunity will be reduced or eliminated.



The medical device industry is highly competitive and subject to rapid and profound technological change. Our success depends, in part, upon our ability
to maintain a competitive position in the development of technologies and products in the drug delivery field.



We face competition from established pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private
and public research institutions in the United States and abroad. Our principal competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials,
obtaining regulatory approvals and marketing approved products than we do. For example, Johnson & Johnson and Boston Scientific, two companies with far greater financial and marketing resources than we possess, have both developed, and are
actively marketing, drug eluting stents which have been approved by the FDA. We may be unable to demonstrate that our CoStar stent offers any advantages over Johnson & Johnsons CYPHER stent or Boston Scientifics TAXUS Express2 stent. In addition, in August 2004, Boston Scientific announced that it had begun enrolling patients in a pivotal study to support commercialization of its new TAXUS Liberte coronary stent as a platform for its paclitaxel eluting coronary stent system. Boston Scientific has stated that the
trial is designed to assess the safety and efficacy of a slow-release dose formulation for the treatment of coronary disease and that the TAXUS Liberte stent system is designed to further enhance deliverability and conformability, particularly in challenging lesions. Many other large companies, including Guidant Corporation, Medtronic
Inc. and Abbott Laboratories, among others, are reportedly developing drug eluting stents. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with, or mergers with or
acquisitions by, large and established companies or through the development of novel products and technologies.



Our competitors may:



| |  |  | develop and patent processes or products earlier than us;
| | - |  | ---------------------------------------------------------

| |  |  | obtain regulatory approvals for competing products more rapidly than us; and
| | - |  | ----------------------------------------------------------------------------

| |  |  | develop more effective or less expensive products or technologies that render our technology or product candidates obsolete or non-competitive.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



The industry in which we operate has undergone, and is expected to continue
to undergo, rapid and significant technological change, and we expect competition to intensify as technical advances are made. Our competitors may develop and commercialize stents or other medical device or pharmaceutical products that are safer or
more effective, have fewer side effects or are less expensive than any products that we may develop. For example, we are aware of companies that are developing various other less-invasive technologies for treating cardiovascular disease, which could
make our stent platform obsolete. We also compete with our competitors in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring
technologies and technology licenses complementary to our programs or advantageous to our business.



If the third parties on whom we rely to conduct our clinical trials and to assist us with pre-clinical development do not perform as contractually
required or expected, we may not be able to obtain regulatory approval for or commercialize our product candidates.



We do not have the ability to independently conduct clinical trials for our product candidates, and we must rely on third parties, such as contract
research organizations, medical institutions, clinical investigators and contract laboratories to conduct our clinical trials. In addition, we rely on third parties to assist with our pre-clinical development of product candidates. If these third
parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if these third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to the failure
to adhere to our clinical protocols or regulatory requirements or for other reasons, our pre-clinical development activities or clinical trials may be extended, delayed,



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suspended or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates on a timely basis, if
at all. Furthermore, our third party clinical trial investigators may be delayed in conducting our clinical trials for reasons outside of their control. For instance, one of our competitors is a major supplier of the intravascular ultrasound, or
IVUS, catheters used in our clinical trials to measure percent volume obstruction, or the volume of the lumen, or the inner channel of the artery through which blood flows, in the stent occupied by restenotic tissue. If the supply of IVUS catheters
to our clinical trial sites is interrupted, our clinical trials may be delayed or terminated.



Our product candidates are based on a new technology, and we have only limited experience in regulatory affairs, which may affect our ability or the time required to obtain necessary regulatory approvals, if at
all.



Drug eluting stents were introduced in the U.S.
marketplace in 2003. To date, the FDA has approved only Boston Scientifics TAXUS Express2 and Johnson & Johnsons CYPHER drug eluting stents for commercial sale. Because drug eluting stents are relatively
new, regulatory agencies, including the FDA, may be slower in evaluating product candidates. For example, there are currently several measures of restenosis, including binary restenosis rate, in-stent late loss, in-segment late loss, percentage
volume obstruction and percentage diameter loss. Treatments may exhibit a favorable measure using one of these metrics and an unfavorable measure using another metric. It has not been settled which of these metrics, or another metric, is the ideal
measure for evaluating the clinical effectiveness of stents. It is possible that a change in the accepted metrics may result in reconfiguration and delays in our clinical trials or our CoStar stent being considered not to be clinically effective.



Furthermore, unlike surface-coated stents, our product
candidates are based on drug delivery polymer reservoirs. Because there are currently no approved products based on this technology, the regulatory requirements governing this type of product may be more rigorous or less clearly established than
those for already approved surface-coated stents or other vascular drug delivery devices. In addition, our CoStar stent has not been approved for use as a bare stent, and we do not expect to obtain FDA approval for this stent as a bare stent prior
to filing our PMA with the FDA. We must provide the FDA and foreign regulatory authorities with pre-clinical and clinical data that demonstrate that our product candidates are safe and effective before they can be approved for commercial sale. We
have only limited experience in filing and prosecuting the applications necessary to gain regulatory approvals, and our clinical staff is limited. As a result, we may experience a longer regulatory process in connection with obtaining regulatory
approvals for our product candidates.



Even if our
products are approved by regulatory authorities, if we fail to comply with ongoing regulatory requirements, or if we experience unanticipated problems with our products, these products could be subject to restrictions or withdrawal from the market.



Any product for which we obtain marketing approval,
along with the manufacturing processes, post-approval clinical data and promotional activities for such product, will be subject to continual review and periodic inspections by the FDA and other regulatory bodies. Even if regulatory approval of a
product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product.
Later discovery of previously unknown problems with our products, including unanticipated adverse events or adverse events of unanticipated severity or frequency, manufacturer or manufacturing problems or failure to comply with regulatory
requirements, may result in restrictions on such products or manufacturing processes, withdrawal of the products from the market, voluntary or mandatory recall, fines, suspension of regulatory approvals, product seizures, injunctions or the
imposition of civil or criminal penalties.



Failure to
obtain regulatory approval in foreign jurisdictions will prevent us from marketing our products abroad.



We intend to market our products in international markets. In order to market our products in the European Community and many other foreign jurisdictions,
we must obtain separate regulatory approvals. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory
approval process may include all of the risks associated with obtaining FDA approval in addition to other risks. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory
authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or by the FDA. We may not be able to file for regulatory approvals and may not receive
necessary approvals to commercialize our products in any market.



We have incurred losses since inception and anticipate that we will incur continued losses for the foreseeable future.



We are a development stage company with a limited operating history. As of March 31, 2005, we had a deficit accumulated during the development stage of
$56.3 million. We have incurred net losses in each year since our inception in 1999. We expect to



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continue to incur significant and increasing operating losses, in the aggregate and on a per share basis, for the next several years. These losses, among
other things, have had and will continue to have an adverse effect on our stockholders equity, net current assets and working capital.



Because of the numerous risks and uncertainties associated with developing medical devices, we are unable to predict the extent of any future losses or
when we will become profitable, if at all. To date, we have not generated significant product revenues and we do not expect to generate significant product revenues until we successfully obtain market approval for and begin selling our CoStar stent
in Europe, which we may not be able to do. We have financed our operations and internal growth primarily through private placements of equity securities and convertible promissory notes, as well as our initial public offering of our common stock. We
have devoted substantially all of our efforts to research and development, including clinical trials.



We expect our research and development expenses to increase in connection with the conduct of our clinical trials. As a public company, our general and
administrative and legal costs have increased due to the additional operational and regulatory burdens applicable to public companies. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002 and related regulations implemented by the Securities and Exchange Commission and the National Association of Securities Dealers, are creating uncertainty for public companies, increasing legal and financial
compliance costs and making some activities more time consuming. We are currently evaluating and monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the
timing of such costs. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with
evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of managements time and attention from product development activities to compliance activities. If our
efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our
business may be harmed. Moreover, subject to regulatory approval of any of our product candidates, we expect to incur sales and marketing and increased manufacturing expenses.



We may need substantial additional funding and may be unable to raise capital when needed, which would force us to
delay, reduce or eliminate our product development programs or commercialization efforts.



We may need to raise substantial additional capital to:



| |  |  | fund our operations and clinical trials;
| | - |  | ----------------------------------------

| |  |  | continue our research and development;
| | - |  | --------------------------------------

| |  |  | scale up our manufacturing operations;
| | - |  | --------------------------------------

| |  |  | defend, in litigation or otherwise, any claims that we infringe third party patent or other intellectual property rights; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------

| |  |  | commercialize our product candidates, if any such product candidates receive regulatory approval for commercial sale.
| | - |  | ---------------------------------------------------------------------------------------------------------------------



We believe that our cash and cash equivalent balances, as well as the
interest we earn on these balances, and revenues from future limited product sales will be sufficient to meet our anticipated cash requirements through at least the first half of 2006. However, our future funding requirements will depend on many
factors, including:



| |  |  | the scope, rate of progress and cost of our clinical trials and other research and development activities;
| | - |  | ----------------------------------------------------------------------------------------------------------

| |  |  | future clinical trial results;
| | - |  | ------------------------------

| |  |  | the costs of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the cost of defending, in litigation or otherwise, any claims that we infringe third party patent or other intellectual property rights;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the terms and timing of any collaborative, licensing and other arrangements that we may establish;
| | - |  | --------------------------------------------------------------------------------------------------

| |  |  | the cost and timing of regulatory approvals;
| | - |  | --------------------------------------------

| |  |  | the cost and timing of establishing sales, marketing and distribution capabilities;
| | - |  | -----------------------------------------------------------------------------------

| |  |  | the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



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| |  |  | the effect of competing technological and market developments;
| | - |  | --------------------------------------------------------------

| |  |  | licensing technologies for future development; and
| | - |  | --------------------------------------------------

| |  |  | the extent to which we acquire or invest in businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of
transactions.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Until we can generate a sufficient
amount of product revenue, if ever, we expect to finance future cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements, as well as through interest income earned on cash balances.



If we raise additional funds by issuing equity securities, our
stockholders may experience dilution. Debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional
funds through collaboration and licensing arrangements with third parties, it will be necessary to relinquish some rights to our technologies or our product candidates, or grant licenses on terms that are not favorable to us. If we are unable to
raise adequate funds, we may be required to liquidate some or all of our assets or delay, reduce the scope of or eliminate some or all of our planned research, development and commercial activities, which could harm our business.



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



We are highly dependent on our Chairman and Chief Executive Officer, Dr. Frank Litvack, and our Chief Technology Officer, John F. Shanley, and our other officers. Due to the specialized knowledge each of our officers
possesses with respect to interventional cardiology and our operations, the loss of service of any of our officers could delay or prevent the successful completion of our clinical trials and the commercialization of our CoStar stent. Each of our
officers may terminate their employment without notice and without cause or good reason. We do not carry key person life insurance on our officers.



In addition, our growth will require hiring a significant number of qualified scientific, commercial and administrative personnel. Accordingly, recruiting
and retaining such personnel in the future will be critical to our success. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. Our offices are located in
the San Francisco Bay Area, where competition for personnel with healthcare industry skills is intense. If we fail to identify, attract, retain and motivate these highly skilled personnel, we may be unable to continue our development and
commercialization activities.



If we are unable to manage
our expected growth, we may not be able to commercialize our product candidates, including our CoStar stent.



We expect to rapidly expand our operations and grow our research and development, product development and administrative operations. This expansion has
placed, and is expected to continue to place, a significant strain on our management and operational and financial resources. In particular, the commencement of our planned U.S. pivotal clinical trial will consume a significant portion of
managements time and our financial resources. To manage any further growth and to commercialize our CoStar stent, we will be required to improve existing and implement new operational and financial systems, procedures and controls and expand,
train and manage our growing employee base. Our current and planned personnel, systems, procedures and controls may not be adequate to support our anticipated growth. If we are unable to manage our growth effectively, our business could be harmed.



If we do not achieve our projected development goals in
the time frames we announce and expect, the commercialization of our product candidates may be delayed and, as a result, our stock price may decline.



From time to time, we estimate and publicly announce (including in this Quarterly Report on Form 10-Q) the timing of the accomplishment of various
clinical, regulatory and other product development goals, which we sometimes refer to as milestones. These milestones include the enrollment of patients in our clinical trials, the release of data from our clinical trials and other clinical and
regulatory events, including the submission to the FDA of a PMA for our CoStar stent. These estimates are based on a variety of assumptions. The actual timing of these milestones can vary dramatically compared to our estimates, in some cases for
reasons beyond our control. If we do not meet these milestones as publicly announced, the commercialization of our products may be delayed and, as a result, our stock price may decline.



Changes in foreign currency exchange rates may increase our expenses or reduce our revenues.



If we obtain regulatory approval, we intend to market our CoStar stent in
foreign markets by contracting with distributors. The related distribution agreements may provide for payments in a foreign currency. For example, our current distribution agreement with Biotronik AG provides for payments to us in euros. In
addition, we are currently developing a manufacturing facility in Ireland, for



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which we expect to incur expenses, including construction expenses, rental payments and employee salaries, denominated in euros. Our contracts for conducting
certain of our clinical trials in Europe are also denominated in euros. Accordingly, if the euro strengthens against the U.S. dollar, our expenses related to our foreign clinical trials and Ireland facilities will increase, and if the U.S. dollar
strengthens against the euro, our payments from Biotronik, if any, will decrease.



We may become exposed to fluctuations in other foreign currencies in the future, and our exposure to foreign currency exchange rates may adversely affect our results of operations.



Risks Related to Our Industry



Legislative or regulatory reform of the healthcare system may affect
our ability to sell our products profitably.



In both
the United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the regulatory and healthcare systems in ways that could impact our ability to sell our products profitably, if at all.
In the United States in recent years, new legislation has been proposed at the federal and state levels that would effect major changes in the healthcare system. In addition, new regulations and interpretations of existing healthcare statutes and
regulations are frequently adopted. For example, the Office of Inspector General of the U.S. Department of Health and Human Services, or OIG, has announced that during the 2005 fiscal year, it will review in-patient and out-patient claims involving
arterial stent implantation to determine whether Medicare payments for these services were appropriate. A determination by the OIG that inappropriate billing of arterial stents to Medicare is widespread could lead to increased enforcement of
Medicare requirements regarding their use. The potential for adoption of these proposals affects or will affect our ability to raise capital, obtain additional collaborators and market our products. We expect to experience pricing pressures in
connection with the future sale of our products due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals. Our results of operations could be adversely affected by
future healthcare reforms.



We face the risk of product
liability claims and may not be able to obtain insurance.



Our business exposes us to the risk of product liability claims that is inherent in the testing, manufacturing and marketing of medical devices. We may be subject to product liability claims if our stents cause, or merely appear to have
caused, an injury. Claims may be made by consumers, healthcare providers, third party strategic collaborators or others selling our products. Although we have product liability and clinical trial liability insurance that we believe is appropriate,
this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, the coverage may not be adequate to protect us
against any future product liability claims. In addition, if any of our product candidates are approved for marketing, we may seek additional insurance coverage. If we are unable to obtain insurance at acceptable cost or on acceptable terms with
adequate coverage or otherwise protect against potential product liability claims, we will be exposed to significant liabilities, which may harm our business. A product liability claim, recall or other claim with respect to uninsured liabilities or
for amounts in excess of insured liabilities could have a material adverse effect on our business, financial condition and results of operations.



We may be subject to claims against us even if the apparent injury is due to the actions of others. For example, we rely on the expertise of physicians,
nurses and other associated medical personnel to perform the medical procedure and related processes to implant our coronary stents into patients. If these medical personnel are not properly trained or are negligent, the therapeutic effect of our
stents may be diminished or the patient may suffer critical injury, which may subject us to liability. In addition, an injury that is caused by the activities of our suppliers, such as those who provide us with cobalt chromium tubing for our stents,
those that laser cut our stents or those that provide the drug and polymer incorporated into our stents, may be the basis for a claim against us.



These liabilities could prevent or interfere with our product commercialization efforts. Defending a suit, regardless of merit, could be costly, could
divert management attention and might result in adverse publicity, which could result in the withdrawal of, or inability to recruit, clinical trial volunteers or result in reduced acceptance of our products in the market.



Our operations involve hazardous materials, and we must comply with
environmental laws and regulations, which can be expensive.



Our research and development activities involve the controlled use of hazardous chemicals. Our operations also produce hazardous waste products. We are subject to a variety of federal, state and local regulations relating to the use,
handling, storage and disposal of these materials. We generally contract with third parties for the disposal of such substances. We cannot eliminate the risk of accidental contamination or injury from these materials. We may be required to incur
substantial costs to comply with current or future environmental and safety regulations. If an accident or contamination occurred, we would likely incur significant costs



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associated with civil penalties or criminal fines and in complying with environmental laws and regulations. We do not have any insurance for liabilities
arising from hazardous materials. Compliance with environmental laws and regulations is expensive, and current or future environmental regulation may impair our research, development or production efforts.



Risks Related to Our Common Stock



Our internal control over financial reporting may not be effective, and
our independent registered public accounting firm may not be able to certify as to the effectiveness of our internal control over financial reporting, which could have a material adverse effect on our stock price.



We are evaluating our internal control over financial reporting in order to
allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the SEC,
which we collectively refer to as Section 404. We are currently in the process of analyzing our systems and processes in an effort to comply with the management assessment and auditor certification requirements of Section 404, which we expect will
initially apply to us as of December 31, 2005. If we determine that we do not have adequate internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we
can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we cannot favorably assess, or our independent registered public accountants are unable to provide an unqualified
attestation report on our assessment of, and on the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect
on our stock price.



Anti-takeover defenses that we have
in place could prevent or frustrate attempts to change our direction or management.



Provisions of our certificate of incorporation and bylaws and applicable provisions of Delaware law may make it more difficult for or prevent a third party from acquiring control of us without the approval of our
board of directors. These provisions:



| |  |  | establish a classified board of directors, so that not all members of our board may be elected at one time;
| | - |  | -----------------------------------------------------------------------------------------------------------

| |  |  | set limitations on the removal of directors;
| | - |  | --------------------------------------------

| |  |  | limit who may call a special meeting of stockholders;
| | - |  | -----------------------------------------------------

| |  |  | establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon at stockholder meetings;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | prohibit cumulative voting in the election of our directors, which would otherwise permit less than a majority of stockholders to elect directors;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | provide our board of directors the ability to designate the terms of and issue a new series of preferred stock without stockholder approval.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



In addition, Section 203 of the Delaware General Corporation Law generally
prohibits us from engaging in any business combination with certain persons who own 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding
voting stock. These provisions may have the effect of entrenching our management team and may deprive you of the opportunity to sell your shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control
premium could reduce the price of our common stock.



Our
principal stockholders and management own a significant percentage of our stock and are able to exercise significant influence over our affairs.



Our executive officers, current directors and holders of five percent or more of our common stock, as of March 31, 2005, beneficially owned approximately
65.2% of our common stock. The interests of these stockholders may be different than the interests of other stockholders on these matters. This concentration of ownership could also have the effect of delaying or preventing a change in our control
or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could reduce the price of our common stock.



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If our stock price is volatile, purchasers of our common stock could incur substantial losses.



Our stock price is likely to be volatile. The stock
market in general and the market for small healthcare companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may not
be able to sell their common stock at or above the price they paid for our common stock. The market price for our common stock may be influenced by many factors, including:



| |  |  | results of our clinical trials;
| | - |  | -------------------------------

| |  |  | developments or disputes concerning patents or other proprietary rights;
| | - |  | ------------------------------------------------------------------------

| |  |  | litigation developments, including developments in our litigation with Angiotech and Boston Scientific;
| | - |  | -------------------------------------------------------------------------------------------------------

| |  |  | failure of any of our product candidates, if approved for commercial sale, to achieve commercial success;
| | - |  | ---------------------------------------------------------------------------------------------------------

| |  |  | regulatory developments in the United States and foreign countries;
| | - |  | -------------------------------------------------------------------

| |  |  | ability to manufacture our products to commercial standards;
| | - |  | ------------------------------------------------------------

| |  |  | public concern over our products;
| | - |  | ---------------------------------

| |  |  | the departure of key personnel;
| | - |  | -------------------------------

| |  |  | future sales of our common stock;
| | - |  | ---------------------------------

| |  |  | variations in our financial results or those of companies that are perceived to be similar to us;
| | - |  | -------------------------------------------------------------------------------------------------

| |  |  | changes in the structure of healthcare payment systems;
| | - |  | -------------------------------------------------------

| |  |  | investors perceptions of us; and
| | - |  | ---------------------------------

| |  |  | general economic, industry and market conditions.
| | - |  | -------------------------------------------------



A decline in the market price of our common stock could cause you to lose some or all of your investment and may adversely impact our ability to attract
and retain employees and raise capital. In addition, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and
attention of our management.



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



If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of our common stock, the market price of our common stock could decline
significantly. As of March 31, 2005, we had 33,100,130 outstanding shares of common stock. Of these shares, the 6,900,000 shares sold in our initial public offering that were outstanding as of March 31, 2005 were freely tradable without restriction
or further registration, unless purchased by our affiliates. The remaining 26,200,130 shares were restricted as a result of securities laws or the lock-up agreements the holders of these shares entered into with the underwriters in connection with
our initial public offering. Beginning on June 13, 2005, the date of the expiration of the lock-up agreements referred to above, the remaining 26,200,130 shares will be available for sale as follows:



| |  |  | 1,967,326 shares of common stock will be immediately eligible for sale in the public market without restriction;
| | - |  | ----------------------------------------------------------------------------------------------------------------

| |  |  | 16,618,898 shares of common stock will be eligible for sale in the public market under Rule 144 or Rule 701, subject to the volume, manner of sale and other limitations under those
rules; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the remaining 7,613,906 shares of common stock will become eligible under Rule 144 for sale in the public market from time to time upon exercise of their respective holding periods.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Existing stockholders holding an aggregate of
22,496,427 shares of common stock, based on shares outstanding as of March 31, 2005, including 483,816 shares underlying outstanding warrants, have rights with respect to the registration of these shares of common stock with the Securities and
Exchange Commission. If we register their shares of common stock following the expiration of the lock-up agreements referred to above, they can immediately sell those shares in the public market.



We have filed a registration statement covering 7,779,014 shares of common
stock that are authorized for issuance under our stock option plans and employee stock purchase plan, which can be freely sold in the public market upon issuance, subject to the lock-up agreements referred to above and restrictions on our
affiliates.



If securities or industry analysts do not
publish research or reports about our business, or publish negative reports about our business, our stock price and trading volume could decline.



The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business.
We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish
reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.



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We do not intend to pay cash dividends on our common stock in the foreseeable future.



We have never declared or paid any cash dividends on
our common stock or other securities, and we currently do not anticipate paying any cash dividends in the foreseeable future. Accordingly, our stockholders will not realize a return on their investment unless the trading price of our common stock
appreciates.



Item 3. Qualitative and Quantitative Disclosures About Market Risk



The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly
increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds and corporate debt
securities. Our cash and cash equivalents as of March 31, 2005 included liquid money market accounts. Due to the short-term nature of our investments, we believe that there is no material exposure to interest rate risk.



We have some obligations in foreign currencies, principally our contracts for
conducting clinical trials and our lease payment obligations in Ireland, which are denominated in euros. We do not currently use derivative financial instruments to mitigate this exposure. However, we do not expect fluctuations in foreign exchange
rates to have a material impact on our financial condition or results of operations.



Item 4. Controls and Procedures



Evaluation of disclosure controls and procedures. Based on their evaluation as of March 31, 2005, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) were effective to ensure, at the reasonable assurance level, that the information required to be disclosed by us in the reports that we file with the SEC is
recorded, processed, summarized and reported within the time periods specified in the SECs rules and instructions for such reports.



Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the
quarter ended March 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



PART II. OTHER INFORMATION



Item 1. Legal Proceedings



On
February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific Corporation (as Angiotechs licensee) initiated legal proceedings against us in the District Court in the Hague, Netherlands, seeking: a declaration that our CoStar stent
infringes European Patent No. (EP) 0 706 376 B1 in the Netherlands and other countries designated in EP 0 706 376 B1; an order that we and our affiliates cease any infringement of EP 0 706 376 B1 in the Netherlands and other designated European
countries; an order that we not use our CE marketing approval, if obtained by us, for three years or for a period of time which the District Court deems appropriate and/or at the choice of Boston Scientific and Angiotech; an order requiring us to
withdraw all information and documentation concerning the clinical trials we have conducted in the Netherlands from all relevant regulatory authorities worldwide; an order requiring us to pay 2,460 euros per sale of our CoStar stent in Europe or, at
the choice of Boston Scientific and Angiotech, 2,460 euros per day that we do not comply; an order that we indemnify Boston Scientific and Angiotech or surrender our profit on sales of our CoStar stent in countries covered by EP 0 706 376 B1; and an
order that we pay the costs of the proceedings.



On February
18, 2005, we initiated proceedings against Angiotech and the University of British Columbia in the High Court of Justice in the United Kingdom requesting that the court invalidate EP 0 706 376 B1 based on the grounds that all claims of the patent
either lack novelty or are obvious in light of the state of scientific knowledge at the priority date of the patent. A trial date for this proceeding has been set for October 4, 2005.



On March 31, 2005, we filed an Application to Revoke Australian Patent Nos. 728873, 771815 and 693797 owned by Angiotech and
University of British Columbia in the Federal Court of Australia (Victoria District Registry), on the bases, among others, that the patents are invalid in light of the state of scientific knowledge as of the priority date of the patents and that
they are not enabled for the



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claimed subject matter. A trial date for this proceeding has been set for June 5, 2006. We are not currently conducting clinical trials in Australia on our
CoStar stent, but we may seek to commercialize our CoStar stent in Australia in the future. However, if the Federal Court of Australia rules that these Australian patents are valid, then we may in the future need to litigate whether we infringe any
of the valid claims. If we are found to infringe one or more valid claims, then we may not be able to commercialize our CoStar stent in Australia without a license from Boston Scientific, which may not be available to us on acceptable terms, or at
all.



We cannot predict the outcome of the legal proceedings we
initiated against Angiotech and the University of British Columbia in the United Kingdom and Australia, nor can we predict the outcome of the legal proceedings initiated against us by Boston Scientific and Angiotech in the Netherlands. Moreover, we
cannot predict the cost of such litigation, which may require a substantial diversion of our financial assets and other resources and consequently prevent us from allocating sufficient resources to the development of our CoStar stent. In the event
that we are found to infringe any valid patent claim held by Angiotech or Boston Scientific (as Angiotechs licensee) we may, among other things, be required to:



| |  |  | pay damages, including up to treble damages in the United States and the other partys attorneys fees, which may be substantial; and outside of the United states, all or
a portion of the other partys attorneys fees, which may be substantial;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | cease the development, manufacture, use, marketing and sale of our CoStar stent;
| | - |  | --------------------------------------------------------------------------------

| |  |  | expend significant resources to redesign our technology so that it does not infringe others patent rights, or to develop or acquire non-infringing intellectual property, which
may not be possible;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | discontinue manufacturing or other processes incorporating infringing technology; and/or
| | - |  | ----------------------------------------------------------------------------------------

| |  |  | obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



In addition, if the outcomes of the legal proceedings we initiated against
Angiotech and the University of British Columbia in the United Kingdom and Australia are not favorable to us, we are likely to be found liable for the opposing parties costs incurred in connection with the legal proceedings, and we could be
found liable for an award of additional damages to the opposing parties if the court decides that our requests to invalidate patents are without sufficient merit or not pursued in good faith. Further, it is not uncommon in cases of this kind for a
defendant to assert counterclaims, which could significantly increase our costs, potential liability for damages, and other risks arising from these legal proceedings.



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



Use of Proceeds from the Sale of Registered Securities



Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-119174), that was declared effective by the Securities and Exchange Commission on December 13, 2004,
and a Registration Statement on Form S-1 filed pursuant to Rule 462 (File No. 333-121224) on December 14, 2004, pursuant to which we and a selling stockholder sold all 6,900,000 shares of our common stock that were registered. We did not receive any
portion of the $3.1 million in net proceeds received by the selling stockholder in the offering. Of the $78.1 million in net proceeds received by us in the offering, after deducting offering expenses and underwriting discounts and commissions:



| |  |  | approximately $8.9 million was used to fund ongoing operations, including the development of our products and our clinical trials and research programs, and for working capital and
general corporate purposes; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | the remainder of the net proceeds from the offering, approximately $69.2 million, remain invested in liquid money market accounts.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



The application of the net proceeds from our initial public offering as set
forth above represents our best estimate and does not represent a material change from the use of proceeds as described in the prospectus for our initial public offering. No such payments were made to directors, officers or persons owning 10 percent
or more of our common stock or to their associates, or to our affiliates, other than payments in the ordinary course of business to officers for salaries and to non-employee directors as compensation for Board or Board committee service.



Unregistered Sales of Equity Securities



On March 1, 2005, we issued 1,235 shares of our common stock to one
accredited investor for an aggregate purchase price of $7,348.25 upon the exercise of a warrant. In issuing the shares of common stock underlying the warrant, we relied upon the exemption from registration provided by Section 4(2) of the Securities
Act of 1933, as amended, for transactions by an issuer not involving a public offering.



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Item 6. Exhibits



|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                           
|               | 
|3.1(1)         |  | Amended and Restated Certificate of Incorporation.                                                                                                
|               | 
|3.2(2)         |  | Amended and Restated Bylaws.                                                                                                                      
|               | 
|4.1            |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                                        
|               | 
|4.2(3)         |  | Form of Common Stock Certificate.                                                                                                                 
|               | 
|10.34(4)       |  | Non-Employee Director Cash Compensation Arrangements, effective as of January 19, 2005.                                                           
|               | 
|10.35(4)       |  | Amendment to Employment Letter Agreement, dated January 19, 2005, between the Registrant and Azin Parhizgar, Ph.D.                                
|               | 
|10.36(5)       |  | Executive Officer Cash Compensation Arrangements.                                                                                                 
|               | 
|31.1           |  | CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a).                                                                                   
|               | 
|31.2           |  | CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a).                                                                                   
|               | 
|32.1(6)        |  | Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350).

---

|(1) | Filed as Exhibit 3.2 to the Registrants registration statement on Form S-1 (No. 333-119174), filed with the SEC on September 22, 2004, as amended, and incorporated herein
by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Filed as Exhibit 3.6 to the Registrants registration statement on Form S-1 (No. 333-119174), filed with the SEC on September 22, 2004, as amended, and incorporated herein
by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Filed as the like numbered Exhibit to the Registrants registration statement on Form S-1 (No. 333-119174), filed with the SEC on September 22, 2004, as amended, and
incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Filed as the like numbered Exhibit to the Registrants Current Report on Form 8-K (File No. 000-51066), filed with the SEC on January 25, 2005, and incorporated herein by
reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Incorporated herein by reference to the information under the heading, Item 1.01. Entry into a Material Definitive Agreement in the Registrants Current Reports on
Form 8-K (File No. 000-51066), filed with the SEC on January 25, 2005 and May 11, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | This certification accompanies the Form 10-Q to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any
filing of the Registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such
filing.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

SIGNATURE



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



CONOR MEDSYSTEMS, INC.By:

/s/    MICHAEL
BOENNIGHAUSENMichael Boennighausen Vice President,
Finance and Administration and Chief Financial Officer (Duly Authorized and Principal Financial and Accounting Officer)




Dated: May 16, 2005



37